India added to EM bond indices: what does this mean for investors?

On 21 September 2023 JP Morgan confirmed Indian government bonds (IGBs) will be added to its GBI-EM Global Diversified Index, ending years of debate.

Below we explain what we can expect in the months ahead, as well as the most important practical considerations for investors.

This blog was originally published prior to the inclusion announcement but was updated with new material following the decision.

What does the timeline of events look like from here?

Following confirmation that India has been added to the GBI-EM Global Diversified Index, the change to the index will follow a similar pattern to that seen following China’s inclusion in bond indices in 2019/2020.

The weighting of India in the GBI-EM Global index suite will be increased in 1% increments over a period of 10 months starting in June 2024. The full 10% weighting (the maximum that is allowed under the index methodology, and on a par with China’s weighting) will be reached in March 2025.

Phase 1: Inclusion announcement

The official announcement alone could potentially lead to increased investor interest and participation in the IGB market.

Phase 2: Market preparation

During this phase, major investors, index providers and market participants will work closely to define the specific criteria for inclusion, trying to ensure a smooth transition. In this phase it’s typically necessary for foreign investors to familiarise themselves further with the specific market structure, regulations and trading practices of the added country.

Phase 3: Actual inclusion

As noted above, inclusion will commence in June 2024, and IGBs will reach their full 10% weight in March 2025.

Following inclusion, index-tracking investors will need to allocate a portion of their portfolios to IGBs. This will naturally drive significant inflows. Considering the current assets under management tracking the GBI-EM Global Diversified Index are around $220bn,¹ roughly $22bn can be expected to land in the Indian market.

The 10-month phased inclusion will help asset managers to reshape their asset allocations and capital markets to account for these flows. 

ETF versus direct bond investments

Now that India has been added to the index, investors will need to evaluate how to access this market.

We believe direct investment in IGBs may potentially be attractive for investors seeking greater control over bond selection – an investor buying IGBs directly has the option to select those bonds with the specific characteristics to which they wish to gain exposure.

ETFs, meanwhile, could offer a straightforward, cost-effective and potentially tax-efficient option for some investors*:

• Easy access to a highly regulated market
• No need to deal with an additional restricted currency
• No need to onboard tax advisers and local brokers
• Potential tax benefits via the reduced withholding tax (WHT) rate applied to Irish-domiciled ETFs (10% WHT vs 20% standard rate)*

Impact on UCITS ETF market

China’s addition to indices took place over 10 months, with 1% added per month culminating in a 10% weight – an identical bond-inclusion journey to that now awaiting India.

As such, flows in China bond ETFs during the inclusion process provide an extremely useful guide to the possible impact on net flows for ETFs tracking IGBs.

The graph below highlights key dates in China’s bond-inclusion journey, most importantly highlighting the phased and progressive adoption of UCITS ETFs to include Chinese bond exposure in investors’ asset allocations. In the two years following inclusion, announced net flows accounted for over $15bn. 

An important financial step for India

Inclusion of IGBs is not just a logical step, but also a necessary one given India’s growing prominence in the global economic and financial landscape.

Inclusion of IGBs in major fixed income indices signifies international recognition of India’s growing significance as a leading global economy, and will likely result in more foreign investments in the country’s capital markets.

For investors tracking these indices, careful consideration around how to best access this exposure is essential.

* Tax treatment is dependent on individual circumstances and is subject to change.

1. Source: https://www.reuters.com/breakingviews/indias-bond-inclusion-will-be-overdue-timely-2022-09-26/