What impact will the addition of Indian government bonds to JPMorgan’s EM index have on Pakistan?

ISLAMABAD: The inclusion of Indian bonds in the JP Morgan Emerging Market Bond Index (EMBI) from June 28, 2024 is expected to attract significant foreign investment of up to $42 billion.

This will not only increase dollar inflow into India, resulting in appreciation of the Indian rupee, but also reduce inflationary pressures and more importantly make Indian products more competitive in the international market.

However, the inclusion of India, whose GDP is $4.11 trillion, in the JP Morgan Index will force investors to diversify their portfolios and reallocate funds from other emerging markets, including Pakistan, to India, given the stability and potential returns of Indian bonds. India currently offers 7-7.5 percent yields to investors.

This could lead to reduced international open market demand for Pakistani bonds, potentially increasing Pakistan’s borrowing costs. If the Indian rupee strengthens significantly, it could affect the trade balance in the region. Pakistani exporters may find it relatively more difficult to compete with Indian goods in the international market if the appreciation of the Indian rupee leads to cheaper exports from India. This is how Pakistan’s exports may suffer in the global market.

According to the FY25 budget document, Pakistan plans to float its $600 million sukuk bond in FY25 so that it can service external loan debt in the next fiscal year. However, there is a chance that Pakistan will not float any bond given Pakistan’s economic prospects.

As of mid-2024, credit ratings for Pakistan by major international rating agencies are not up to par as Fitch has affirmed Pakistan’s rating at ‘CCC’. This rating reflects significant credit risk, indicating that default is a real possibility and has rated S&P Pakistan at ‘CCC+’ with a stable outlook. This rating indicates significant risks, with vulnerability to default dependent on favorable economic and business conditions. Under the given situation, Pakistan is not allowed to issue any bond in the open market.

Dr. Ashfaque Hasan Khan, a leading economist and director of NUST, who has also been an advisor to the Ministry of Finance, said the inclusion of India’s bond in the JP Morgan Emerging Market Bond Index will certainly boost the Indian economy, but it will have no impact on Pakistan. He said that considering Pakistan’s current rating, it is not the right time for the finance department to float its bonds in search of loans as investors would look for high premiums and returns.

He said that according to him Pakistan need not opt ​​for releasing bonds in the international market because according to IMF Pakistan needs to arrange $9 billion for the next three budgets – $3 billion per year and the amount of $3 billion can be arranged from World Bank, ADB and other IFIs once the country manages to get the next IMF loan program. He also argued that investors prefer to invest in high yielding securities while buying paper of any country rather than investing in lower yielding securities. So Pakistan will not face any consequences if it releases its bonds in the open market after upgrading its rating.

Dr. Khan said Pakistan’s financial managers should aim for economic stabilization and once this is achieved and the country’s rating is improved, they should move to floating bonds. Pakistan should avoid floating bonds at least for the next financial year 20024-25 as Pakistan may face a higher risk premium in the given situation, meaning investors will demand higher returns for the perceived increased risk.

Khan said Pakistan was also included in JP Morgan EMBI in 2005-2006, during the Musharraf regime, when Pakistan’s foreign exchange market rose to $42 billion. However, Pakistan ceased to be part of it when the stock market collapsed. Since then, Pakistan cannot be included in the JP Morgan bond index.

Another economist, Sakib Sherani, said merging India with JP Morgan index will have no impact on Pakistan. He suggested that Pakistan should not float the bond for arranging funds in FY25 unless the country’s rating is improved. He said Pakistan can manage its repayment of foreign loans through rollovers of loans from friendly countries and arranging more loans from IFIs.

However, to finance imports, Pakistan should not depend on dollar loans and should continue the existing import regime of compressing imports to address the current account deficit and only manage the repayments of the external loans. Sherani said the government has taken up releasing $600 million in sukuk bonds in FY25, but he said this is not the right time as the country’s rating needs to be improved and economic stabilization still needs to be improved.