Indian Bonds In Global Indices- Has The Best Outcome? 30th September 2023

 

Just as FPI flows have boosted the stock market as well as flow of foreign exchange, there are good chances of withdrawals too which can spook the market. Hence it will also be necessary for other institutions like mutual funds to step in and support the market.

A major development which took place last week was the news of the inclusion of Indian bonds in the JP Morgan bond index for emerging markets. This has been a long-standing expectation which will finally materialise in June 2024. This development fits in with the global face that India has exhibited throughout the year which hence does justice to the effort put in over the last few years to make India truly global. In a way it is an acceptance of India’s economic strength.

In simple language, Indian government securities would be a part of the global index of JP Morgan. The weight assigned for Indian bonds will be around 10% in the index and their inclusion will be gradual over time starting at a rate of 1% per month. By March 2025, the total weight will be 10%. This means that any fund which buys the index in global markets would automatically be investing in Indian bonds. This is so because index investment, which is probably the most popular form of passive investment, will allocate every dollar to the components of the index and hence there will be demand for these securities. It is said that 23 such securities would constitute this 10% allocation.

Intuitively it can be seen that FPI investment will increase in the debt segment. Today, investment is permitted but not more than 20% of the permitted limit gets absorbed as interest is limited. With the inclusion in global indices, there will be automatic interest generated. Further, just like how funds trade in specific scrips of the Sensex which behave in a certain manner when the index moves, there will also be additional interest in buying such securities in the bond index. Hence there will be secondary interest too in GSecs.

The immediate advantage is that there will be more dollars flowing into the market. Hence the pressure on domestic investors, which are primarily the financial institutions, will come down. In fact, banks will have more space to lend to the commercial sector. On the other hand, as these 23 securities are already issued, the demand for such paper will rise leading to a decline in yields assuming the status quo in other financial conditions. Hence typically once included in the bond index, interest rates could move downward in the market. The beneficiary will be the government as it will be able to raise funds at a lower rate, other things being the same. The benefit for corporates or households will not change as their borrowing rates will continue to be linked with the repo rate that is guided by inflation perspectives.

There is hence some reason to be excited about this development. Prima facie it appears that there can be around $ 25-30 bn that can come in once the share of Indian government bonds in total goes up to 10% of the total weightage in the index. This may not be a large amount, but considering that flows have been whimsical so far, a steady inflow will be useful to strengthen the balance of payments situation. The collateral effect is that once included in a global bond index there will be a nudge to other owners of indices like Bloomberg, Morgan Stanley, and Goldman Sachs etc. to also include Indian securities. This is so because often traders arbitrage across indices thus adding to the volume of transactions. Hence, this can be another positive outcome for India.

One must however remember that just as FPI flows have boosted the stock market as well as flow of foreign exchange, there are good chances of withdrawals too which can spook the market. Hence it will also be necessary for other institutions like mutual funds to step in and support the market though admittedly they will be constrained by their investor preferences. But it may be useful for the market to evolve stabilising traders who can offer support when there are erratic swings inflows. These swings can be caused both by perceptions of the Indian economy or even extraneous developments.

For example, a high fiscal deficit of the government or even a failure of a disinvestment process can cause ripples in the bond market. At the same time, a decision of the Fed to do away with the support of the liquidity programme can lower the quantum of investable funds thus causing a withdrawal from emerging markets. Or at times investors may just like to book profits which can cause a sale in the market. This is something that we have to be prepared for which is the case with any developed and evolved market.

The immediate reaction to the news was positive with bond yields coming down by 5-7 bps. But it has been back to normal subsequently. So clearly the benefit will be seen only when the inclusion actually takes place and funds come in. In the interim period, there could be certain positions taken in the market in anticipation of the inclusion in the index which can add some buoyancy to the market. This however needs to be monitored.

The inclusion of Indian government securities in the bond index is also a strong signal sent to the global credit rating agencies that they need to take a different view of India’s sovereign rating. If the trading community now recognises the strength of the Indian economic story, there is the reason for an upgrade for sure. This is definitely signaling a victory for India that it is not just the FDI investors but also the market investors who smell great opportunity here.

India in global bond indices: pros and cons Business Line 23rd September 2023

 The inclusion of Indian bonds in global bond indices, which has been on the cards for some time, is a reality now. JP Morgan has announced that 23 Indian bonds will be included with a notional value of $330 billion from June 2024. The share will rise to up to 10 per cent in 10 months at an incremental rate of 1 per cent per month. With Russia out of the index after being ostracised post the invasion of Ukraine, there was place for another country and India fit the bill quite well. What are the pros and cons of this development?

Essentially when Indian bonds, which would be government securities (G-Secs), are included in a global index, the Indian bond market will get a fillip as foreign funds would buy G-Secs in larger quantities than they are doing today. Several funds have mandates to trade in bonds that are part of global bond indices. Hence having the bonds included becomes some sort of gold standard as there is global recognition of the same.

The way it works is like this. A fund which deals with the index would take positions in both the index, which will have Indian bonds as a component, as well as arbitrage between the components and the index. When one invests passively in a bond index, funds would automatically be allocated to Indian bonds which will see forex inflows. For example, if a fund invests $1 billion in a global bond index, it would be automatically allocated across the components of the index in a proportionate manner. This will automatically lead to an increase in FPIs in the debt market. But doesn’t this happen today?

Yes, FPIs do invest in government debt based on the limits that are prescribed. But they have not utilised the full amount as these are exogenous decisions. Presently, around 19 per cent of the total limit offered is utilised by FPIs. Being part of global indices will add buoyancy to the interest. This is the good part of the story as one can expect more FPI to come in as these funds deal with billions of dollars of investment. We may see additional flows which could even go up to $330 billion over the next few years. Other indices could have the same effect when they include Indian bonds.

The RBI has already given more space to invest, with there being no limits for certain specified securities. In fact, once included in the index, at a later stage, there is also the possibility of corporate bonds getting included at an opportune time. But making an entry is important for this chain to be set in motion.

Are there any cons? Here it is necessary to add several caveats that need to be understood when Indian bonds are included in the bond indices. Once any decision gets linked to the global markets, there can be no let off from any repercussions due to exogenous forces.

First, a Lehman-like crisis would lead to sell-off across markets and once Indian bonds are part of these indices, there would be capital flight. In 2008, India was quite insulated from the entire episode due to the inherent decoupling across Indian and global markets. While the reverberations were felt in the stock market, bonds were relatively insulated. This will not be the case once large investors invest in domestic bonds.

Second, domestic policies always get closely tracked when part of an index. For example, today as all Indian debt is denominated in rupees, it does not really affect global traders. But once a part of the index, a higher fiscal deficit for example which entails more borrowing, will cause volatility in the global index which gets translated into Indian markets too.

This has been seen in the equity market too when there are certain policy decisions taken which may be perceived differently by the investors. To this extent the intervention by the RBI will be paramount to stabilise both the forex and the bond market.

Exogenous reasons

Third, at times volatility can be induced in the market by FPI behaviour due to exogenous reasons. For example, when the Western central banks went in for quantitative tightening, relatively smaller pools of investable funds were available for investing in emerging markets. This meant there would be a withdrawal from emerging countries just like what was witnessed in the equity market.

At another level it was observed in 2022-23 that the main factor that caused the rupee to depreciate was the external factor of dollar strengthening in the global market due to the Fed increasing rates; this triggered flight of capital back to the US. Any outflow of dollars due to FPIs withdrawing from the market will require more intervention in the forex market by the RBI. Hence, the benefit derived from getting in the dollars will become a cost when there is an outflow.

Fourth, the country rating, which today is not really important for the market, can have collateral effects on positions taken by fund managers as well as trading patterns. India has been right in arguing for a higher rating which is not materialising. Any change in rating or outlook can affect investment patterns of funds, which can cause volatility.

Fifth, presently, the RBI can successfully regulate excess volatility in the bond market by affecting liquidity. It has been observed that the yields are range bound most of the time and this also helps the government in keeping cost of borrowing moderate and stable. One of the factors for this is that there is less scope for external shocks to affect the bond yields in domestic markets. But once there is more FPI activity in the G-Sec market, the picture will change. For example, the imposition of ICRR (incremental cash reserve ratio) can spike up yields as funds get into a sell mode, thus putting more pressure on the monetary authority.

Hence the inclusion of Indian bonds in global indices is an interesting development. The economy is one of the best performing one in the last few years. The positive is that there will most certainly be an influx of funds depending on the space permitted. Once in, the market has to be prepared for more volatility; and the central bank has to ensure that there is stability in both the bond and forex markets.

Our problem is a drop in gross savings than net : Mint 22nd September 2023

 

Plaudits For Holding the G20, But Are There Too Many Such Groups? Free Press Journal 16th September 2023

 The G20 meeting has evoked a varied response. What is unequivocal is that it has been a resounding success in terms of getting different minded countries to agree to an agenda for the future. It also raises India’s stature as a thought leader which can drive the agenda for the world economy in the coming years.

Cynics may lament the expenditure involved for a developing country like ours. But this does not really count in the larger scheme of things. There could legitimately have been some disappointment from the point of view of there being no effort to resolve the Ukrainian war. But this is not a forum for resolution of issues that the UN has also not managed to address. As an extension China’s aggression at our borders was not put up for discussion. But what then has exactly been achieved here? 

Like the G20 meet, group meetings are necessary to keep conversations alive in a multi-polar world where every country looks for self-enhancement. It would not be incorrect to say that in the past, most of these meetings which go with a prefix of ‘G’ have been only discussion forums with no firm agreements. India can take credit for making a difference here. 

There are several reasons to be proud of this conclave. First, it has been done on such a large scale, involving myriad meetings over several months in different places, that it has gotten representatives from member countries to discuss various issues. Second, by making it a big event, unlike what was done in the past, it sets a precedent for the next member country when the event is hosted in 2024. Third, while heads of two important states, China and Russia, were absent, the active participation of heads of governments of US, UK, Germany, France etc gives the satisfaction of like-minded countries coming to the table. Fourth, the fact that this was done with élan at a time when the geo-political situation is far from united does credit to India’s organisation power. Last, the resolution to also enhance the size of the group to include Africa comes as a breath of fresh air as it makes the group truly global.

The issues on which there was consensus can be said to be no-brainers as it is something everyone is concerned with. But this is a major achievement. Technology and digitisation are something where India has been a forerunner and hence there are templates to be followed by other nations. Similarly global warming and climate change is an issue where there needs to be regular conversations though admittedly it would take a long time to get everyone on the same page. Financial inclusion is more relevant for developing or emerging countries, and getting the rich nations into the discussion is always useful. 

Talks on developing the India-ME-Europe corridor is probably the biggest achievement or outcome from these deliberations. By getting more countries on the G20 platform it becomes easier to implement such designs as it is a win-win situation for the world at large. Given the pre-eminent economic position that we occupy, it has become expedient to have such a passage for augmenting trade and commerce which will help to create the desired infrastructure which is involved. 

An interesting thought that comes to mind when looking at the concept of G20, considering that the final meetings come just after the meeting of BRICS, is whether or not there are too many such gatherings — each pulling in a different direction? While the developed nations have their G7 elite club, there are other such alliances like the APAC, QUAD, ASEAN, G20, G77, BRICS and so on. Countries which are part of different groups often have different agendas to deal with. 

For example, when BRICS meets, there is a joint agenda against countering the economic hegemony of developed economies as there are talks of creating a strong bloc to counter Western ideology. Here there is a decoupling from the rich nations. QUAD is more a security-based group where the members India, USA, Japan and Australia have an alliance. Here the goal is to ensure that there are checks on China. But the same China is a part of BRICS and G20. And when it comes to G20, the entire set of countries are talking of cooperation with one another. 

To top it all BRICS has been widened to include also Iran and Saudi Arabia along with Egypt, UAE, Argentina and Ethiopia while G20 will embrace the African Union of 55 countries. This adds to the complexity, given the latent hostility between several member countries outside the Russia and China axis. 

While this may sound fair enough, often issues which are discussed within one group and are contentious get left out from the other one. This can lead to contradictions. Hence countries which are on the other side in certain groups meet as friends when it comes to a larger group.

The failure of the WTO did lead to more regional trading alliances coming up where like-minded countries got together to trade further. Smaller groups of countries work better, as the agenda is specific and affects all the same way. But with these groups expanding in size under the umbrella of becoming more inclusive, which is the case with BRICS or G20, there will be more differences and hence it becomes more challenging to bring all to a common ground. 

One thing for sure is that individual countries like China or Russia, which have rather wayward political ambitions when it comes to Taiwan or Ukraine, would just not be willing to talk with any other nations on grounds of these being internal or bilateral issues. Hence the possibility of political reconciliation from such jamborees looks unlikely. It would be economic issues which could work better, though would admittedly take a lot of time as the number of countries involved increases. 

Problem posed by converging nominal, real GDP: Businessline 6th September 2023

 The latest GDP numbers for the economy reveal an interesting phenomenon. The growth rates in both nominal and real terms are almost the same, at 7.8-8 per cent. This means there is hardly any difference in the growth rates when production is reckoned at current prices and at constant (base 2011-12) prices. Normally the growth in GDP in nominal terms tends to be higher than that of real GDP.

The answer lies in the queer case of inflation in India, where CPI inflation is moving in the positive direction, and quite prodigiously, WPI inflation is in negative territory. Technically the difference between the nominal and real GDP of any country is the GDP deflator and that is a derived number.

The way the GDP numbers are calculated is that output is reckoned in nominal terms, which is at current prices; this is how they are available in the market. This is the data that comes from balance sheets of companies or tax collections which are always at current prices. Real GDP in a way reflects the physical volume of goods and services denominated in monetary terms which takes out the inflation effect. To arrive at the real numbers, which is what is quoted when we talk of GDP growth, price deflators are used.

For every component of nominal GDP there are appropriate price deflators. And in this calculation, the WPI indices are generally used. Hence, if WPI inflation is in the negative zone, which is what it was in Q1, then growth at both constant and current terms would tend to converge. For Q1, the WPI registered -2.7 per cent growth with the three components primary, fuel and manufactured goods witnessing negative inflation of -1 per cent, -7.1 per cent and -2.7 per cent, respectively.

Given the overall wholesale price environment, it does look like that this will be the trend during the course of the year as global commodity prices have a role to play here. This will in turn bring about near convergence in these two rates. If this is the case, then the normal assumption that economists work with, which is that nominal GDP growth will generally be 4-5 per cent higher than real GDP growth will definitely not hold. In FY23 for instance, the difference between nominal and real GDP growth rates was 8.9 per cent while it was 9.4 per cent in FY22. Does this create a problem?

The answer is yes. When we talk of becoming a $5 trillion economy, the reference is to the size of the economy in nominal terms. Low nominal growth will come in the way of achieving this target; the time taken to reach this mark will be more. More so if low global inflation continues for another year, which cannot be ruled out as the IMF does not see a major bounce-back of the world economy in 2024, prices will remain benign in the absence of a China shock. Under normal conditions of ‘deflator’ inflation at 4-5 per cent, it would take us four more years to reach the target. The challenge becomes stiff under such deflationary conditions.

The other issue relates to various policy ratios that are calculated. The fiscal deficit ratio has been projected at 5.9 per cent for the year with GDP growth of 10.5 per cent. As budgetary numbers are always in nominal terms, the GDP at current prices is used as the denominator. With the growth rate now coming down to 6.5 per cent (going by RBI forecast of real GDP), the denominator effect will automatically raise the fiscal deficit ratio as the GDP will be of a lower order under ceteris paribus conditions. Another fallout on the fiscal side will also be that the debt-to-GDP ratios will tend to look higher and this would hold for both the Centre as well as States due to this statistical effect.

Budget assumptions

Now, the Budget has been drawn up under rather conservative assumptions of growth being 10.5 per cent. But disinvestment has been targeted on the aggressive side and it does look like that revenue receipts on both taxation and disinvestment will be challenged this year. This is so as tax collections are contingent on GDP increasing at a faster tick which provides buoyancy to the system. Add to this the announcement on reduction of price of LPG for the rest of the year and probably some other pre-elections sops on the cards, managing the fiscal balances will be something to watch. Therefore, fiscal slippage cannot be ruled out this year purely due to this statistical factor.

Another ratio that is often quoted against the GDP is the current account deficit. While there is no official deficit target announced, it was largely believed that it would be 1.4-1.6 per cent in FY24. There are already risks to this ratio with export of goods falling while services exports growth has slowed down. The global environment for trade and investment does not look too bright this year with conservative to aggressive monetary policies being pursued by central banks. Now with the denominator of this ratio, GDP in nominal terms, being lower than was expected the current account deficit is likely to be pushed ahead. While the ratio will still be comfortable, the impact of a lower nominal GDP stands out.

Therefore, while less attention is paid to the nominal GDP growth as it is the real GDP growth that is focused on which holds the clue to consumption and investment, it is critical from the point of view of targeting fiscal plans as well as external balances. Had the WPI and CPI would be moving in the same direction, this problem would not have surfaced. However, with food inflation spiking CPI and low global prices keeping WPI down, this anomalous situation has arisen. This means that care must be taken when interpreting any of these ratios as the denominator effect can exert undue influence.

Our employment trends call for deep thought on job-stealing AI: Mint 5th September 2023

 

Fighting inflation is futile: Economic Times 5th September 2023

 

When Technology Runs Faster Than The Processes: Free Press Journal 2nd September 2023

 

While we are doing a lot on technology and making sure that things get digitised, there are large gaps in terms of tying up loose ends

Just think of this situation. To get an Aadhaar card one has to show proof of residence, and the passport is a valid document here. Getting a card also entails having your fingerprints registered with the government as this is then linked to other amenities like, say, acquisition of a new mobile connection. So far, so good.

Next when you go to get your passport renewed, you need to show your Aadhaar card which then completes the formality. Your fingerprints are again taken. There is police verification, which makes sense. But when the cop comes home and all members of the family are not there, you have to report at the station where he signs the final paper. Very often there can be trouble over something trivial and you pay a bribe.

Now when the government is moving towards a faceless system, why should personal verification be necessary for everyone, as one shows the same set of documents? The police do not do anything else but file the papers. In case there is something against a person then there could legitimately be a call to the applicant to present himself at the station. On the whole it is sloppy; and often if people are from lower income groups and are semi-literate there will be money to be made. One can hear rude encounters where the cop questions why the person wants to go abroad and then seeks a monetary return for filing the papers. The passport should be an automatic process where everyone pays the fees and gets it without any personal interaction based on the Aadhaar card.

Next, let’s look at the banking system. There is a rule which says that Know Your Customer (KYC) has to be done for every customer periodically. So the bank sends reminders which sound like threats as the last day approaches. What one has to do is to sign forms and show PAN and Aadhaar as proof. This is ridiculous because these two documents never change, and the same are presented repeatedly. Logically a simple affirmative click on the website should obviate the need to go back to the branch if there is no change in the KYC details.

Last, let us look at the income tax system, which now uses artificial intelligence to gather all monetary transactions of the person which is linked to a PAN number. The form, AIS, tracks everything and leaves out nothing. One assumes it is still work in progress as there are major errors on, say, mutual fund purchases which are credited to both the joint holders when it should be the first name. One assumes this will get corrected.

But a pertinent question is this. Why can’t there be a TDS on every transaction not at a standard rate of 10% but the relevant tax slab of the beneficiary? This can easily be done by a person stating her tax bracket. Just like how a person who does not have to pay tax submits a form 15H, one can always state the tax rate. This is a win-win solution for both parties. The government will get the tax on a timely basis. The taxpayer need not go through calculating the tax to make the advance tax payments, and is provided convenience.

These three examples show that while we are doing a lot on technology and making sure that things get digitised, there are large gaps in terms of tying up loose ends. The system looks at the narrow picture of “achieving something not done anywhere in the world”. But rarely do we look at following up to add to the convenience of the individual, which should be the primary goal. This is what happens when technological innovation runs faster than the ability to implement the same across the country.

The Fastag, for instance, was supposed to bring about efficiency in letting vehicles cross the toll gates seamlessly. But in a city like Mumbai it can take a horrendous amount of time at the Vashi or Dahisar toll gates where the inability of the machine to read the tag can lead to snarls, and vehicle drivers blaring their horns. Hence while the system is good for the government or the toll collector where the people manning the station cannot keep the money for themselves, the inconvenience to the motorists can be quite substantial.

The solution is to carefully draw up plans to the end point rather than look only at the creation of a technology – which is the case today. The issue is that once a technology gets introduced, there is rarely any incentive to bring about improvements. Maybe there are cost considerations, as in the case of modifications of Aadhaar there are no new cards sent and one has to download the same. In fact, finding a centre for these changes can be a challenge as most have been closed down.

Often the issues flagged with technology, especially in the financial space, is by the regulators with intensive education programmes which is creditable. Hence there are constant campaigns against being tricked into giving passwords etc on the phone. But when it comes to other amenities, there is a lot of work still to be done. The policy of faceless tax assessment is a brilliant step by the government which has addressed a serious issue, though using AI can create chaos as they can raise questions to thousands of people in case the algorithm demands so. Hence a difference of ₹1 and ₹1 crore are treated the same across all formulae attached.

The way forward is to get public views in each of these areas and have the engineers sort them out so that the loose ends are tied up. More importantly, public views should be solicited and included in the schemes because at the end of the day the user should find it convenient rather than onerous – which is the case at times today.