Even when viewed in isolation, the $14 billion outflow from India’s bond market in 2020 is remarkable: Foreign investors haven’t sold such a lot during a single year.

That they did so at a time when Chinese bonds are attracting record foreign inflows underscores just how frustrated some money managers became with the pace of capital-market reforms by Narendra Modi’s government.

While China’s steady progress on bond-market liberalization has earned it a spot in benchmark indexes and helped lure $119 billion of inflows this year, India still has a number of Asia’s toughest restrictions on foreign funds. The country’s failure so far to hitch China in global debt indexes is adding to investor concerns about meager inflation-adjusted yields and a widening fiscal deficit.

That could become a drag for Modi as his government borrows record amounts of cash to fight the pandemic. While financing costs have remained subdued this year, the danger is that the growing supply of Indian bonds begins to outstrip local demand. that would put upward pressure on interest rates and restrain the recovery in Asia’s third-largest economy from its deepest contraction on record.

India’s “financing needs are growing significantly given the deterioration in fiscal deficits and it’s therefore key for policy makers to determine a transparent framework toward a gradual opening of the market,” said Jean-Charles Sambor, London-based head of emerging markets fixed income at BNP Paribas Asset Management, which oversees about $727 billion.

In a response to questions from Bloomberg News, an Indian finance ministry official said the govt is making progress on debt-market reforms and expects to hitch global indexes in mid-2021. “We are now completing the method and institutional changes needed to permit all participants to be ready to buy and sell rupee Indian bonds easily ,” said Sanjeev Sanyal, a principal economic adviser within the finance ministry.

Bloomberg LP, the parent company of Bloomberg News and Bloomberg Barclays Indices, said in September 2019 it might help Indian authorities navigate a path to inclusion in international bond gauges.

It’s also debatable whether the short-term benefits of opening to international bond investors outweigh the risks. India’s borrowing costs have declined this year despite foreign outflows, thanks partially to bond purchases by the nation’s financial institution . Foreign inflows into the stock exchange , meanwhile, have swelled to an eight-year high.

Yet because the government’s borrowing needs increase, it’s going to have a harder time finding enough bond buyers domestically. Modi’s administration plans to borrow a record 13.1 trillion rupees ($178 billion) within the financial year ending March and is forecast to post a deficit like 8% of gross domestic product, the most important shortfall in additional than three decades. That comes at a time when yields on 10-year Indian bonds are hovering at around 6%, almost a full decimal point below the rate of inflation .

India has taken some small steps to open its bond market this year, including by removing ownership restrictions on certain sorts of government debt. But the moves have done little to stem the tide of outflows, with foreigners holding just 2% of outstanding Indian bonds at the top of November.

The reforms have also paled as compared to those taken by China, whose debt is now included in — or on a phased path to inclusion in — benchmark indexes compiled by FTSE Russell, Bloomberg Barclays Indices and JPMorgan Chase & Co. JPMorgan kept India out of its widely followed GBI-EM Global Diversified index in September, citing among other shortcomings the country’s capital controls, settlement issues and outdated trading requirements.

That doesn’t mean international investors have given abreast of India entirely. Closer cooperation between local authorities and index providers, along side a more stable rate of exchange , could help pave the way for eventual inclusion in indexes and more global portfolios, said Joevin Teo, head of Asia fixed-income at Amundi Singapore Ltd.

Julio Callegari, lead portfolio manager for Asia rates and FX at JPMorgan Asset Management in Hong Kong , said he’s also hopeful India will make progress on reform. But he warns it could take time.

“The truth is that India remains in early stages,” Callegari said. “It should take one or two years to ascertain the inclusion that might drive more bond investments within the country.”-Bloomberg

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