India’s inclusion in JPMorgan’s bond index needs sober analysis

livemint.com:

₹26.4 trillion or around 9.7% of gross domestic product. A Bloomberg report suggests this is the highest among the 20 countries in JPMorgan’s bond index. Over the years, governments in India have funded themselves through financial repression, with a significant portion of every new deposit coming into the banking system being funnelled into buying government bonds.

The same holds true for premiums collected by insurance companies through traditional investment policies. This has ensured that the government’s fiscal condition isn’t scrutinized deeply. If active foreign investors show significant interest in Indian government bonds, that’s likely to change.

Increased scrutiny will make it harder for the government to use limitations of the cash-based accounting system to declare a lower fiscal deficit than it actually is. Fourth, a more diverse set of investors investing in Indian government bonds and increasingly scrutinizing public finances as well as India’s economy could lead the bond market to serve as a much better ‘early warning system,’ helping discipline the government of the day. Economist Stephen D.

King explains how this mechanism works in We Need to Talk About Inflation: “Hungry investors [spend] time prowling… in search of fiscal or monetary weakness. When they [find] it… the relevant bond market [comes] under heavy selling pressure." This can send the government’s borrowing costs soaring and the country’s currency falling, forcing fiscal discipline upon the government. Of course, this is a possibility and depends on how much interest foreign investors take in Indian bonds over the long-term.