Great Lakes Chennai Academician Opines about the Benefits that Indian Banks Stand to Gain from the Country’s Inclusion in JP Morgan’s EM Index

Chennai, October 2023: JP Morgan’s recent announcement to incorporate Indian G-Sec bonds into the GBI-EM Global index suite, effective June 28, 2024, has ignited a wave of excitement and anticipation within the Indian financial landscape. Ranjitha Ajay – Assistant Professor, Finance, Great Lakes Institute of Management, Chennai & Rintu Anthony, Rajagiri Business School has opined that the decision to include Indian sovereign bonds, with a combined notional value of $330 billion, in this esteemed index is poised to yield a multitude of benefits, including reduced borrowing costs, enhanced stability for the Indian rupee, and an influx of foreign investments estimated at $20-30 billion, all of which could translate into heightened economic growth

Additionally, they said that this development carries several compelling advantages for the banking sector. “In accordance with the Reserve Bank of India’s (RBI) regulations, banks within our financial system are mandated to invest in bonds primarily across three categories: Held to Maturity (HTM), Held-for-Trading (HFT), and Available-for-Sale (AFS). While bonds in the HTM segment are not available for sale until the redemption period, those in the HFT and AFS categories can be sold and are subject to marked-to-market losses. Consequently, banks must consistently set aside provisions for potential losses on their bond holdings should bond prices fall. This predicament arises from the inverse relationship between bond yields and prices, where rising interest rates lead to a fall in bond prices,”said Ranjitha Ajay.

In response to the challenges posed by the COVID-19 pandemic, the RBI had increased the HTM limit for banks. Consequently, banks, which are obligated to allocate a specific percentage of their deposits to sovereign debt, now find themselves holding a considerably larger supply of government bonds. “Since May 2022, when the RBI initiated its cycle of monetary tightening, banks have become more vulnerable to losses on their bond holdings as bond prices react to rising interest rates. This situation mirrors a past incident in the United States when Silicon Valley Bank (SVB) faced collapse due to mismanagement of interest rate risk. SVB, with a substantial portion of its investments in long-dated US Treasury securities, suffered significant losses when the value of these securities plummeted due to escalating federal fund rates,” said Rintu Anthony.

The decision to include Indian G-Sec bonds in this high-rated index, following Russia’s exit, represents a substantial relief for our banking balance sheets. The most immediate consequence has been the softening of sovereign yields, which have decreased from 7.14% to 7.08% in the 10-year segment. This reduction in yields will correspondingly boost bond prices, resulting in favorable gains for banks within the marked-to-market segment.

On what can we expect in the near future? Ranjitha said, “Investors can be categorized into two groups: active and passive investors. While the inclusion of our bonds, scheduled to commence in June 2024, will attract significant flows through passive investments in the coming year, active investors will already be positioning themselves in response to this news. A favorable outcome here is expected to pique the interest of the Barclays Bloomberg index, potentially ushering in additional investments into the Indian fixed-income segment.”

Presently, the decision to incorporate 23 G-Sec bonds has been made, which may lead to some corporate bonds making their way into the index over time. This augments liquidity in the relatively parched liquidity segment, fostering industrial and economic growth in India. A robust and liquid corporate segment will ultimately benefit banks, which have been granted the latitude to include corporate bonds in their bond portfolios within the HTM segment.

Overall, a robust banking system is poised to yield a lower probability of default and an improved credit rating for the country.

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