Five things to know as India enters JPMorgan EM debt index

By Nimesh Vora and Dharamraj Dhutia

MUMBAI (Reuters) - India's government bonds will gradually become a part of JPMorgan's widely tracked emerging market debt index, beginning on Friday.

The announcement of the change was made in September, setting the stage for billions of dollars to flow into the world's fifth-largest economy.

Here are five things to know as the South Asian nation draws more investment from global bond investors and its stock markets attract increased portfolio inflows.

WHAT KIND OF INFLOWS?

Indian bonds should receive $2 billion inflows from index-tracking funds around the June 28 inclusion date, followed by a similar quantum each month and total inflows of at least $20 billion over the next 10 months as the country slowly reaches maximum weight in the index.

The market has received inflows from active fund managers and other investors totalling $10.5 billion since September's announcement, nearly six times the inflows received from early 2021 to August 2023.

About 32-40% of the expected $20-25 billion of index-related inflows to India may have already arrived, JPMorgan strategist wrote in a note on June 25.

WHAT FACTORS ARE LURING FOREIGN INVESTORS?

Global investors are keen on India's high growth, the government's commitment to fiscal prudence, the rupee's low volatility and the central bank's pledge to bring inflation down.

Foreign holdings of India's debt are around 2.4% of total outstanding debt and JPMorgan expects the level to nearly double by the end of 2025.

India offers a positive real yield. Although lower than other big emerging markets, its appeal is increased by a backdrop of moderate and controlled inflation and that government's commitment to fiscal prudence and low currency volatility.

HOW WILL LARGE INFLOWS IMPACT THE RUPEE?

Any dollar inflows should boost the local currency, but a large appreciation is not expected as the Reserve Bank of India (RBI) is likely to absorb dollars and accumulate forex reserves.

At $652.9 billion, India's currency reserves are the fourth largest in the world. This indirectly benefits the rupee as large buffers allow the central bank to intervene and smooth volatility.

The rupee, largely because of India's active central bank, has been the most stable among major emerging market currencies.

"Lower volatility of the Indian rupee makes it an attractive carry story," Sergei Strigo, co-head of emerging markets fixed income at Amundi Asset Management said.

HOW WILL THE FLOWS IMPACT THE BOND MARKET?

Large foreign flows have pushed government bond trading volumes to the highest in nearly five years.

In recent months, foreigners have started buying longer tenor government bonds in the hope of better returns once the RBI starts cutting rates later this year.

The larger long-end buying has led to further flattening of India's yield curve with the 3-year to 40-year yield spread at only 11 basis points.

Securities included in global bond indices do not have any foreign investment limits.

WILL THE INCLUSION CHANGE MUCH FOR INDIAN ECONOMY?

The increase in inflows related to the inclusion, alongside a moderate current account deficit, estimated at 1.1% to 1.3% of GDP, is expected to keep India's balance of payments in surplus.

A larger set of buyers for Indian debt and the heavy inflows will ensure yields are capped, but analysts say the government may lose some of its budget flexibility as there will be greater scrutiny of its finances.

The government's fiscal management will be watched closely, said Vivek Kumar, an economist with QuantEco Research. "Unwarranted indiscipline might involve higher cost for the government."

(Reporting by Nimesh Vora, Dharamraj Dhutia and Swati Bhat; Editing by Vidya Ranganathan and Barbara Lewis)