Being part of a global bond index is a good idea
Finance minister P Chidambaram, media reports suggest, is meeting big bond investors in the US as well as financial services firms like JP Morgan who manage global bond indices. While India allows foreign investors to invest up to $35 billion in government bonds—the total market is around $600 billion right now—the problem arises when, as in months after May, FIIs started withdrawing their money from debt funds. This is where various bond indices come in. Since all investors need to benchmark their returns, the best way to do this is vis-à-vis an index. In the case of equities, the MSCI is the most followed index and fund managers allocate investments in line with it. So, if the MSCI Emerging Markets Index has an India-weight of 5.9%, even those who are not bullish may invest just 4-5% of their portfolio, but not much less. The weight on the MSCI depends on parameters such as the size of the economy, the liquidity of stocks, and their performance. Given that fund managers tend to invest around what the index says is the best option, such investment tends to be a lot stickier, which is why, even while the economy was slowing and the rupee plummeting, very small amounts of FII investments—$200 billion since FIIs first came in—actually flowed out from equity markets.
This is what Chidambaram will be discussing in the US since, in the case of the JP Morgan Emerging Markets index, around $250 billion of debt funds invest on the basis of the weights put out by it. And since this includes ‘long only’ pension funds or some of the biggest global fund managers—at $2 trillion of funds under management, Pimco is the world’s largest bond investor—the chances of this money being sticky is high. The only criterion is that the country have no limits at all on foreigners purchasing GSecs. This is something the government is uncomfortable with since, the belief is that were all the fund managers to go short on India, yields would skyrocket. That, however, is also a danger with, for instance, FII investments in equity but the money has remained sticky since it attracts a different class of investors. The finance minister would do well to work on including India in an index since at least $20-25 billion more of debt funds could easily flow in—no country can have a weight of more than 10% in the index. Since being part of an index automatically implies a responsible government behaviour and good returns, this increases India’s attractiveness to funds that don’t benchmark themselves as well. All in all, it’s an idea worth closing quickly.