Bond Market Financial Mkt

8/11/2019 Bond Market Financial Mkt

1/38

1

INTRODUCTION

The importance of the debt market in an emerging economy cannot be

overemphasised. In the presence of uncertainty and prudential norms,

banks often decline to lend for long term projects, and borrowing

from overseas markets may be constrained by country risk

perceptions and restrictions on capital mobility. At the same time,

businesses in these countries are often closely held within families

and communities, and the fear of loss of power often keep such

companies away from the primary market for equities. In such cases,

the market for debt securities may emerge as the mainstay of the

credit and capital markets. Even in a fairly well developed emerging

financial market like that in India, only INR 58.92 billion, INR 36.78

billion and INR 98.55 billion respectively were raised by way of

equity shares during 1997-98, 1998-99 and 1999-2000. The amounts

raised through non-convertible debentures during the corresponding

years were INR 265.39 billion, INR 286.98 billion and INR 363.93

billion.

Besides, the debt market allows appropriate evaluation of non-

systematic risk, and dissemination of the perception of the investors

about firm specific risk by way of the spreads that the corporate bonds

command over the benchmark rates. Finally, the debt market helps

generate the (zero coupon) yield curve which reflects the expectations

of the investors about future interest rates, and thereby becomes an

invaluable analytical tool for both monetary authorities and investorsin instruments like financial derivatives.


2/38

2

Recent research on the bond market has focussed primarily on the

term structure of interest rate. For example, attempts have been made

to bridge the gap between stylised models like those by Cox, Ingersoll

and Ross, and Heath, Jarrow and Morton . Others have used non-

parametric techniques to estimate the term structures of specific

countries (Jiang, 1998) and specific types of securities (Briys and de

Varenne, 1997; Duffie and Singleton, 1999). And yet others have

explored the covariance between the prices of futures contracts and

the cost-of-carry relationship that is determined by the underlying

interest rates (de Roon, Nijman and Veld, 1998).

However, analyses of the structure of the debt market are few and far

between.

Indeed, the literature on the impact of market structures on

the price discovery mechanism and market efficiency has largely been

limited to the equity market, with special emphasis on the market for

limit orders. But it is safe to hypothesise a priori that market

structures have a definitive impact on the price discovery process in

the debt markets, and hence on their efficiency. The endeavour of this

paper would be twofold: it would trace the evolution of the Indian

bond market, and draw conclusions about the nature of the market

itself from the available data. Given that the market for dated

government securities is much deeper and wider than the market for

corporate bonds, the empirical analysis will be restricted to the data

available from the market for dated securities.


3/38

3

As we shall see later, the data indicates that while the market for

government bonds in India has matured significantly during the

1990s, the structure of the market still fosters illiquidity and, as a

consequence, perverse pricing of government securities.

The paper has been structured as follows. In the second section of the

paper, we trace the evolution of the Indian market for government

securities. Some preliminary observations about the market are

presented in the following section, using data made available by the

Reserve Bank of India (RBI). The fourth section takes a closer look at

the bond market, and highlights certain peculiarities in the behaviour

of the market participants that can explain pricing anomalies. Finally,

section five sums up the findings of this paper, and explores policy

options that can make the market more liquid and the pricing process

less perverse.

The Market for Government Securities

The most pervasive feature of the Indian bond market is that while a

large number of financial institutions, banks and corporate entities

issue bonds on a regular basis, trading in the secondary market is

overwhelmingly dominated by government securities. Indeed, the

fraction of the turnover in the secondary market that is accounted for

by treasury bills (T-bills) and dated government securities

increased

from 90.6 per cent in 1996-97 to 96.5 per cent during the first three

quarters of 1999-2000.

The corresponding increase in the share of the

latter was from 64.7 per cent to 93.1 per cent.


4/38

4

Hence, as mentioned above, we shall focus on the structure of the

market for dated government securities.

Prior to April 1993, the prices/yields of government securities were

not market driven. The government fixed the yields (and coupons) at

low levels in the primary market, so as to reduce its cost of

borrowing. As a consequence, banks had little incentive to purchase

government securities, and hence the statutory liquidity ratio (SLR)

was continually raised during the 1970s and 1980s. Since banks

purchased government securities largely (if not wholly) to meet their

SLR requirements, transactions in the secondary market were few and

infrequent. Further, the secondary market remained an over-the-

counter (OTC) market with scheduled commercial banks as the main

market participants. Hence, there were significant barriers to

dissemination of information about prices and yields in the secondary

market, and it was marked by absence of market makers. The

resultant informational problems, and the ability of large buyers and

sellers to influence prices added to the unattractiveness of trading in

the secondary market for government securities.

The years 1994 and 1995 were marked by developments that arelikely to shape the future of Indias debt market. In June, 1994, the

wholesale debt market (WDM) of the National Stock Exchange

(NSE) commenced operation with 224 securities carrying an

outstanding debt value of INR 135 billion.


5/38

5

The WDM provides a fully automated screen-based trading platform

that is order driven. It matches best buy and sell orders on a price-time

priority, while maintaining complete anonymity. Though most market

participants have not graduated to this trading mechanism and prefer

the OTC platform, OTC trades are usually reported to the WDM

segment and this helps disseminate data on intra-day prices and traded

quantities.

The initiative taken by the NSE found official support in March, 1995

when the government and the RBI oversaw the emergence of primary

dealers. The emergence of primary dealers (PDs)

coincided with

auction-based sale of government securities in the primary market,

replacing the earlier system whereby government securities were

wholly underwritten by the RBI at some pre-determined price-yield.

More importantly, the PDs were in a position to make markets

and

provide two-way quotes to participants in the secondary market.

Screen based trading, together with two-way quotes for securities,

was expected to alleviate the informational problems in the secondary

market. Further, the SLR requirements were reduced to 30 per cent in

March 1995, from 37.5 per cent in 1992, thereby releasinggovernment securities for price-driven trade in the secondary market.


6/38

6

In 1995, the RBI also introduced the delivery-against-payment system

for all government securities. Apart from making it difficult for

traders to manipulate prices with uncovered long or short positions,

which could be netted out before actual delivery, the system was

aimed at eliminating counterparty risk. This system, which mandated

that all trades in government securities be routed through the

subsidiary general ledger (SGL) accounts with the RBI, was followed,

in 1998, by the establishment of custodial and depository services for

these securities by National Securities Depository Limited (NSDL),

Stock Holding Corporation of India Limited (SHCIL) and National

Stock Clearing Corporation Limited (NSCCL). The establishment of

these services significantly reduced the probability of bad deliveries,

and therefore encouraged trading in the secondary market. Further

encouragement came from the government in 1998, in the form ofelimination of stamp duty on trades in debt securities.

It is evident that the Indian market for government securities has

come a long way since the days of financial repression which

persisted till the early 1990s. However, several problems continue to

persist. First, the market continues to lack in width. On any given day,

only about 20 government securities are traded in the secondary

market, and even two-way quotes are available for about 25 securities,

the total number of dated government securities outstanding being

about 120. The securities that are frequently traded during any time

period are commonly known as benchmark securities.


7/38

7

Further, while the depth of the market has increased considerably in

terms of rupee turnover, the number of trades per security continues to

be low on average. Indeed, most of the trades in the government

securities market be traced back to asset-liability mismatch of

participating institutions or in their statutory obligations (Nag and

Ghose, 2000). As we shall see later, rupee turnover is not a good

indicator of competitive trading in the secondary market, especially

when the market is OTC and is dominated by large players like State

Bank of India (SBI), Life Insurance Corporation of India (LIC) and

Unit Trust of India (UTI). As a result, trading in the secondary market

for government securities does not yet take place in a competitive

price-searching environment, and hence the pricing of securities in the

market is often perverse.

Unlike stock prices, bond prices have precise relationships with an

important macroeconomic variable: the interest rate.

Hence, while a

stock market is deemed to be efficient if the stock prices are a random

walk, efficiency in the bond market would imply that, given a well-

defined term structure of interest rates, bonds of similar maturities and

characteristics would have similar prices, i.e., all market participants

are informed about, and have endogenised all information about, the

term structure.


8/38

8

However, if a market is largely OTC in nature, and is characterised by

a few trades among a handful of traders, the probability of market

manipulation and mispricing increases manifold, and prices may be

determined more by relative bargaining powers of the buyer and the

seller rather than by expectations about the future interest rates.

Alternatively, the possibility of mispricing, and hence market

inefficiency, decreases if there is an increase in the number of

participants and trades in the market, and if the trades take place

online such that the buy and sell orders are available to all market

participants in real time. In such a situation, if the market has

mispriced bonds, even marginal players are able to identify arbitrage

opportunities, and can exploit such opportunities successfully. The

ability of market participants to engage in competitive price searching

activity increases manifold if, not surprisingly, there are a large

number of buyers and sellers, a good proxy for which is the number of

trades recorded during a particular time period. The monotonically

increasing relationship between the number of trades and the

efficiency of the bond market, in an environment of transparent

trading, is, therefore, obvious. Further, if an efficient bond market

characterised by theoretically consistent relationships between bond

prices and expected interest rates, there should be little variance

among yields of plain vanilla bonds with similar maturity structures.


9/38

9

ORIGIN OF BOND MARKET

Towards the eighteenth century, the borrowing needs of Indian

Princely States were largely met by Indigenous bankers andfinanciers. The concept of borrowing from the public in India was

pioneered by the East India Company to finance its campaigns in

South India (the Anglo French wars) in the eighteenth century. The

debt owed by the Government to the public, over time, came to be

known as public debt. The endeavors of the Company to establish

government banks towards the end of the 18th Century owed in no

small measure to the need to raise term and short term financial

accommodation from banks on more satisfactory terms than they were

able to garner on their own.

Public Debt, today, is raised to meet the Governments revenue deficits

(the difference between the income of the government and money

spent to run the government) or to finance public works (capital

formation). Borrowing for financing railway construction and public

works such irrigation canals was first undertaken in 1867.


10/38

10

The First World War saw a rise in India's Public Debt as a result of

India's contribution to the British exchequer towards the cost of the

war. The provinces of British India were allowed to float loans for the

first time in December, 1920 when local government borrowing rules

were issued under section 30(a) of the Government of India Act,

1919. Only three provinces viz., Bombay, United Provinces and

Punjab utilised this sanction before the introduction of provincial

autonomy. Public Debt was managed by the Presidency Banks, the

Comptroller and Auditor-General of India till 1913 and thereafter by

the Controller of the Currency till 1935 when the Reserve Bank

commenced operations.

Interest rates varied over time and after the uprising of 1857 gradually

came down to about 5% and later to 4% in 1871. In 1894, the famous

3 1/2 % paper was created which continued to be in existence for

almost 50 years. When the Reserve Bank of India took over the

management of public debt from the Controller of the Currency in

1935, the total funded debt of the Central Government amounted to

Rs 950 crores of which 54% amounted to sterling debt and 46% rupee

debt and the debt of the Provinces amounted to Rs 18 crores.


11/38

11

Broadly, the phases of public debt in India could be divided into the

following phases.

Upto 1867: when public debt was driven largely by needs of

financing campaigns.

1867- 1916:when public debt was raised for financing railways and

canals and other such purposes.

1917-1940: when public debt increased substantially essentially out

of the considerations.

1940-1946: when because of war time inflation, the effort was to

mop up as much a spossible of the current war time incomes

1947-1951: represented the interregnum following war and partition

and the economy was unsettled. Government of India failed to

achieve the estimates for borrwings for which credit had been taken inthe annual budgets.

1951-1985:when borrowing was influenced by the five year plans.

1985-1991:when an attempt was made to align the interest rates on

government securities with market interest rates in the wake of the

recommendations of the Chakraborti Committee Report.


12/38

12

1991 to date: When comprehensive reforms of the Government

Securities market were undertaken and an active debt management

policy put in place. Ad Hoc Treasury bills were abolished;

commenced the selling of securities through the auction process; new

instruments were introduced such as zero coupon bonds, floating rate

bonds and capital indexed bonds; the Securities Trading Corporation

of India was established; a system of Primary Dealers in government

securities was put in place; the spectrum of maturities was broadened;

the system of Delivery versus payment was instituted; standard

valuation norms were prescribed; and endeavours made to ensure

transparency in operations through market process, the dissemination

of information and efforts were made to give an impetus to the

secondary market so as to broaden and deepen the market to make it

more efficient.

In India and the world over, Government Bonds have, from time to

time, have not only adopted innovative methods for rasing resources

(legalised wagering contracts like the Prize Bonds issued in the 1940s

and later 1950s in India) but have also been used for various

innovative schemes such as finance for development; social

engineering like the abolition of the Zamindari system; saving the

environment; or even weaning people away from gold (the gold bonds

issued in 1993).


13/38

13

Normally the sovereign is considered the best risk in the country and

sovereign paper sets the benchmark for interest rates for the

corresponding maturity of other issuing entities. Theoretically, others

can borrow at a rate above what the Government pays depending on

how their risk is perceived by the markets. Hence, a well developed

Government Securities market helps in the efficient allocation of

resources. A countrys debt market to a large extent depends on the

depth of the Governments Bond Market. It in in this context that the

recent initiatives to widen and deepen the Government SecuritiesMarket and to make it more efficient have been taken.


14/38

14

INDIAN BOND MARKET

The Indian Bond Market has been traditionally dominated by the

Government securities market. The reasons for this are:

The high and persistent government deficit and the need to

promote an efficient government securities market to finance

this deficit at an optimal cost.

A captive market for the government securities in the form of

public sector banks which are required to invest in governmentsecurities a certain per cent of deposit liabilities as per statutory

requirement1.

The predominance of bank lending in corporate financing and

Regulated interest rate environment that protected the banks

balance sheets on account of their exposure to the government

securities.

While these factors ensured the existence of a big Government

securities market, the market was passive with the captive

investors buying and holding on to the government securities till

they mature. The trading activity was conspicuous by its

absence.

The scenario changed with the reforms process initiated in the early

nineties. The gradual deregulation of interest rates and the

Governments decision to borrow through auction mechanism and at

market related rates.


15/38

15

Debt Market

Debt market as the name suggests is where debt instruments or bonds

are traded. The most distinguishing feature of these instruments is that

the return is fixed i.e. they are as close to being risk free as possible, if

not totally risk free. The fixed return on the bond is known as the

interest rate or the coupon rate. Thus, the buyer of a bond gives the

seller a loan at a fixed rate, which is equal to the coupon rate. Debt

Markets are therefore, markets for fixed income securities issued by:

Central and State Governments

Municipal Corporations

Entities like Financial Institutions, Banks, Public Sector Units,

and Public Ltd. companies.

The money market also deals in fixed income instruments. However,

difference between money and bond markets is that the instruments in

the bond markets have a larger time to maturity (more than one year).

The money market on the other hand deals with instruments that have

a lifetime of less than one year


16/38

16

Segments of Debt Markets

There are three main segments in the debt markets in India,

Government Securities,

Public Sector Units (PSU) bonds and

Corporate securities.

The market for Government Securities comprises the Centre, State

and State-Sponsored securities. The PSU bonds are generally treated

as surrogates of sovereign paper, sometimes due to explicit guarantee

and often due to the comfort of public ownership. Some of the PSU

bonds are tax free while most bonds, including government securities

are not tax free. The Government Securities segment is the most

dominant among these three segments.


17/38

17

Many of the reforms in pre-1997 period were fundamental, like

introduction of auction systems and PDs. The reform in the

Government Securities market which began in 1992, with Reserve

Bank playing a lead role, entered into a very active phase since April

1997, with particular emphasis on development of secondary and

retail markets.


18/38

18

1.MARKET STRUCTURE

There is no single location or exchange where debt market

participants interact for common business. Participants talk to each

other, conclude deals, send confirmations etc. on the telephone, with

clerical staff doing the running around for settling trades. In that

sense, the wholesale debt market is a virtual market.

In order to understand the entirety of the wholesale debt market we

have looked at it through a framework based on its main elements.

The market is best understood by understanding these elements and

their mutual interaction. These elements are as follows:

Instruments - the instruments that are being traded in the debt

market.

Issuers -entity which issue these instruments.

Investors -entities which invest in these instruments or trade in

these instruments.

Interventionists or Regulators - the regulators and the

regulations governing the market.

It is necessary to understand microstructure of any market to identify

processes, products and issues governing its structure and

development. In this section a schematic presentation is attempted on

the micro-structure of Indian corporate debt market so that the issues

are placed in a proper perspective. Figure gives a birds eye view of

the Indian debt market structure.


19/38

19

The Structure of the Indian Debt Market


20/38

20

2.MARKET PARTICIPANT

As is well known, a large participant base would result in lower cost

of borrowing for the Government. In fact, retailing of Government

Securities is high on the agenda of further reforms.

Banks are the major investors in the Government Securities markets.

Traditionally, banks are required to maintain a part of their net

demand and time liabilities in the form of liquid assets of which

Government Securities have always formed the predominant share.

Despite lowering the Statutory Liquidity Ratio (SLR) to the minimum

of 24 per cent, banks are holding a much larger share of Government

Stock as a portfolio choice. Other major investors in Government

Stock are financial institutions, insurance companies, mutual funds,

corporate, individuals, non-resident Indians and overseas corporate

bodies. Foreign institutional investors are permitted to invest in

Treasury Bills and dated Government Securities in both primary and

secondary markets.

Often, the same participants are present in the non-Government debt

market also, either as issuers or investors. For example, banks are

issuers in the debt market for their Tier-II capital. On the other hand,

they are investors in PSU bonds and corporate securities. Foreign

Institutional Investors are relatively more active in non-Government

debt segment as compared to the Government debt segment.


21/38

21

Central Governments, raising money through bond issuances, to

fund budgetary deficits and other short and long term funding

requirements.

Reserve Bank of India, as investment banker to the government,

raises funds for the government through bond and t-bill issues, and

also participates in the market through open-market operations.

Primary Dealers, who are market intermediaries appointed by the

Reserve Bank of India who underwrite and make market in

government securities, and have access to the call markets and repo

markets for funds.

State Governments, municipalities and local bodies, which issue

securities in the debt markets to fund their developmental projects, as

well as to finance their budgetary deficits.

Public Sector Units are large issuers of debt securities, for raising

funds to meet the long term and working capital needs. These

corporations are also investors in bonds issued in the debt markets.

Public Sector Financial Institutions regularly access debt markets

with bonds for funding their financing requirements and working

capital needs. They also invest in bonds issued by other entities in the

debt markets.

Banksare the largest investors in the debt markets, particularly the

treasury bond and bill markets. They have a statutory requirement

to hold a certain percentage of their deposits (currently the

mandatory requirement is 24% of deposits) in approved securities


22/38

22

Mutual Funds have emerged as another important player in the

debt markets, owing primarily to the growing number of bond

funds that have mobilized significant amounts from the investors.

Foreign Institutional Investors FIIs can invest in Government

Securities upto US $ 5 billion and in Corporate Debt up to US $ 15

billion.

Provident Funds are large investors in the bond markets, as the

prudential regulations governing the deployment of the funds they

mobilise, mandate investments pre-dominantly in treasury and PSU

bonds. They are, however, not very active traders in their portfolio,

as they are not permitted to sell their holdings, unless they have a

funding requirement that cannot be met through regular accruals

and contributions.

Corporate treasuries issue short and long term paper to meet the

financial requirements of the corporate sector. They are also

investors in debt securities issued in the debt market.

Charitable Institutions, Trusts and Societies are also large

investors in the debt markets. They are, however, governed by their

rules and byelaws with respect to the kind of bonds they can buy

and the manner in which they can trade on their debt portfolios.


23/38

23

3.MARKET INSTRUMENTS

The instruments traded can be classified into the following segments

based on the characteristics of the identity of the issuer of these

securities

Commercial Paper (CP): They are primarily issued by corporate

entities. It is compulsory for the issuance of CPs that the company be

assigned a rating of at least P1 by a recognized credit rating agency.

An important point to be noted is that funds raised through CPs do not

represent fresh borrowings but are substitutes to a part of the banking

limits available to them.


24/38

24

Certificates of Deposit (CD): While banks are allowed to issue CDs

with a maturity period of less than 1 year, financial institutions can

issue CDs with a maturity of at least 1 year. The prime reason for an

active market in CDs in India is that their issuance does not warrant

reserve requirements for bank.

Treasury Bills (T-Bills): T-Bills are issued by the RBI at the behest

of the Government of India and thus are actually a class of

Government Securities. Presently T-Bills are issued in maturity

periods of 91 days, 182 days and 364 days. Potential investors have to

put in competitive bids. Non-competitive bids are also allowed in

auctions (only from specified entities like State Governments and

their undertakings, statutory bodies and individuals) wherein the

bidder is allotted T-Bills at the weighted average cut off price.

Long-term debt instruments: These instruments have a maturity

period exceeding 1year. The main instruments are Government of

India dated securities (GOISEC), State Government securities (state

loans), Public Sector Undertaking bonds (PSU bonds) and corporate

bonds/debenture. Majority of these instruments are coupon bearing

i.e. interest payments are payable at pre specified dates.


25/38

25

Government of India dated securities (GOISECs): Issued by the

RBI on behalf of the Central Government, they form a part of the

borrowing program approved by Parliament in the Finance Bill each

year (Union Budget). They have a maturity period ranging from 1

year to 30 years. GOISECs are issued through the auction route with

the RBI pre specifying an approximate amount of dated securities that

it intends to issue through the year. But unlike T-Bills, there is no

preset schedule for the auction dates. The RBI also issues products

other than plain vanilla bonds at times, such as floating rate bonds,

inflation-linked bonds and zero coupon bonds.

State Government Securities (state loans): Although these are

issued by the State Governments, the RBI organizes the process of

selling these securities. The entire process, 17 right from selling to

auction allotment is akin to that for GOISECs. They also form a part

of the SLR requirements and interest payment and other modalities

are analogous to GOISECs. Although there is no Central Government

guarantee on these loans, they are believed to be exceedingly secure.

One important point is that the coupon rates on state oans are slightly

higher than those of GOISECs, probably denoting their sub-sovereign

status.

Public Sector Undertaking Bonds (PSU Bonds): These are long-

term debt instruments issued generally through private placement.

The Ministry of Finance has granted certain PSUs, the right to issue

tax-free bonds. This was done to lower the interest cost for those

PSUs who could not afford to pay market determined interest rates.


26/38

26

Bonds of Public Financial Institutions (PFIs): Financial Institutions

are also allowed to issue bonds, through two ways - through public

issues for retail investors and trusts and secondly through private

placements to large institutional investors.

Corporate debentures: These are long-term debt instruments issued

by private companies and have maturities ranging from 1 to 10 years.

Debentures are generally less liquid as compared to PSU bonds.


27/38

27

4.MARKET INFRASTRUCTURE

Securities Settlement System: Settlement of government securities

and funds is being done on a gross trade-by-trade Delivery vs.Payments (DvP) basis in the books of Reserve Bank, since 1995. A

Special Funds Facility from Reserve Bank for securities settlement

has also been in operation since October 2000 for breaking gridlock

situations arising in the course of DvP settlement.

With the introduction of Clearing Corporation of India Ltd (CCIL) in

February 2002, which acts as clearing house and a central

counterparty, the problem of gridlock of settlements has been

reduced. To enable Constituent Subsidiary General Ledger (CSGL)

account holders to avail of the benefits of dematerialised holding

through their bankers, detailed guidelines have been issued to ensure

that entities providing custodial services for their constituents employ

appropriate accounting practices and safekeeping procedures.

Negotiated Dealing System: A Negotiated Dealing System (NDS)

(Phase I) has been operationalised effective from February 15, 2002.

In Phase I, the NDS provides on line electronic bidding facility in

primary auctions, daily LAF auctions, screen based electronic dealing

and reporting of transactions in money market instruments, facilitates

secondary market transactions in Government securities and

dissemination of information on trades with minimal time lag.


28/38

28

In addition, the NDS enables "paperless" settlement of transactions in

government securities with electronic connectivity to CCIL and the

DvP settlement system at the Public Debt Office through electronic

SGL transfer form.

Clearing Corporation of India Limited:The Clearing Corporation

of India Limited (CCIL) commenced its operations in clearing and

settlement of transactions in Government securities (including repos)

with effect from February 15, 2002. Acting as a central counterparty

through novation, the CCIL provides guaranteed settlement and has in

place risk management systems to limit settlement risk and operates a

settlement guarantee fund backed by lines of credit from commercial

banks. All repo transactions have to be necessarily put through the

CCIL, while all outright transactions up to Rs.200 million have to be

settled through CCIL (Transactions involving larger amounts are

settled directly in RBI).

Transparency and Data Dissemination : To enable both

institutional and retail investors to plan their investments better and

also to providing further transparency and stability in the Government

securities market, an indicative calendar for issuance of datedsecurities has been introduced in 2002. To improve the information

flow to the market Reserve Bank announces auction results on the day

of auction itself and all transactions settled through SGL accounts are

released on the same day by way of press releases/on RBI website.


29/38

29

Statistical information relating to both primary and secondary market

for Government securities is disseminated at regular interval to ensure

transparency of debt management operations as well as of secondary

market activity. This is done through either press releases or Banks

publications viz., (e.g., RBI monthly Bulletin, Weekly Statistical

Supplement, Handbook of Statistics on Indian Economy, Report on

Currency and Finance and Annual Report).

The Bond Market in India with the liberalization has been

transformed completely. The opening up of the financial market at

present has influenced several foreign investors holding upto 30% of

the financial in form of fixed income to invest in the bond market in

India.

The bond market in India has diversified to a large extent and that is a

huge contributor to the stable growth of the economy. The bond

market has immense potential in raising funds to support the

infrastructural development undertaken by the government and

expansion plans of the companies. Sometimes the unavailability of

funds become one of the major problems for the large organization.

The bond market in India plays an important role in fund raising fordevelopmental ventures. Bonds are issued and sold to the public for

funds.


30/38

30

Bonds are interest bearing debt certificates. Bonds under the bond

market in India may be issued by the large private organizations and

government company. The bond market in India has huge

opportunities for the market is still quite shallow. The equity market

is more popular than the bond market in India. At present the bond

market has emerged into an important financial sector.

He different types of bond market in India

Corporate Bond Market

Municipal Bond Market

Government and Agency Bond Market

Funding Bond Market

Mortgage Backed and Collateral Debt Obligation Bond Market

The major reforms in the bond market in India

The system of auction introduced to sell the government securities.

The introduction of delivery versus payment (DvP) system by the

Reserve Bank of India to nullify the risk of settlement in securities

and assure the smooth functioning of the securities delivery and

payment.

The computerization of the SGL.

The launch of innovative products such as capital indexed bonds and

zero coupon bonds to attract more and more investors from the wider

spectrum of the populace.


31/38

31

Sophistication of the markets for bonds such as inflation indexed

bonds.

The development of the more and more primary dealers as creators of

the Government of India bonds market.

The establishment of the a powerful regulatory system called the trade

for trade system by the Reserve Bank of India which stated that all

deals are to be settled with bonds and funds.

A new segment called the Wholesale Debt Market (WDM) wasestablished at the NSE to report the trading volume of the

Government of India bonds market.

Issue of ad hoc treasury bills by the Government of India as a funding

instrument was abolished with the introduction of the Ways And

Means agreement.


32/38

32

CURRENT STATUS IN INDIAN BOND MARKET

In 2012, the size of the Indian bond market was approximately

equivalent to 27% of the Chinese bond market and 69% of the Koreanbond market. Towards the end of 2012, the total volume of

outstanding bonds accounted for roughly USD 1 trillion, reflecting an

overall increase of 24% from the previous year which both

government securities and corporate bonds contributed.

Government securities comprise 79% of the total amount of

outstanding bonds, a larger percentage than government securities in

China, which is 73%, and in Korea, which accounts for only 39%.

Last year, the amount of outstanding government securities increased

more steeply, at a growth rate of 23% and reaching USD 792 billion,

compared to the average rate of 18% per year over the period

spanning from 2000 to 2012.


33/38

33


34/38

34

The percentage of outstanding corporate bonds to GDP indicates the

small size of the Indian corporate bond market. The total share

accounts for 5.48% representing an extremely small proportion of the

total. In the Asia-Pacific region, the corporate bond markets of

namely Malaysia, South Korea, Thailand, Singapore and China,

exceeds that of India as a percentage of GDP. Only Indonesia has a

weaker corporate bond market in the region. Although it is very small

in size as a share of GDP, the corporate bond market is actually one of

the largest in East Asia outstripping most of these emerging bond

markets, with the notable exceptions of China and Korea. However,

the non-financial corporate sector is not actively represented in the

Indian bond market. In fact, financial institutions, such as banks and

non-bank financial, together comprise 72% of the overall amount of

outstanding corporate bonds.

As of end 2012, government securities and government bonds

accounted for the largest proportion of the market at approximately

USD 543 billion or 68%. By contrast, state government as well as

municipal bonds amounted to 20% of the total securities, growing on

average at an annual rate of 22% from 2000 to 2012. The steady pace

of growth can be explained by the increasing need to fund and finance

several large-scale infrastructure plans.


35/38

35

The different types of bonds in the Indian bond market can be

categorized into the following:

1- Government bonds: issued directly by the government of India, the

so called G-Sec;

2- Borrowing by state governments: made by single states within

India;

3- Tax free bonds: issued directly by quasi-sovereign companies

allow market expansion for investors and, in particular, embody retailinterest into the market;

4- Corporate bonds: this market must be further developed as proved

by the ratio of outstanding government bonds to total outstanding

bonds;

5- Banks and other financial institutions bonds: they areunderperforming;

6- Tax-savings bonds: issued directly by the government of India,

they provide investors with tax rebates, in addition the normal rate of

interest;

7- Tax-saving infrastructure bonds: issued directly by infrastructurecompanies approved by the government, they offer tax rebates along

with a decent rate of interest.


36/38

36

CONCLUSION

The Indian bond market has matured significantly during the past

decade. The amount raised by the government, public sector andquasi-government entities and corporate organisations from the

market for fixed income securities far outstrip the amount raised by

way of equity. This has been matched by an increase in the depth and

width of the secondary market for bonds, both in terms of the face

value of the bonds traded and in terms of the average frequency of

trading per bond. At the same time, the fixed income instruments have

become increasingly sophisticated. Both the government and

corporate organisations issue floating rate bonds, and bonds with

embedded options have made their appearance. Indeed, with the

abolition of stamp duty, and the introduction of rupee denominated

interest rate derivatives, the bond market may be poised for a take off.

However, the growth of the secondary market for bonds has been held

back by three factors that continue to haunt the Indian market. First,

while there has been a significant improvement of the Indian economy

in so far as macroeconomic stability is concerned, high fiscal deficit

and the need to frequently change the short-term stance of monetarypolicy still make it difficult to form accurate expectations about future

short-term interest rates. Second, the market is dominated by large

buyers and sellers like the UTI and SBI who can influence the market

price significantly, and many of the large buyers and sellers are

commercial banks who buy and sell bonds largely to mitigate

problems associated with asset-liability mismatch.


37/38

37

Finally, the market is largely OTC in nature, and hence, despite the

existence of the primary dealers, the WDM of the NSE, and Reuters

and Bloomberg terminals, dissemination of information about bond

prices (and hence interest rate expectations) is neither spontaneous

nor widespread. In brief, on the one hand, market making is limited

and, on the other hand, informational asymmetry continues to be a

dominant feature of the market.

Macroeconomic stability is a goal that is desirable by its own right,

and its discussion lies outside the scope of this paper. Other than

enhancement of such stability, the need of the hour is not only online

trading, or at least real time reporting of prices negotiated in OTC

trades, but also a manifold increase in the number of active portfolio

managers who would roll over their bond portfolios often, and who

would collectively provide two way quotes for a wide array of

securities. Given that a two way quote is a proxy for a trade, albeit

imperfect, the depth of the bond market can then increase sufficiently,

thereby increasing the markets efficiency. However, as suggested by

experience, the governments attempt to increase the depth of the

bond market by allowing foreign institutional investors (FIIs) to trade

in both T-bills and dated government securities is unlikely to be a

panacea. The exposure of the FIIs to Indian debt instruments is

marginal at best. The liberalisation of the insurance industry would,

hopefully, act as a panacea for the Indian bond market.


38/38

The study, though pioneering in nature, suffers from the shortcoming

that some of the arguments have not been adequately backed up by

data. This is, in part, the consequence of a conscious attempt to reduce

the time taken for analysis, given that market structures in a country

like India, which is in transition, can change fast, thereby rendering

carefully done analysis anachronistic. Hence, stylized facts like the

dominance of large traders like UTI in the bond market has not been

sunstantiated with data. In part, the analysis manifests the fragmented

nature of data of the Indian bond market which makes statistical and

econometric analysis difficult if not impossible. The challenge in the

future would, therefore, be to rigorously evaluate the hypotheses that

have been explicisstly and implicitly generated by the above analysis,

as the depth and width of the bond market increase over time.

Documents

Bond Market Financial Mkt