Gilts are bland. But aren’t even Indian bonds spicy?


The double whammy of rising US interest rates and a stronger dollar has investors chasing spicy returns. Markets were in turmoil last week when Britain’s 10-year gilts struggled to find takers even at 4.5% – and only calmed down when the Bank of England stepped in as a buyer . However, it’s not just British dishes that are said to be too bland. Take the example of a large emerging economy like India, which has been trying for three years to get asset managers to engage in its trillion-dollar government bond market. But they are stagnating. Why aren’t returns above 7% hot enough for them?

FTSE Russell said on Thursday it would continue to keep Indian government bonds on its watchlist for possible inclusion in its emerging market debt index until March 2023, when the next assessment is due. Separately, Reuters reported that India’s much-desired entry into a similar benchmark maintained by JPMorgan Chase & Co. could also be pushed back to next year. A decision is expected in the coming days. (Bloomberg LP is the parent company of Bloomberg Index Services Ltd., which administers indices that compete with those of other service providers.)

Foreigners own only $17.8 billion, or 2%, of Indian government bonds. In contrast, foreign ownership is nearly 10% in China and over 14% in Indonesia. In 2019, Prime Minister Narendra Modi’s government flirted with dollar-denominated sovereign debt, but abandoned the inaugural $10 billion issue when it came under fire. And rightly so. It would have been risky for a government that has always struggled with high budget deficits to borrow in a currency that the country often lacks, due to its large energy imports. The since-revised aspiration has been to raise up to $40 billion over two years (in rupees, not dollars) by pushing for India’s inclusion in global bond indices.

It’s the right way to go, but pesky tax issues have arisen. New Delhi imposes up to 30% capital gains levy on listed bonds sold within the year. There is also a 5% withholding tax on interest income for foreign portfolio investors.

With Russia exiting benchmarks, asset managers would welcome the boost India would provide. However, they hope that in its desperation to find a new source of capital ahead of further rate hikes by the Fed, the Modi administration will blink first and offer tax relief. Hence the deadlock. The fact that all rupee bond trading has to be settled on land, and not on an international platform like Euroclear, is not the show stopper as is often claimed. As Bloomberg News noted last week, even Indonesian and Chinese bonds are not on Euroclear but are part of the JPMorgan index. The real problem is that operations managers at large asset managers balk at the idea of ​​obtaining a tax clearance before settling every onshore transaction in India.

What will break the deadlock and when? Apart from some simplification of processes and taxation, much will depend on the policies of the Reserve Bank of India, particularly with regard to exchange rates.

As the relentless surge in the dollar puts pressure on economies across Asia, the responses of individual nations have been “eclectic,” as Nomura Holdings Inc. recently noted. The Philippines, China and South Korea took a more passive approach to depreciation, while India, Thailand and Indonesia stepped in more heavily and sold more dollars from their official coffers to shore up their local currencies. RBI reserves, which stood at $641 billion last September, are down to $537 billion and falling. The question for investors is how long before the RBI changes track? In 2013, when India was dragged into the Fed’s tantrum, its hard currency war chest was enough for six months of imports. According to Nomura’s estimates, the current coverage is sufficient for just over eight months.

A more liberal approach to the exchange rate will not be an easy choice. The risk is that the rupee becomes a sitting duck for speculators trying to drive it down in one-way bets. In this case, no investor – stocks or bonds – will venture near India. The outlook for economic growth next year, already uncertain due to the collapse in global demand, will become more risky.

Perhaps the trick is to simply put the ambition to land $40 billion in foreign money on hold until the Fed has finished tightening. Right now, an investor gets virtually no extra boost by forgoing three-year US Treasury yields of 4.2% and exploring options on the other side of the world. In the foreign exchange market, the cost of insuring against rupee depreciation absorbs almost all of the additional 3 percentage point yield offered by Indian government debt of similar maturity. In this respect, the yields on UK three-year gilts are even less appetizing – which is why analysts mostly agree that the Bank of England will need to continue raising rates. India also raised its policy rate by half a percentage point for the third consecutive time last week to 5.9%; economists expect the RBI to be realized only when it hits 6.5%.

A combination of high yields and a sufficiently weakened currency could finally convince global investors to bite. For now, though, it looks like they’re only getting their appetites through next year.

More from Bloomberg Opinion:

• The RBI is getting its way on rates. So far: Andy Mukherjee

• The discomfort you feel is that the Fed is pushing recession: John Authers

• Gilt market carnage prompts risky BOE U-turn: Mark Gilbert

(Adds a chart before the penultimate paragraph on Indian government bond yields versus other Asian sovereign debt.)

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.

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