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Opportunity abounds as India gains entry to JP Morgan's bond index

'Significant foreign investor inflows’

It has been a year of meticulous productivity and many successes for India, the world's fifth largest economy, and there are still more than two months to go.

2023 has so far seen the country celebrate a milestone in space exploration, bolster its position as an international manufacturing hub and strengthen global alliances - which has included issuing a 29-point joint statement on areas of cooperation from its prime minister, Narendra Modi, and US President Joe Biden.

Meanwhile, India's domestic bourses, the Sensex and Nifty 50, defied cynics and reached record highs of 67,771 and 20,167.65, respectively, early last month.

On 22 September, US bank JP Morgan announced it would be adding India to its Government Bond Index-Emerging Markets indices from 28 June 2024, a move expected to result in billions of dollars of inflows to its government debt market.

The decision concludes years of negotiations between banks, investors and India's government, and comes after the Reserve Bank of India introduced rupee-denominated bonds that had no restrictions on foreign ownership in 2020, paving the way for this moment.

It also provides a fresh opportunity for foreign investors looking to diversify as growth continues to slow in neighbouring China, and Russia has been removed from indices in light of its ongoing attack on Ukraine.

"India has been on the agenda of many index providers over a number of years," said Lee Collins, head of index fixed income at LGIM.

"Our view is that the market can offer an attractive yield, volatility and maximum drawdown levels that are more akin to lower yielding, higher rated issuers, such as the US and China, as well as low levels of correlation to other emerging and developed market issuers.

"We would anticipate the decision will result in significant foreign investor inflows."

Estimates for the size of prospective inflows have ranged from $20bn to $26bn as investors begin rebalancing their portfolios, while Goldman Sachs has estimated the figure to be closer to $30bn.

JP Morgan will include 23 Indian government bonds worth $330bn in its emerging markets benchmarks starting from 28 June next year and staggered the addition over a 10-month period ending in March 2025.

The US bank said the country would have a maximum weight of 10% of the index.

A potential downside of the news could be the arrival of active investors who may sell faster than passive tracker funds in a downturn, according to Jayesh Mehta, India country treasurer at Bank of America.

Meanwhile, Abhay Gupta, emerging Asia FI/FX strategist at Merrill Lynch (Singapore), argued Indian government bonds have already seen steady inflows ($3.5bn year-to-date), though this is "not particularly large in historical context and leaves room for more active inflows ahead of actual inclusion".

He added that yields have held up well this year despite the sudden increase in domestic inflation. Meanwhile, markets have priced in rate hikes as liquidity tightened and bond issuance remained elevated.

China's loss is India's gain

In 2021, China enjoyed a similar situation when the implementation of its own government bonds - announced In 2019 - into major indices was completed.

However, while providing a steady source of secure returns during the pandemic years, investors have since reduced their holdings in Chinese government bonds while its economy continues to struggle in a post-Covid world.

By comparison, India "literally roared back to life after Covid, and by the end of 2021, the market had perhaps run ahead of itself," according to Aubrey Capital Management's Rob Brewis.

"The Nifty 50 index reached a price-to-earnings ratio of 25x, well above its decade-long range of 18 to 22x," he added.

Earlier this year, the country reclaimed its position as the fifth-largest stock market after the US, China, Japan and Hong Kong, following a surge in the value of its equities as foreign investors bought into its robust economic growth story.

Dina Ting, head of global index portfolio management at Franklin Templeton, said as investors diversify away from China, there has been a surge of new investment for India, where companies like Amazon, Apple, Boeing, Samsung and Nokia are "banking on the country as a formidable manufacturing alternative".

She added: "China's weaker-than-expected economic recovery appears to be lending positive momentum to Indian equities, especially among international investors who have favoured smaller, domestically focused companies.

"India's structural trends, rising affluence, expanding manufacturing prowess, government reforms and burgeoning influence on the world stage are compelling growth drivers that investors should be watching closely."

The political picture

India knows it is in a good position, already a powerful player on the world's economic stage and now emerging from behind China's shadow, while prime minister Modi has promoted its "Made in India" initiative as he travels around the world and builds alliances.

He has taken the opportunity to highlight measures aimed at better integrating the "Global South's" developmental needs and ambitions with that of the G20, announcing a new multilateral rail and sea corridor project to connect India with the Middle East and the European Union.

James Carthew, head of investment companies at QuotedData, said: "The government is looking to next year's elections and is pushing ahead with vote-winning infrastructure investments.

"This has been accompanied by the signing of a number of trade agreements, as countries recognise India's potential and seek some mutual benefit which will help with India's balance of payments."

Modi and his pro-business Bharatiya Janata Party have long been popular among investors for their fiscal reforms, including the revolutionary Goods and Services Act, which created a single market in India.

Carthew added: "Painful reforms that weighed on the stock market a couple of years ago laid the foundations for recent strong returns.

"A good example of that is in the financial sector, where non-performing loans that had hamstrung the banking sector have been tackled and there has been a dramatic shift to digitalisation, which has encouraged much greater adoption of bank accounts and created an environment where fintech businesses can flourish."

Will India be too expensive?

But India's growth has also caused concerns that it may be overvalued, a feeling that could heighten following the recent announcement.

The IMF's latest report on its projected growth rate for the country in 2023 sits at 6.1%, a 0.2 percentage point upward revision compared with its April projection. This compares with just 1.8% for the US and 3% for global growth.

But Aubrey's Brewis believes India is far from expensive when taking fundamentals into consideration.

"The Nifty 50 is currently sitting just below 20x, so marginally below the 10-year average, despite being on the cusp of another investment upcycle, and most likely the fastest growing major economy in the world for the foreseeable future," he added.

"Not to mention the fact that most Indian companies are starting this cycle with little debt and enviably strong cashflows. We focus on the consumer, which we believe will continue to be the best way to invest in the Indian story.

"Is India expensive? We do not think so. Certainly not relative to history, and not relative to its potential."


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