Key drivers: the liberalisation of the Indian bond market
India’s bond market has historically been dominated by domestic investors. Foreign investors could access the market through a quota system that effectively served as a cap on access. In 2020, however, Indian regulators began classifying certain government bonds as ‘fully accessible route’ (FAR) securities. Thereafter, FAR bonds could be traded without quotas by licensed foreign investors.
The accessibility of Indian bonds continued to grow, reaching US$300bn by the end of 2023. This made them increasingly eligible for inclusion in leading global bond indices. Indeed, the bonds were included in JP Morgan’s GBI-EM Index in June 2024. Markets expect India’s weighting in this index to reach 10% by March 2025.
Major investor benefits of Indian bonds
Attractive structural features
Index providers have responded positively to these liberalisation measures. Additionally, several attractive structural features boost the attractiveness of Indian bonds. The Indian government bond market is vast, with assets of US$1.3 trillion (trn). It also trades with tight bid-offer spreads of only 1-3 basis points, indicating good liquidity. Additionally, the bonds of various state governments amount to US$500 billion (bn), while the corporate bond market is worth a further US$500bn.
Indian bond market volatility is also historically low at 5%, with the rupee one of the least volatile currencies globally in recent years.
Diversification/low correlation to other markets
Domestic Indian government bonds offer good diversification thanks to their historically low correlation with other global assets. This is mainly attributed to the minimal level of foreign ownership. As of April 2024, foreign holdings of Indian government bonds were less than 3% of the US$1.3 trillion domestic market and less than 2% of the overall market. Post-index inclusion, foreign ownership is only expected to rise to just under 4%. 1
Meanwhile, India’s corporate bond market is chiefly driven by companies that predominantly focus on domestic customers. This, along with India’s relatively limited global trade integration, often lessens Indian bonds’ correlation to other global asset markets.
Defensive benefits in more challenging market environments
Another factor is Indian bonds’ relatively better performance in more challenging market environments. For example, from the end of 2019 to the peak of the market sell-off during the Covid-19 crisis on 20 March 2020, India’s domestic bond market was down only 3% (including the impact of FX). As shown below, this performance significantly outpaced many other asset classes.
Chart 1: Selected asset class performance in Covid-19 period
Source: abrdn, Bloomberg, cumulative returns as at the end of 2019 to 20 March 2020. Data shown for illustrative purposes only. No assumptions regarding future performance should be made.
Positive structural reform story
Over the past decade, the government has enacted important reforms, putting India on a more stable economic footing. In particular, the 2017 goods & services tax and reduced subsidies have strengthened the government’s fiscal position. They’ve also helped limit the need for new bond issuance. On the corporate side, the acceleration of digitalisation has made companies more efficient, driving profitability.
Looking ahead, with the political continuity secured by the recent elections, India's economic policy is expected to remain pro-business and investor-friendly.
Valuations – attractive yields
In our view, Indian bond valuations offer a compelling opportunity, particularly for income-orientated investors. Indeed, they are one of the few global investment-grade asset classes offering yields of around 7%.
The real yield picture is also improving. In July 2024, consumer price inflation fell to 3.5% year-on-year. That’s below the central bank’s target rate of 4% and the lowest since August 2019. As a result, markets anticipate that the central bank will soon start a new rate-cutting cycle. This would likely boost the capital returns from Indian bonds.
- Source: JP Morgan, April 2024