Bloomberg to Seek Feedback On Including Govt Bonds in Its EM Index

India’s Bonds Potential Inclusion in Bloomberg Index: Implications for Industries and Investors

Source and citation: Bloomberg to Seek Feedback On Including Govt Bonds in Its EM Index, ET Bureau, Economic Times, January 9, 2024

Analysis for Layman

The Bloomberg Emerging Market Local Currency Index monitors the performance of currencies in emerging markets. Now, there’s a possibility of including India’s government bonds in this index. What does this mean? Essentially, foreign investors might increase their holdings of these bonds, injecting a substantial $2-4 billion into India’s bond market.

When large investors purchase bonds, it tends to raise their prices and lower their yields (interest rates). Consequently, this move could lead to a reduction in Indian government bond yields. Lower yields, in turn, have a cascading effect, lowering corporate and consumer borrowing costs within India.

The process of inclusion in the index is gradual, spanning over 5 months starting September 2024. This approach aims to prevent sudden market volatility and allows time for the market to adjust.

Impact on Retail Investors

For retail investors, the potential decrease in government bond yields could result in lower interest rates on bank fixed deposits and small savings schemes. However, the Reserve Bank of India (RBI) might reduce rates more slowly if foreign inflows alleviate pressure to support the rupee.

Lower corporate borrowing costs could lead to companies accelerating expansion plans, potentially boosting earnings and driving up stock prices. While this is positive for investors, it’s important to note that stock valuations may become expensive.

Overseas investments also tend to strengthen the rupee, reducing imported inflation—a positive for consumers. However, it could negatively impact exports, affecting stocks of IT and pharma exporters. Investors are advised to make balanced decisions in response to these potential changes.

In the long run, increased foreign ownership can make markets more volatile to global swings. Retail investors may consider allocating funds into balanced Advantage Funds, which dynamically adjust equity exposure to mitigate risks.

Impact on Industries

Lower yields are advantageous for rate-sensitive sectors like housing, auto, and banking. Housing finance firms and banks stand to gain, along with potential acceleration in auto sales due to lower interest rates on car loans.

However, a rapidly strengthening rupee may adversely affect the export competitiveness of IT services and pharma. Stocks of companies like TCS, Infosys, Sun Pharma, and Dr. Reddy’s could experience muted growth. These stocks, however, offer resilience during global downturns.

If accelerated growth revives the investment cycle, capital goods companies like Larsen & Toubro, Thermax, and Siemens could benefit. Higher imports may widen the trade deficit, benefiting port operators like Adani Ports.

Telecom, aviation, and other rate-sensitive sectors could also gain from lower interest rates over time, potentially boosting earnings for companies like Bharti Airtel and Indigo Airlines. Investors are advised to be selective in their choices rather than investing indiscriminately in all rate-sensitive stocks.

Long Term Benefits & Negatives

Over 3-5 years, increased foreign flows can enhance policy discipline, maintaining deficits, and improving India’s macro stability. This could lead to rating upgrades, further lowering corporate borrowing costs.

Deeper bond markets with higher foreign ownership can improve the transmission of global rate signals, reducing mispricings and enhancing financial stability. However, higher overseas ownership also makes markets more susceptible to external shocks, as seen in the 2013 taper tantrum.

While the RBI has substantial reserves as a buffer, periods of sharp volatility may occur. Investors might experience bouts of instability on the path to long-term gains.

Short Term Benefits & Negatives

Over the next 6-12 months, accelerated inflows may support the Indian rupee, containing imported inflation and allowing the RBI to hike rates more slowly. However, if the rupee appreciates too quickly, export competitiveness could suffer, and the current account deficit might widen.

For investors, suppressed yields may impact returns on fixed-income assets, but rate-sensitive equities in banking, autos, and real estate could benefit. Tactical investment decisions are encouraged.

Sudden volatility cannot be ruled out, especially if global recession risks increase, leading to rapid fund exits from emerging assets. India, however, may exhibit relative resilience due to strong local demand dynamics, providing potential opportunities for long-term investors during market dips.

Potential Impact of Bloomberg EM Index Inclusion on Companies:

Indian Companies to Gain:

1. HDFC Bank: As India’s largest private bank, HDFC stands to benefit from lower corporate borrowing costs due to potentially falling government bond yields. This could improve their profit margins and boost share prices.
2. Reliance Industries: India’s largest conglomerate has significant debt obligations. Lower interest rates can significantly reduce their financial burden, freeing up resources for investment and growth, potentially positively impacting stock performance.
3. Larsen & Toubro: A leading infrastructure and engineering company, L&T heavily relies on government spending. An influx of foreign capital could boost infrastructure projects, benefiting L&T’s order book and potentially driving stock appreciation.
4. Axis Bank: Another major private bank, Axis could see similar benefits to HDFC from lower borrowing costs, enhancing profitability and potentially attracting investor interest.
5. Bajaj Finance: As a prominent NBFC (non-banking financial company), Bajaj Finance’s lending rates are closely linked to government bond yields. Lower rates could attract more borrowers, boosting their business and potentially driving stock price increases.

Indian Companies to Lose:

1. Fixed Income Mutual Funds: These funds invest in Indian government bonds. If yields fall due to foreign inflows, existing bondholders could see a decline in their portfolio value, potentially impacting sentiment towards these funds.
2. Public Sector Banks: These banks rely heavily on government deposits and may face competition for funds from foreign investors attracted to the EM index. This could squeeze their deposit base and profitability, potentially affecting share prices.
3. Exporters: A stronger rupee due to foreign inflows could hurt exporters by making their products less competitive in the global market. This could negatively impact companies like Tata Steel and Infosys, potentially leading to lowered stock valuations.
4. Real Estate Developers: Lower interest rates could fuel a surge in demand for real estate, pushing up property prices. This could hurt affordability for first-time buyers and potentially dampen sentiment towards real estate stocks like DLF and Indiabulls Real Estate.
5. Microfinance Institutions: These institutions primarily cater to low-income borrowers whose loan rates are often linked to government yields. Lower rates could lead to reduced profitability for microfinance companies, potentially impacting their stock performance.

Global Companies to Gain:

1. Asset Managers: Global asset managers with expertise in emerging markets could see increased inflows into their India-focused funds, potentially boosting their revenue and share prices.
2. Foreign Banks: Increased foreign investment in India could benefit global banks with Indian operations, such as HSBC and Citigroup, through higher fee income and potential expansion opportunities.
3. Emerging Market ETFs: ETFs tracking the Bloomberg EM index could see increased inflows as investors seek exposure to India’s growing bond market, potentially benefiting companies like iShares and Vanguard.
4. Commodity Traders: Increased economic activity in India due to foreign inflows could lead to higher demand for commodities like oil and copper, benefiting companies like ExxonMobil and BHP Billiton.
5. Investment Consulting Firms: Firms advising investors on emerging markets strategies could see increased demand for their services due to the heightened interest in India, potentially boosting their business and stock prices.

Global Companies to Lose:

1. US Treasuries: Increased foreign investment in India could potentially divert funds away from US Treasuries, leading to lower demand and potentially pushing yields up. This could negatively impact bondholders, including pension funds and insurance companies.
2. Other Emerging Markets: Increased focus on India within the EM index could attract more investor attention away from other emerging markets, potentially dampening their inflows and impacting companies and assets in those countries.
3. Risk-Averse Investors: If the inclusion of India leads to increased volatility in the EM index, risk-averse investors may choose to withdraw funds, potentially hurting companies reliant on such inflows.

Important Note: This analysis is based on the information provided in the news article and should not be considered financial advice. Please consult with a professional financial advisor before making any investment decisions.