The Markets will be entering a new phase from July onwards with the inclusion of Indian bonds in the JP Morgan Index. In fact, after the announcement of inclusion of these bonds in September, there was a gradual build-up of holdings in government securities (G-Secs) by foreign portfolio investors (FPIs). The assets under custody of sovereign bonds held by FPIs climbed from around $19 billion in September-end to $28 billion in mid-June. Clearly some of the players wanted to build their positions in advance to take advantage of the indices, once included. This phase was also associated with considerable activity in the G-Sec and forex market though there were several other factors at play. What can be expected going forward?

The basics can be put together to begin with. The JP Morgan index of bonds involving government paper would assign a weight of 10% to India at the rate of 1% per month. Hence even passive investment in the index would mean some allocation for Indian bonds. Twenty-three securities would qualify for investment where there are norms on the residual maturity as well as amount outstanding. Both are necessary for rebalancing the index. Unlike equity which is perpetual, debt matures at some point of time and would require replacement of appropriate securities. The Reserve Bank of India (RBI) has also included several securities under the FAR banner which denotes fully accessible route, where no limits are placed on FPI holdings. If one were to arbitrage between the market and the index, there could be additional inflows as one could take a call on the index and also a position in the particular security. All put together, there are estimates which point to an inflow of $20-25 billion on this score. This comes to around `1.8-2 trillion of potential purchases.

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Now, the total borrowings for the year for the government is around `14 trillion. While only some securities would qualify to meet the index criteria, intuitively it can be seen that there would also be secondary market purchases of existing securities and hence it would free funding space of existing holders who could easily subscribe to the new securities issued this year. Hence, there will be easing of liquidity to a large extent as there is a new player in the market. Banks, in particular, will be less pressured to subscribe to these securities and can use them for lending purposes. Therefore, the advantage of liquidity will accrue over time.

Second, as there is more demand for paper, prices would tend to increase given that the supply is limited to existing stock or the announced fresh set of securities. Higher prices in the market would mean lower yields and hence this is something that will happen in the natural course. For banks holding on to paper, there will be mark-to-market gains to be made in........

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