Why India’s balance of payments surplus may swell in FY25

A spurt in foreign institutional investment (FII) inflows to the tune of $25 billion, largely on account of the inclusion of government debt in a JP Morgan index, is expected to lead to a balance of payments surplus of about $52 billion this fiscal, the State Bank of India (SBI) said.

“FII inflows, which are $3.5 billion so far this fiscal, are expected to be around $25 billion, getting the support through the debt inflows on account of bond inclusion ($2.3 billion so far, plus another $18 billion expected),” SBI’s research wing said in a report.

US’ largest commercial bank JP Morgan Chase had last September announced the slated inclusion of Indian government bonds in its benchmark emerging-market global diversified (GBI-EM GD) index.

The index provider began adding the securities starting 28 June but monthly net inflows into securities under the Fully Accessible Route (FAR) hit ₹90,000 crore between October 2023 and June 2024 post the September announcement.

FAR is a category of Indian government bonds that are freely available for foreign investors to purchase without significant curbs, and all FAR designated government bonds maturing after 31 December 2026 are eligible.

The GBI-EM GD, or Global Bond Index Global Diversified, index had an assets under management (AUM) benchmark of $213 billion as of August last year.

Post inclusion, India’s weight in the GBI-EM GD index is expected to reach the maximum threshold of 10%. In the broader GBI-EM Global index, India’s weight is projected at about 8.7%. This could lead to passive flows (investments driven by composition of the index rather than active decisions) of around $20-22 billion by March 2025, based on current AUM and holdings, the lender said.

In March this year, Bloomberg had announced the inclusion of Indian FAR bonds in the Bloomberg Emerging Market (EM) Local Currency Government Index and related indices, to be phased in over a 10-month period, starting January 2025.

Once completely phased into the Bloomberg Emerging Market 10% Country Capped Index, India is expected to join both China and South Korea as markets that reach the 10% cap.

Using data as of 31 January 2024, the index would include 34 Indian securities and represent 7.26% of a $6.18 trillion index on a market value weighted basis.

SBI sees India’s current account deficit in this fiscal year at $36 billion, or 0.9% of gross domestic product (GDP), with goods exports of $455 billion and imports of $708 billion.

The lender also said said net foreign direct investment (FDI) inflows, which dropped to the lowest level since 2007 in fiscal 2024, is expected to recover in the current fiscal year to around $30 billion.

In its annual report for FY24, the Reserve Bank of India (RBI) said net FDI inflows had sunk to $10.6 billion in the past fiscal from $28 billion the previous fiscal on account of a jump in repatriation of FDI to the tune of $44 billion from India.

The index inclusion of Indian bonds may lead to monthly inflows of about $2 billion for the next nine months, which in turn will boost demand for government papers, leading to lower yields with greater and faster impact on short-end tenor, SBI said in the report.

The foreign investment expected to come after inclusion in the indices will widen market depth of government bonds and boost system liquidity. “Thus, the liquidity situation which has been affected due to the adoption of just in time (JIT) mechanism through its impact on government surplus cash balances might get some respite,” the lender said.

With JIT, the government may reduce its cash holdings because it can procure goods or services closer to the time they are needed, rather than maintaining large cash reserves.