Exposing India’s financial markets to the vultures

Syllabus
GS Paper 3 Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment

Applications where to apply?
When asked about
– Internationalisation of rupee
– Bond Markets
– India’s Economic growth
– $ 7 trillion economy
– Prelims oriented terms

Context
The article discusses India’s efforts to integrate its government bonds into global indices towards internationalisation of bond market and the potential benefits and risks associated with this move.

Source
The Hindu | Editorial dated 2^nd February 2024

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Exposing India’s financial markets to the vultures

India’s recent initiative to include its local currency government bonds in global indices represents a pivotal moment in the nation’s economic trajectory. This move holds profound implications, encompassing a spectrum of potential advantages and challenges.

Key Terms and Definitions

1. Local Currency Government Bonds (LCGBs): These are bonds issued by a government in its own currency and are typically used to raise funds for public projects or to manage the government’s finances.
2. Government Bond Index-Emerging Markets (GBI-EM) Global Index Suite: A collection of indexes compiled by J.P. Morgan that tracks the performance of government bonds issued by emerging market countries.
3. Fully Accessible Route (FAR) Bonds: Bonds issued by the Indian government that can be purchased by foreign investors without restrictions.
4. Bloomberg Emerging Market Local Currency Index: An index created by Bloomberg Index Services that measures the performance of local currency-denominated government bonds issued by emerging market countries.
5. FTSE Russell: A global index provider that compiles indexes used by investors to track the performance of various markets and asset classes.
6. Original Sin: Refers to the inability of emerging economies to borrow internationally in their own currencies, which exposes them to exchange rate risk.
7. Offshore Market: A financial market operating outside the borders of a country where foreign currencies are traded, often with fewer regulations

Measures adopted by India for the internationalization of its bond market

Several measures were adopted by India for the internationalization of its bond market

• Introduction of the Fully Accessible Route (FAR): India had introduced the Fully Accessible Route, which allowed a segment of government bonds to be accessible to foreign investors without constraints.
• Policy Stability despite Challenges: Despite encountering delays related to issues such as the government’s stance on capital gains taxes and local settlement, the fundamental policy of integrating Indian government bonds into global indices remained unchanged.
• Granting Authorization to Banks: The Reserve Bank of India (RBI) granted authorization to 17 banks to settle trade in the Indian rupee across 18 countries and establish 65 offshore deposit accounts.
  • This move effectively created an offshore Indian rupee market, opening new avenues for speculation and potential instability.
• Permitting Banking Services in the Indian Rupee (INR) outside the Country: India permitted banking services in the Indian rupee outside the country. For instance, trade with Russia in the Indian rupee for crude oil resulted in an accumulation of the rupee in Russian banks.

These measures represent steps taken by India to facilitate the internationalization of its bond market and currency, aimed at increasing accessibility to foreign investors and enhancing the global profile of Indian financial assets.

Merits of internationalization of bond market

• Enhanced Visibility and Attractiveness: Inclusion of Indian bonds in global indices increases visibility and attractiveness to international investors.
  • J.P. Morgan unveiled its plan to include Indian local currency government bonds (LCGBs) in its Government Bond Index­ Emerging Markets (GBI­EM) Global index suite.
• Stimulated Capital Inflows: Participation in global indices stimulates capital inflows, fostering liquidity in the Indian bond market.
• Credibility and Creditworthiness: Integration into global indices signals confidence in the Indian economy, potentially improving its credibility and creditworthiness.
• Lower Borrowing Costs: Improved credibility may lead to lower borrowing costs for the government, facilitating infrastructure development and critical investments.

De-Merits of internationalization of bond market

• Susceptibility to External Shocks: Increased foreign investment exposes India to external shocks and volatile capital flows, potentially destabilizing the bond market.
• Interest Rate Risks and Loss of Autonomy: Dependency on external investors for funding exposes India to interest rate risks and limits government autonomy in controlling long-term interest rates.
• Macro Vulnerabilities during Turmoil: Reliance on foreign investment may exacerbate macroeconomic vulnerabilities during periods of global economic turmoil, undermining domestic policy objectives.

Case study Malaysia   During the Asian financial crisis in 1997, Malaysia faced significant economic challenges, partly due to speculative activities in the offshore ringgit market in Singapore. Speculators in the offshore market exacerbated the crisis by betting on a substantial devaluation of the Malaysian currency, leading to increased offshore ringgit interest rates and putting pressure on domestic interest rates, liquidity, and overall financial stability.

• Risk of Sudden Outflows: Fluctuations in global risk appetite can precipitate sudden outflows of foreign capital, putting pressure on domestic bond prices and currency values.

Case study Türkiye   In Türkiye, where macroeconomic imbalances were much more serious, foreigners totally left the bond market after Spring 2018, and reserve losses and currency declines were aggravated as unhedged local forex debtors joined in to avoid exchange rate losses. In 2022, Turkey experienced turmoil in its offshore lira market in London, which became a major source of speculation against the Turkish currency. The Turkish government responded by implementing measures to curb speculative activities, including restrictions on bank lending to firms engaged in offshoring lira trading. These examples highlight how offshore markets can contribute to currency instability and financial vulnerability in emerging economies

Conclusion

While India’s endeavour to integrate its local currency government bonds into global indices promises to unlock new avenues for investment and economic growth, it also underscores the imperative for prudent risk management and policy coordination.

RELATED TOPICS

Internationalisation of the Rupee

The internationalisation of the rupee refers to the process of increasing its use in cross-border transactions. This means that more and more international trade and financial activities would be conducted in rupees, instead of relying solely on major global currencies like the US dollar.

For India, internationalising the rupee offers several potential benefits:

• Reduced dependence on the US dollar: This can lessen vulnerability to fluctuations in the dollar’s value and associated risks.
• Lower transaction costs: Using the rupee for trade could save businesses money on currency conversion fees.
• Increased financial stability: A more internationalised rupee could enhance India’s financial system and attract foreign investment.
• Boosted global trade: Facilitating trade in rupees can encourage regional trade partnerships and strengthen India’s economic influence.

References

https://www.weforum.org/agenda/2023/04/ranked-the-largest-bond-markets-in-the-world/#:~:text=Over%20the%20last%20three%20years,bond%20markets%20in%20the%20world.

https://www.indiafilings.com/learn/rbi-allows-international-trade-settlement-in-indian-rupees/ .

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Practice Question

Evaluate India’s move to integrate its local currency government bonds into global indices and internationalisation of bond market. [150 words]