Indian government bonds in its Government Bond Index-Emerging Markets (GBI-EM) with effect from June 2024 says it all. Predictably, markets are elated, policy makers, circumspect. This is not surprising.
Markets are not known to look beyond the immediate. Hence, the prospect of additional inflows into the government securities (G-Sec) market by investors based on the GBI-EM is enough to make markets swoon. Soon after JPMorgan’s announcement, the Indian rupee and 10-year bond prices jumped.
The domestic currency opened at 82.83 against the US dollar, rising from its previous close of 83.09, and ended the day at 83.26. The 10-year bond yield fell 6 basis points to hit a two-month low of 7.101% from its previous close of 7.163 % only to close at 7.156%. ‘Irrational exuberance’? Remember, one of the biggest strengths of the Indian economy so far has been the limited exposure of our bond market to overseas investors.
If the experience of the SE Asian crisis, and prior to that, the Latin American crisis, has taught us anything, it is that excessive exposure of local debt markets to fickle overseas investors and markets can bring the entire economy to its knees. Apart from the fact that access to a larger pool of funds could prove a temptation to governments in search of easy money, large inflows and outflows linked to developments overseas can have an outsized impact on our relatively shallow and one-sided domestic bond and currency markets. Even if the debt is rupee-denominated, repayment requires externalisation or conversion of local currency into foreign currency, typically US dollars.
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