Indian Bonds: Set to Extend Rally into 2025

The Indian bond market has been on a remarkable run, driven by a combination of liberalization, index inclusion, and attractive structural features. As we look ahead to 2025, the stars seem to be aligning for Indian bonds to extend their rally, presenting investors with compelling opportunities. This article explores the key factors behind this bullish outlook and the potential risks that investors should be aware of.

Liberalization and Index Inclusion

The liberalization of the Indian bond market, particularly the classification of certain government bonds as 'fully accessible route' (FAR) securities, has opened the floodgates for foreign investors. This has led to a surge in foreign inflows, with over $15 billion invested in 2024 alone. The upcoming inclusion of Indian bonds in global indices like the FTSE EM Government Bond Index is expected to attract an additional $40 billion in foreign investment by mid-2025.



Attractive Structural Features

Indian government bonds offer several attractive structural features that make them an appealing investment option. The Indian government bond market is vast, with assets totaling $1.3 trillion, and it trades with tight bid-offer spreads of only 1-3 basis points, indicating good liquidity. Additionally, the bonds of various state governments amount to $500 billion, while the corporate bond market is worth a further $500 billion. Indian bond market volatility is also historically low at 5%, with the rupee one of the least volatile currencies globally in recent years.



Diversification and Defensive Benefits

Domestic Indian government bonds offer good diversification thanks to their historically low correlation with other global assets. This diversification effect is attributed to the minimal level of foreign ownership, which is expected to rise to just under 4% following index inclusion. Additionally, Indian bonds have shown relatively better performance in challenging market environments, as demonstrated by their 3% decline during the Covid-19 market sell-off.

Potential Headwinds and Risks

While the outlook for Indian bonds appears bullish, investors should be aware of potential headwinds and risks. A resurgent dollar and higher US Treasury yields could dent emerging-market assets, although the ongoing bond index inclusion flows are likely to provide sustained solid passive support to Indian bonds. A weaker GDP growth outlook for 2025 and geopolitical uncertainties could also impact investor confidence.



In conclusion, the Indian bond market is well-positioned to extend its rally into 2025, driven by liberalization, index inclusion, and attractive structural features. However, investors should remain vigilant and monitor the market closely to navigate potential headwinds and risks. By staying informed and adaptive, investors can capitalize on the opportunities presented by the Indian bond market and maintain a balanced and diversified investment portfolio.

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