There has been a strong chatter around the Government’s purported intention of considering a waiver on Capital Gains tax for overseas debt investors. If the Finance Minister indeed bites the bullet, it may pave a strong path for the Indian debt market towards globalization.
How Will India Enter Global Bond Market Indices?
India’s inclusion in widely tracked global bond indices of Bloomberg Global Aggregate Index and JPM GBI-EM Global Diversified Index has been on the agenda list for Fin Min.
Incidentally, India is among the last of the large investment grade (IG) rated developing economies whose government bonds are not yet a part of global bond indices.
Earlier, a cap of 6% on the foreign ownership of government bonds had been the main factor preventing India’s inclusion in these bond indices. In April 2020, RBI introduced a separate Fully Accessible Route (FAR) for foreign investors in certain specified Government bonds, requiring no minimum residual maturity, concentration, and investment limits. Since this notification, RBI has expanded the number of securities under FAR-eligibility from 5 to 17, amounting to around $200 billion.
The waiver of capital gains tax for foreign bond investors will further reflect the Government’s conviction, while also resulting in ease of transactions at international securities settlement platforms such as Euroclear. None of the 49 countries currently listed on Euroclear charge capital gains tax on bond transactions.
Indian Bond Markets and The Impact of Entering Global Indices
To explain how this inclusion in global indices is going to help the Indian debt market, we need to understand the components of bond pricing. In addition to risk premium, the bond pricing also includes a component of ‘Illiquidity premium’ which reflects the difficulty of trading in a particular paper. Thus, by getting included in large global indices, Indian bonds will get on the radar of International fund managers, who will adjust their portfolios in proportion to the weight of India in any index that they benchmark with and consequently growing the market for Indian Government’s bond offerings.
Deeper/bigger the market, better is the liquidity resulting in lower illiquidity premium and consequently lowering overall borrowing costs. The same will also have a cascading impact on Corporate debt securities, owing to lowering of benchmark rates (G-sec) and access to a wider set of foreign investors. China started its journey on this path four years back, since then foreign ownership of its central-government bonds has more than doubled from 4.5% to 10.6%. As per estimates from Morgan Stanley, India’s inclusion into global indices could trigger $170 billion in bond flows over the next decade, which would push foreign bond ownership, currently less than 2% to 9% by 2031.
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It will be interesting to see how this pans out in the upcoming Union Budget 2022, scheduled to be presented on Feb 1, 2022 in the Lok Sabha. To stay updated with all things Budget, keep following Yubi on LinkedIn and Twitter as we continue with our #GetTheBudget series!