Historically, beyond theatrics, Budgets have rarely delivered on the ground. As a result, over time, Budgets have come to be seen as an exercise that is sweeping in scope, but short on specifics. But over the past two years, something seems to be on a serious mend, especially after the current team took the control of the North Block. Of course, the initial slips were scary from this team. That refers to the regressive start in 2019. After that slippery start, the team seems to have moved very high on the learning curve.
One may be wondering why we are talking about Budgets when the next one is many months away. Because the bond market story and Budget 2020 are closely connected. Here is how.
To attract capital flows to the bond market, Budget 2020 announced a programme that allows foreign investors to buy unlimited amounts of select government bonds via the fully accessible route (FAR). This was a major policy shift through which the government sowed the seeds for India’s inclusion in global index. On March 31 that year, RBI quickly followed suit by notifying special series of G-secs under ‘fully accessible route’.
In response to the notification, the Finance Ministry tweeted: “This will substantially ease access of non-residents to the Indian Government securities markets and facilitate inclusion in global bond indices.”
Now, more than a year down, that prospect looks close and real. Come 2022, Morgan Stanley says, India is likely to be added to global bond indices, which will bring one-off index inflows over $40 billion in 22/23, followed by annual flows of over $18 billion in the next decade. That should be music to ears for long-term India Bulls.
Looking beyond the headline-grabbing billion dollar flows, we feel this will have far-reaching implications in three major macro areas as listed below.
Cost of Capital
It is a well-known fact that India’s public debt to GDP is at an elevated level compared with its emerging market peers. It is at over 85 per cent of GDP. With growing fiscal pressures, government borrowings are unlikely to soften anytime soon. So far, the public debts have been primarily funded by Indian banks via the SLR (statutory liquidity ratio) mechanism. With significant rise in government borrowings over last few years, RBI had to come to the rescue in many auctions because of surge in supply of government papers. This kept the yields higher than policy rates (spread of about 2.8 per cent on 12-month trailing basis). This is precisely where the index inclusion will do its magic.
With new demand for papers from foreign funds (index-tracking funds), yields can track the policy rates much more closely and, thus, bring down the overall cost of capital structurally. As per some estimates, the foreign ownership of G-secs could rise to over 9 per cent by 2031 from the current level of 1.9 per cent.
India has historically run a current account deficit of around 1.8 per cent of GDP (going by last 10 years). This is unlikely to change in the coming years. Though, handling BOP (balance of payments) has never been a challenge because of FPI and FDI inflows, opening up India’s bond market will help diversify the sources of capital in a phased manner and, thus, bring in more stability and strength to the Indian rupee. Most of the brokerages now expect the overall balance of payments to remain in surplus in the range of 1.5-1.7 per cent of GDP in the next 10 years because of index inclusion. This means we may continue to see a surge in forex reserves.
Investments and Capex
As highlighted earlier, India’s public debt, so far, has been primarily funded by Indian banks via SLR mechanism. This meant that public spending and public investments have been crowding out private investments. Now, with the opening up of G-secs to foreign funds, it creates a possibility for RBI to reduce the SLR window in the future and, thus, make more capital available for private investments. For a capital-starved country like India, this means a huge potential for capex-driven structural growth.
In conclusion, more than anything, in opening up the government securities to foreign investors, one sees India’s growing confidence in the overall macro stability in terms of price (inflation and currency), fiscal (govt. spending) and monetary policies (interest rates). In our view, this is the biggest takeaway from this yet another reform measure from this administration. In the same breath, it is also important to highlight that this opening up should bring in the much required discipline to the current and future administration/policymaking by rewarding or punishing pro-growth or regressive policies respectively.
Future governments will have to think not twice, but many times, before stepping on to any slippery (regressive) policies. That is a huge structural positive for long-term growth. Interesting times to watch out for!!
(ArunaGiri N is Founder CEO & Fund Manager at TrustLine Holdings. Views are his own)