In January, independent benchmark administrator Bloomberg Services Index Ltd (BISL) had deferred the decision to include Indian government bonds in its global index, citing the need for further assessment of operational and market infrastructure issues.
For the Bloomberg Global Index, India was being evaluated for a potential weight of around 1 per cent in the index, an allocation that could have translated into $25 billion of inflows, spread over roughly 10 months, starting from April 2027. If Indian government securities (G-secs) are included this time around, the actual inflows could come in FY28, but the announcement itself will boost sentiment. Typically, investors tend to take positions in anticipation of the upcoming change.
The tax reforms for FPIs’ in Indian government securities, unveiled last Friday, were initiated with the primary objective of creating a more competitive and investor-friendly framework for foreign investment in Indian government securities, deepening the sovereign bond market, and strengthening the case for these bonds’ eligibility for inclusion in global indices, said a person involved in the deliberations between the central bank and the government.
The further deepening of the bond market remains a key policy priority for the government, said another person aware of the rationale. “There’s a realisation that a deeper and more liquid market requires a diversified investor base that goes beyond the current concentration of domestic banks and insurers to include global institutional investors with large pools of stable capital,” he said.
With FPIs being taxed on interest and capital gains, the effective post-tax yield on Indian government bonds was seen as lagging relative to comparable bonds in peer emerging markets, many of which are already index constituents. Removing this structural disadvantage was thus, seen as necessary to make Indian sovereign papers genuinely competitive in the global market.
Index-tracking funds and active global bond investors evaluate the after-tax return on Indian government securities against comparable peer market securities before making allocation decisions.
Terming the tax exemptions significant, analysts at Barclays said this will improve the attractiveness of India’s real yields and relative carry over peers. “Importantly, it also removes a structural barrier for bond index inclusion. Combined with the fully accessible route (FAR) expansion and easing investment restrictions, index providers could look favourable on these measures,” economists Aastha Gudwani and Amruta Ghare, along with forex analyst Mitul Kotecha, said in a note.
This exemption will improve the post-tax attractiveness of Indian sovereign papers for global investors, support secondary market liquidity and price discovery, and demonstrate a stable and long-term policy commitment to opening the Indian sovereign bond market to international capital.
“One key factor to watch out for will be a possible announcement of inclusion in the Bloomberg Global Aggregate Index. The chances of index inclusion have improved following the removal of tax on government securities for FPIs, which enhances ease of compliance,” said Gaura Sen Gupta, chief economist, IDFC First Bank.
That the list of specified securities under the FAR has been expanded to include new government bonds with maturities of 15, 30, and 40 years, also bodes well for attracting inflows. “It will ensure more FPI demand for G-secs, lower long-end yields, lower government borrowing cost, better liquidity in long-tenor bonds, and some support for Rupee. Also, these measures can make India’s case for inclusion in larger Global Bond indices stronger,” Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India said in a report.
The government also exempted interest and capital gains of the Bank for International Settlements (BIS) from investments in government securities. The move follows BIS’ request for an exemption for income arising from investments in Indian government securities through a rupee-denominated investment pool.
BIS participation would facilitate investment into Indian government bonds from global central banks, a category of investors particularly valued for its long-term, stable and non-speculative character. Sources said the move sends a strong signal to global institutional investors and to index compilers that the Indian government bond market meets international standards of accessibility and investor protection.
While these steps would attract inflows that will make the government bond market more vibrant, this will also help to stabilise the exchange rate which has been under pressure in the last one year, particularly since the beginning of the West Asia conflict.
The rupee has depreciated around 10 per cent in the last one year and hit a record low of 96.83 a dollar on May 20. The local currency settled at 94.94 per dollar on Friday, rising by almost a per cent (its highest single day gain in two months) after the Reserve Bank of India (RBI) announced measures to attract foreign flows.
Short term easing in bond yields
Moreover, the government bond yields are also expected to cool following these measures. The yield on the 10-year government bonds which topped 7 per cent, is expected to trend lower.
“The announcement effect of status quo [on policy rates by RBI on Friday] saw India’s 10Y yield dipping tad below the 7%-mark. Further, reports of government measures of exempting capital gains tax and withholding tax on interest income of debt instruments of FIIs, have impacted yield positively,” said Dipanwita Mazumdar, economist with Bank of Baroda. The yield on the 10-year benchmark government bond ended at 6.98 per cent on Friday.
Foreign investor participation in the debt market has shown signs of recovery in the current financial year. FPIs net bought ₹5,262 crore worth of government securities under the FAR route in April and ₹5,512 crore in May, followed by inflows of ₹3,395 crore this month, as of June 5.
Economists at QuantEco Research reckoned that liquidity from scheduled G-sec redemptions, the record high RBI dividend, and the likelihood of a short-term boost from foreign debt inflows could keep liquidity conditions comfortable with sentiment remaining broadly supportive.
“As upside risks intensify in H2 FY27, and market participants start focusing on the impact of 8th Pay Commission on the FY28 fiscal trajectory, the 10Y g-sec yield could drift higher towards 7.25-7.50% range by March 27,” economists Shubhada Rao, Vivek Kumar and Yuvika Singhal said in a report titled ‘Currency defense sans interest rates’.
