RECENT REFORMS IN INDIAN

DEBT MARKET

Ankit Kheria 11IB-009

Astha Gupta 11HR-008

Prabhav Sethi 11FN-074

Vikash Bagri 11FN-116

CONTENTS

AN OVERVIEW

KEY SUCCESS FACTORS

THE G-SEC MARKET

REFORMS

THE CORPORATE

BOND MARKET

Structure Indian debt Market

The Debt Market – What is it?

Debt market refers to the financial market where investors buy and sell debt securities,

mostly in the form of bonds.

These markets are important source of funds, especially in a developing economy like India.

The debt market in India is also considered a useful

substitute to banking channels for finance.

Why do we need a Debt Market?

Ensuring financial system stability A liquid corporate bond market can play a critical role because it supplements the banking

system to meet the requirements of the corporate sector for long-term capital investment and asset creation.

Enabling meaningful coverage of real sector needs The financial sector in India is much too small to cater to the needs of the real economy. The debt markets need to grow manifold to ensure that the financial sector becomes

adequate for an economy as large and as ambitious as India’s.

Creating new classes of investors Financial institutions like insurance companies and provident funds have long-term

liabilities and do not have access to adequate high quality long-term assets to match them. Creation of a deep corporate bond market can enable them to invest in long-term

corporate debt, thus serving the twin goals of diversifying corporate risk across the financial sector and enabling these institutions to access high quality long-term assets. 

Reduced Currency Mismatches These markets help reduce potential currency mismatches in the financial system by

allowing for the issue of local currency bonds. Therefore, well-developed and liquid bond markets can help firms reduce their overall

cost of capital by allowing them to tailor their asset and liability profiles to reduce the risk of both maturity and currency mismatches.

Term Structure and Effective transition of Monetary Policy The creation of long-term debt markets will also enable the generation of market

interest rates at the long end of the yield curve. A deeper, more responsive interest rate market would in turn provide the central bank

with a mechanism for effective transmission of monetary policy.

Why do we need a Debt Market?

Classification of the Debt Market

Government Securities MarketIt consists of central and state government securities. It implies public loans being taken by the central and

state governments. It is the most dominant category in the Indian context.

Corporate Bonds MarketIt consists of bonds issued by Fls, Corporate bonds and

debentures and PSU bonds. These bonds are issued to meet financial requirements at

a fixed cost and hence remove uncertainty in financial costs. 

KEY SUCCESS FACTORSThe 7i Framework

Investors Issuers Instruments Infrastructure Intermediary Incentives Innovation

Government Securities Market:

Reforms

Government Debt Issuance

Investor Profile

Reforms in GSM

System of Primary Dealers (PDs)Introduced by RBI in 1995, act as merchant bankers of GoISupports a liquid and efficient secondary market

NDS-OMIntroduced in 2005, over the NDS in 2002Electronic trading screen, with settlement on price/time basis.Sellers and buyers are ensured anonymity due to settlement via

CCIL

Clearing Corporation of India Ltd.(CCIL)Introduced in 2001, the first clearing house of India

Reforms in GSM (contd.)

Marginal Standing Facility (MSF) Short-term liquidity adjustment facility available to banks at 100 basis points above the repo

rate Banks get a rebate of SLR requirements, up to 1% of their time and debt liability

Facility of retail trading in stock exchanges Non-competitive bidding Retail debt segment on stock exchange Web-based access

DVP system This ensures that unless the funds are paid, the securities are not delivered and vice versa DvP settlement eliminates the settlement risk in transactions

Introduction of ‘when issued’ market (2006) Stretches the actual distribution period for each issue and allows the market more time to

absorb large issues without disruption. Allows for price discovery process by reducing uncertainties surrounding auctions.

The Corporate

Bond Market in India

Banks accounted for 14.4% of the financing of large firms in 2000-01, which went up to 17.8% in 2010-11. The bond market stagnated, with 3.5% in 2000-01 and 3.9% a decade later.Source: FINMIN

Key issues with Indian corporate bond market functioning

TransparencySystemic flaws in the credit rating process by the

Credit Rating AgenciesRight to rate the issuers of bond is not confined to

entities registered as CRAs (Credit rating agencies) and currently ratings are being done by entities not registered as CRAs.

Issuers can shop for credit ratingLack of regulatory mandate on monitoring norms of

CRAs can potentially lead to conflict of interest and hence create further gap in the information asymmetry between issuers and investors.

Key issues with Indian corporate bond market functioning

LiquidityAbsence of a liquid corporate bond market acts as a key

deterrent for investors to participate.98% of bond placements being private,

bonds for trading in secondary market is pre-empted by a handful of investors and limits price discovery in the secondary market

Key investors like insurance companies preferring to hold till maturity

Lack of activity from pension funds and FIIs in corporate bond market owing to policy limitation

Only mutual funds and Banks are left to trade and offer volume in the secondary market.

Key issues with Indian corporate bond market functioning

Market MakingLack of competitive, capable and capitalized

intermediaries as market makerCurrently banks and FIs dominate the market for arrangers.

However as they lend money through banking channels, their appetite for market risk is limited as compared to credit risk.

Very few NBFCs / Brokers are arrangers owing to lack of funds and low appetite for market risk

To minimize underwriting risk, arrangers prefer highly rated corporate bonds. This makes access to market arduous for those who are not highly rated e.g. SMEs or not highly rated corporate bonds.

Policy Recommendations

Transform Credit Rating Agencies and the credit rating process towards ensuring greater TransparencyAll entities offering credit rating as a service must be registered

as a credit rating AgencySEBI to conduct operations and process compliance audit of CRAs All credit ratings once obtained must be compulsorily published

by the enterprise who is the issuer and have purchased the service

Improve reliability of benchmark yield curve – Encourage trusted issuers like banks/FIs to issue bonds across maturities

Source: Finance Ministry of India

Policy Recommendations

To encourage SMEs to issue bonds and raise funds from the debt marketOffer special Repo window to market makers dealing with SME

bonds, for instance FIs focusing on SMEs like SIDBI.Reduce landed cost of the bonds - No stamp duty to be levied on

SMEs for issuing bonds. Encourage public issue of bonds over private placement - revise

private placement norms. Corporate issuing bonds for more than Rs. 4,000 Cr in a financial

year shall make public issue of bonds for at least 30% of their fund requirements

For placement to >30 investors, public issue of bonds are required (vis-à-vis 50 investors currently)

All infrastructure bonds to be exchanged traded with a minimum lot size of Rs. 5000/-.

Increase deduction under section 80CCF from infrastructure bonds from Rs. 20,000 to Rs. 50,000

Reforms for Investor

Calibrated access to foreign investors Enhanced limits US$ 45 billion in corporate bond US$ 15 billion in G-sec Improved access to G-Sec market for mid

segment retail investors Mandates to PDs for minimum targets Web based access

Source: FIMMDA

New Instruments

Introduction of new products Interest Rate Futures (IRFs) repo in corporate bonds Issuance of Floating Rate Bond (resumed) Credit Default Swaps

Source: FIMMDA