Investor confidence | Editorial Comment
There is considerable enthusiasm among financial-market participants over India’s inclusion in the JP Morgan Government Bond Index-Emerging Markets. Last week, India officially became part of the index, which global investors widely track. India’s weighting in the index will be increased by one percentage point every month till the cap of 10 per cent is reached. According to estimates, funds worth about $240 billion track this index, which means about $24 billion will flow into India. In fact, the flows may be higher because non-index investors too may want to increase their exposure to India after its inclusion in the index. While Russia’s exclusion from the index may have hastened India’s inclusion, it does reflect global investor confidence in India’s relative performance. Bloomberg has also announced that it will include Indian bonds in its emerging-market and related indices.
However, with the inclusion in global bond indices and the intent to tap foreign funds to fund the fiscal deficit, it is worth noting that the process has both benefits and risks. As Reserve Bank of India Governor Shaktikanta Das had rightly noted last year, it is a double-edged sword. The increased flow into government bonds would reduce the requirement for borrowing in the domestic market, leaving domestic savings to that extent for domestic businesses. This will help reduce the cost of money, which would improve investment outcomes and growth. However, on the other hand, higher exposure to foreign funds can significantly increase volatility in financial markets. To be sure, funds tracking indices tend to be more stable, but money can move out quickly in times of increased stress in global markets. In times of stress, this can add to the pressure because funds from other instruments also tend to move out. Any adjustment in India’s weighting can also lead to sudden outflows.
Further, the index inclusion has come at a time when the government is running a higher fiscal deficit and the public debt remains elevated. Even though India is growing at a relatively high rate and the current account remains manageable — it recorded a surplus in the March quarter — India’s fiscal position remains a source of risk. According to the International Monetary Fund projections, India’s general government Budget deficit is likely to remain at 7 per cent of gross domestic product (GDP) or above at least till 2027. India’s public debt is unlikely to reach the pre-pandemic level of 75 per cent of GDP, which was already high, at least till 2029. Sustained higher deficits and public debt can affect investor confidence.
It is thus important for India to reduce the general government Budget deficit at a faster pace. A large part of the adjustment in this context will need to be done by the Union government. It would be worth watching if the government revises its fiscal-deficit target for the current year from 5.1 per cent of GDP (announced in the Interim Budget) in the upcoming full Budget. One big constraint for the government is that economic growth is driven largely by government expenditure. However, at some point, the government would need to start borrowing less and make way for the private sector. In sum, to boost investor confidence, including foreign investors, it is important that India not only achieves high economic growth but also maintains a low and stable fiscal and current account deficit, with price stability.
