Benefits To Infrastructure Sector From Inclusion In Bond Index
Infrastructure development is a prerequisite for realising our vision of reaching the milestone of US $5 trillion GDP by 2025 due to the multiplier effect it would have across sectors such as steel, cement, auto, real estate among others. Infrastructure projects require long tenure financing that can only be provided by debt funds. For long, the biggest problem with private sector participation in infrastructure projects in India has been the lack of suitable debt capital. Our bond markets were insignificant and clearly not deep enough to attract patient capital, such as from pension and insurance funds. While asset-liability mismatch held back the banks from going far into infrastructure lending, the huge NPAs of public sector banks (the closest equivalent to development financial institutions), caused a virtual dry down in private sector funding. As a consequence, in the last five years the government has hardly launched any PPP projects. Almost all the infrastructure projects today are essentially government funded – under schemes like EPC or HAM. While this has helped the speed of execution, it is not sustainable in the long run.
At present, India has a BBB- rating from S&P Global Ratings for India’s creditworthiness, which is neither too good nor discouraging. However, the recently announced inclusion of India's sovereign bonds into the important JP Morgan's Government Bond Index-Emerging Markets (GBI-EM) index is a significant positive recognition of India’s economic credibility and thereby good news for its overall sovereign rating. It could also be the beginning of a new renaissance in private sector investment in infrastructure. It will also assist the government in its various fiscal measures to influence the economy.
India will be represented and is expected to reach the maximum weight of 10 per cent in the JP Morgan Global Diversified Index (GBI-EM GD). This inclusion will be phased through a 10-month period from June 28, 2024 to March 31, 2025, which means an inclusion of one per cent per month in the 2024-25 period. The key advantages that will benefit Indian infrastructure will be as follows:
First, as with any positive financial sector news, the overall attractiveness of India as an investment destination and of Indian infrastructure projects to foreign investors will improve.
Second, inclusion in the GBI-EM GD will improve the rating of Indian sovereign debt as the index is tracked globally.
Third, and most importantly, since a total of 23 Indian sovereign bonds with a cumulative value of $330 billion will be included in the GBI-EM Global Index, there will gradually be higher demand for these bonds and so, the government will be able to raise money by offering lower interest rates. In effect, this will, therefore, reduce the borrowing cost for the government. According to reports that have appeared, the price of the 10-year benchmark 7.26 per cent, 2033 government bond, which settled at Rs 100.63, or 7.17 per cent yield within two days of the announcement, may approximate 7.05 per cent by mid-October.
This is a definite positive relief for the government of India. Since Covid, the fiscal deficit in India has remained aggravated due to higher borrowing for meeting the Covid crisis and the lack of funding globally due to uncertainty. As a percentage of the country’s GDP and difference between the government’s total expenditure and revenue, the fiscal deficit stood at 6.4 per cent in 2022-23, and 6.7 per cent in 2021-22. In fact, as a result of the government’s heavy expenditure following the Covid outbreak in 2020, the fiscal deficit for 2020-21 had reached a figure as high as 9.3 per cent of the GDP.
Considering India’s massive development and infrastructure aspirations, this ensuing cost reduction in borrowing will put the Indian government at an advantage as it plans to raise up to Rs 6.55 lakh crore through sale of bonds in the second half of 2023-24.
Fourth, at a more structural level, this development will lower India’s cost of funding. It will help the liquidity and ownership base of Government Securities (G-Secs) and support to finance not only the fiscal but also the current account deficit, currently under stress due to rising oil prices in the international market, by channelling fresh flows in the debt market at reduced cost. The impact will be felt also on the corporate bonds.
Fifth, another beneficiary of this inclusion will be the beleaguered Indian rupee. With lower cost of borrowing and expected inflows between June 2024 and March 2025 due to a higher demand for the rupee, the exchange rate will be supported against the US dollar and volatility in the global commodities market.
The Indian bond market is worth about $2 trillion. Thanks to the fact that the government has removed restriction on foreign ownership of government bonds, there will be greater visibility and credibility for Indian bonds. Besides, India needs to spend about $1.4 trillion on infrastructure to realise the vision of emerging as a $5 trillion economy by FY2025. Yet scaling up investment in this sector remains a challenge with demand for funds far exceeding supply. In fact, according to some estimates, India’s infrastructure financing gap exceeds five per cent of GDP. The government had envisaged an allocation of Rs 111 lakh crore ($1.4 trillion), under the National Infrastructure Pipeline (NIP) in December 2019 for a five-year period between FY2019 and FY2025, covering diverse projects in roads, rail, ports, airports, power among others. The pipeline anticipated 80 per cent investment by the government and government entities and 20 per cent by the private developers. However, the private sector has not been able to meet its end of investment. The current development will help to increase the attractiveness of the increasing number of real estate investment trusts (REITs) and infrastructure investment trusts (InvITs) formed for monetisation of infrastructure assets held in private hands.
More infrastructure and developmental spending will lead to more overall demand, further growth and overall superior spin-offs all around for the economy.
The author is a former Secretary Government of India
