People check market prices on a display screen outside the Bombay Stock Exchange building in Mumbai, in July 2019. Photo: AP
by Nicholas Spiro
by Nicholas Spiro

Fears of ‘hot money’ flows temper India’s desire to join global bond indices

  • There is massive scope for further inflows into India’s bond market, and China’s success shows index inclusion can have great benefits
  • New Delhi has reason to be wary of speculative money flows, though, and bond market liberalisation could not come at a more perilous time

A cursory glance at levels of foreign ownership in local currency bond markets in developing economies reveals where the greatest untapped opportunities for overseas investors lie.

In China and India – the largest and second-largest debt markets in the developing world in terms of value and the number of outstanding securities – foreign investors’ share of central government bonds currently stands at 10 per cent and 1.7 per cent respectively, according to JPMorgan data.

For an indication of just how low these levels are given the size of both countries’ economies, South Africa, the Czech Republic and Malaysia – which do not even rank among the world’s top 30 economies – all have shares of foreign ownership ranging between 23 and 29 per cent, according to JPMorgan.

However, for many foreign investors, the huge scope for further inflows into the domestic bond markets of Asia’s two biggest developing economies is a key driver shaping global capital markets. China has already made significant progress in opening up its debt market, partly by allowing its sovereign bonds to be included in global indices compiled by Bloomberg, JPMorgan and FTSE Russell.
Index inclusion has contributed to the influx of foreign capital in the past several years. Last year alone, foreigners bought almost US$90 billion of Chinese central government bonds, accounting for nearly half the total inflows into Asia’s local currency debt markets, according to JPMorgan.

Foreign investors cut Chinese bonds, dumped equities in July

The rapid pace of inflows is striking in a country that is notoriously wary of capital flows. Although foreign ownership as a percentage of the outstanding stock of central government bonds has doubled since 2018, China has maintained strict controls on its capital account, ensuring the bulk of the nation’s vast household savings has remained trapped within its borders.
Beijing’s cautious approach to opening its debt market to foreign investors has paid off. China has minimised the volatile ebb and flow of capital that has exacerbated major sell-offs in other emerging markets.

One of the big questions in developing economies’ bond markets this year is whether India can replicate China’s success in integrating parts of its financial system into global capital markets.


JPMorgan has held discussions with major international investors in the past few months about adding India to its flagship emerging market local currency bond index. Expectations are rising that India will soon be admitted. This would be the first time the nation is represented in a global bond index and could trigger tens of billions of dollars of inflows.

A customer and vendor exchange rupees in Bangalore, India, on August 15. Photo: Bloomberg

Index inclusion could help India on several fronts. Steady inflows would provide a new source of funding to help repair the nation’s tattered public finances and shore up its credit rating. Government bond yields would fall, companies would be able to borrow more cheaply and pressure on the Indian rupee would ease.

The question is whether these inflows would be stable and reliable. India, which is just as wary of capital flows as China, has driven a hard bargain in negotiations with index providers. The government only recently lifted a cap on foreign ownership of domestic debt and has insisted that bond trading is settled in India rather than on an international clearing platform.

More importantly, although New Delhi is increasingly in favour of index inclusion, bond market liberalisation could not come at a more perilous time sentiment-wise. Last Friday, US Federal Reserve chairman Jerome Powell warned markets that the US central bank “must keep at it” in lifting interest rates despite the sharp slowdown in the economy.
India’s markets are sensitive to shifts in US monetary policy. They have suffered large outflows numerous times in the past decade – in particular during the “taper tantrum” across emerging markets in 2013 – because of fears about tighter policy.

US interest rates pledge spells ‘bad news’ for China

While inflows stemming from membership of global bond indices are generally less volatile than the speculative “hot money” flows developing economies dread, countries that joined the indices, such as Indonesia and Malaysia, have still suffered sizeable outflows.

It is telling that multilateral institutions, which previously opposed all forms of capital controls, have become more ambivalent. In a review of its position on capital flows published in March, the International Monetary Fund said countries “should have more flexibility” to introduce measures to manage capital flows, which have often amplified volatility in markets.

This is music to the ears of Chinese and Indian policymakers, especially given this year’s sharp outflows from emerging market bond funds, driven mainly by the dramatic Fed-induced rally in the US dollar. Even China – whose sovereign bonds have been touted as a safe haven by some asset managers because of their low correlation with other major debt markets – has suffered heavy outflows this year.

India’s bond market is too big to be left out of global indices. Yet, New Delhi’s concerns about the dangers of volatile capital flows are justified. When it comes to opening up India’s debt market, caution is the watchword.

Nicholas Spiro is a partner at Lauressa Advisory