It is difficult to keep up with Andy Mukherjee. At the rate at which he is writing, he might give Amol Agrawal of ‘Mostly Economics’ a complex with his prolificity of writing. In the last twenty-four hours alone, I have counted three Andy pieces – joining the Bond index, on the lone SELL rating on ICICI Bank and on Uber selling out to GRAB in SE Asia.
We shall focus on the column on China joining the Barclays-Bloomberg Bond index with India an onlooker. Andy thinks that India should be less fussy about foreigners holding its sovereign debt issued in Indian rupees. After all, the country runs a current account deficit and it can do with some foreign savings. Once you are in the index, index tracking funds will be invested, no matter what the fundamentals are. Of course, they can go underweight but they won’t sell and scoot fully. That is the sum and substance of his argument, if I understood them correctly.
I do not disagree with the logic. There is something to be said in its favour. Andy’s points are well made. But, on balance, I think India is not ready for it and I am not sure it will be ready in the very near future. India lacks the governance and discipline required for sustained macroeconomic stability. China can and will brazen it out. It is ‘Too big to fail’. India is not.
Whether most investors stay invested or not because of index tracking requirements, what matters to asset prices is the behaviour of the marginal investor.
Whether the debt held by foreigners is denominated in local currency or in foreign currency matters little in the end. If investors whose reference currency is not INR decide that they wish to get rid of INR risk, then the foreign exchange risk comes into play fully, regardless of the currency of denomination of the Indian debt.
India frequently gets into situations in which foreigners would want out. Despite its savings rate at a low 30% (given its growth ambitions), India has not given up the ambition to become a high growth nation. Governments feeling shaky politically – that may be a reality after 2019 elections – might want to go for high growth and do so via fiscal populism something that India did, not so long ago (2009 to 2011) and that is recipe for disaster for debt and for the currency because with a savings rate of 30% and low capital and labour productivity, high growth can come only via a ramp-up of aggregate demand and that would blow out the current account deficit.
The bond market – rational as they are with respect to emerging markets (only) – would administer tough love. Sometimes, it is too tough.
Bond markets are far more sanguine with respect to fiscal profligacy and debt accumulation by advanced nations. Indeed, over the last thirty five years, bond investors have rewarded advanced nations’ public debt accumulation with ever-lower interest rates. So much for market discipline!
Therefore, all told, if one is not sure of self-control and discipline and would likely binge, it is better not to look at the plate of delicious sweets.
So, India is better off not regretting missing out on the bond index membership.