According to a BIS report 2009, the world debt market is the size of 82.2 trillion dollar. So what is the size of the Indian debt market against this background? Only 0.6% of the world debt market. Around 8% of GDP growth has vociferously increased the need of capital both for the Government as well as the private sector. In such a scenario the sources of financing need to be broaden to keep India on the growth track and further accelerate it to prosperity. Here we discuss the manner in which the Indian debt market has evolved and the challenges it is facing today.
The Government securities market before the 1990s was characterised by administered interest rates, high SLR requirements that led to the existence of captive investors and the absence of a liquid and transparent secondary market for G-Secs. Low coupon rates were offered on Government securities to keep Government borrowing costs down, which made real rates of return negative for several years till the mid-1980s. During the 1980s, the volume of Government debt expanded considerably, particularly short-term debt, due to automatic accommodation to Central Government by the Reserve Bank, through the mechanism of ad hoc Treasury Bills. However, with a captive investor base and low interest rates, the secondary market for Government bonds remained dormant. Artificial yields on Government securities affected the yield structure of financial assets in the system, and led to an overall high interest rate environment in the rest of the market. Driven by these compulsions, the Reserve Bank’s monetary management was characterised by a regime of administered interest rates, and rising Cash Reserve Ratio (CRR) and SLR prescriptions.
Along with the initiation of overall economic reforms in the early 1990s, the development of the government securities market was initiated in 1992.The reforms that were introduced thereafter were auctioning of securities, ending of monetization of deficit, introduction of primary dealer system, allowing FIIs to invest, initiation of NDS-OM and CCIL to name a few. All these reforms helped the G-Sec market to grow by leaps and bounds in the following years. The RBI has done a commendable job but it should look to carry on the good work and not rest on its laurels. The G-Sec market might be big, but for a country with huge potential like India there is still enough scope left.
Corporate Debt Market
Traditionally Indian corporates have mobilized short term resources for working capital from banks and long term resources from the erstwhile development financial institutions like ICICI, IDBI and IFCI which were nurtured by GOI & RBI at that time. This happened because the commercial banks feared of asset-liability mismatch as also their absence of project appraisal skills especially in relation to large and technologically complex projects. To enable term-lending institutions to finance industry at subsidized concessional rates, Government and RBI gave them access to low cost funds. They were allowed to issue bonds with government guarantee, given funds through the budget and RBI allocated sizeable part of RBI’s National Industrial Credit (Long Term Operations) funds to Industrial Development Bank of India, the largest DFI of the country. However all these changed after the onset of economic reforms. The withdrawal of budgetary support and government guarantee to raise funds from the market through SLR-eligible bonds at concessional rates as well as the other policy changes introduced resulted in DFIs slowly converting themselves into commercial banks for survival. It enabled them to access to public deposit mechanism as well as freedom to lend both on a short term as well as long term basis.
This left the option of either going to banks or the debt market for the corporates. With most of the commercial banks keenly competing in the term loan market there is very little incentive for corporates to tap the primary market for borrowing through long term debt bonds. Even banks prefer to lend money in form of loans rather than subscribe to bonds as they would have to then mark to market the bonds subscribed. Also even if the Corporates do venture into issuing bonds, they prefer private placement process for ease rather than going for public issues. So we are in a situation now where the corporates are heavily dependent on the banks for long term financing.
CURRENT SCENARIO OF THE DEBT MARKET- CHALLENGES & SUGGESTIONS
The trading volume in Corporate bond market is only Rs 4, 01,198 cr which is quite low when compared to the Government securities market which is Rs 89, 88,291 cr.
The volume of the markets also appears extremely miniscule when compared to other developed markets such as Japan and U.S. Even the depth appears to be quite less in both the markets as only a few securities out of various available are liquid in the Government securities market. In the Corporate bond market also most are privately placed and held till maturity. Only few are actively traded.
Volumes and liquidity are restricted to 5-7 securities out of the close to 100 available in Government securities market. And these change every year. What makes the situation worse, on the other hand, is the fact that yields on the more illiquid securities are substantially higher than those on the liquid ones. Reissuance of large volumes of different tenures and different types of securities will add to market liquidity and make the market more vibrant.
The investor base needs to be broadened through different means. The Government can broaden the investor base by offering inflation linked bonds at the retail level. The inflation linked bonds can make the governments accountable for higher inflation since the cost of borrowings will be linked to inflation (if coupon paid is inflation hedged).
Market makers provide psychological support as well as exit options to investors to buy or sell bonds whenever desired by the investors. The market making in corporate bonds is necessary as market is in a nascent stage.
A Credit Default Swap (CDS) offers insurance to the bond holder against default in interest or principal repayment. Local debt investors should be allowed to buy CDS for Indian companies (whose bonds the investors own) from offshore counterparties. Once Indian investors have effectively transferred credit risk to overseas buyers, the capital they have had to set aside for prudential reasons will be free to buy new debt. The domestic bond market thus will grow.
Withholding tax has been a hurdle for the bond market. To ensure active participation by offshore investors and to make offshore financing more competitive, withholding tax needs to be removed. Within a month of removal of withholding tax by South Korea (May 2009), net purchases of Korean bonds by foreign investors rose by over 300 per cent to $7.7 billion.Â
Tax sops should be provided for foreign portfolio investors or FIIs investing in long term infrastructure bonds of companies. The recent tax sop given to encourage investment in infrastructure bonds is a welcome step. Further relaxation should be given to insurance companies to increase their exposure towards infrastructure bonds. Infrastructure in India today needs lot of financing and the asset liability mismatch of banks dissuades them from investing in this sector.
The stamp duty on debt instruments should be made uniform across all the States to reduce the complexity arising from inter-State differences in stamp duty rates and linked to the tenor of securities to ease the issuance process.
The scope of investment by provident/pension/gratuity funds and insurance companies in corporate bonds needs to be enhanced and rating should form the basis of such investments rather than the category of issuers.
Setting up an exchange exclusively for bond trading with appropriate arrangements for clearing and settlement should be done to enhance corporate bond trading.
Rollover should be allowed in corporate bond repo to make it more attractive. At the same time the institutions feel that the haircut of 25% on repos is too much and should be lowered.
The debt market in India has been growing at a good pace both in volumes as well as in meaningful regulations. However, a lot of reforms still need to be introduced. Loose ends must be tied up. The success that the Government securities market has achieved in terms of depth, regulation & infrastructure must be extended to the Corporate bond market. With India poised to grow at an average rate of 8-10% over the next 5 years, there will be a lot of demand for funds. We need various sources of financing. With the implementation of BASEL II, banks would be forced to mark to market the loans .As such there is a huge pressure to step up and design appropriate policies or fall on the face. The Indian Financial system regulators have been following the right path albeit a bit slowly. It is hoped that they would now speed up things and not kill the required timely growth in the name of market stability. To put it in a nut shell, the following is quoted
