FTSE gives Indian bonds a pass; potential inclusion into emerging markets index pushed to next year

Global index provider FTSE Russell while announcing the result of its 2022 annual country classification review for equities and fixed income said India has been retained on the watch list for potential inclusion in the FTSE Emerging Markets Government Bond Index (EMGBI) but pushed a potential inclusion to next year.

EMGBI index is a gauge of government bonds of 16 countries; it enables performance comparisons across sovereign debt markets.

The announcement dashed the hopes of the fixed income industry that a potential entry into the benchmark this year will bring new vigour to the $1 trillion Indian government debt market. India will be reassessed in March 2023, FTSE Russel said.

“India will be retained on the Watch List for a potential upgrade to Market Accessibility Level ‘1’ and for consideration for inclusion in the FTSE Emerging Markets Government Bond Index (EMGBI). FTSE Russell continues to engage with its index users and Indian market authorities regarding ongoing market structure reforms, with a focus on securities that are available via the Fully Accessible Route channel,” said the London Stock Exchange group-owned company in a statement.

Is Capital gains tax the culprit?

The announcement comes two days after the Indian government reportedly ruled out any potential changes to tax policies citing concerns that tweaking the capital gains tax levy will lead to increased foreign inflows, thereby increasing volatility in local markets. Indian investors had hoped to see foreign inflows worth $30 billion into Indian bonds as a result of the inclusion.

Notably, a major hindrance to India’s inclusion in key indices such as FTSE Russel and JP Morgan Chase is the capital gains tax, an irritant for foreign investors as it eats into returns. Capital gains tax has wrecked previous such negotiations as well.

"Feedback from global index users continues to demonstrate an interest in Indian government securities issued through the Fully Accessible Route (FAR), which was introduced in 2020," the statement added.

The FAR originally removed foreign ownership restrictions for new issuance of Indian local currency fixed-rate government securities at the 5-, 10-, and 30-year tenors. On 06 July 2022, the Reserve Bank of India (RBI) announced the expansion of the FAR scheme to include all new issuance of 7- and 14-year tenors. Based on the October 2022 index profile, there are 21 index eligible FAR bonds with $284 billion in par amount outstanding representing 29.5% of the FTSE Indian Government Bond Index.