Indian debt market: Need for development

Why there is need for developing the Indian debt market when there are many others issues to be sorted in the financial sector like derivative market, new products etc.The reason particularly is changing dimension of Indian economy that have arises over the last 17 years with the starting of economic reforms.

The Indian debt market is one of the largest markets in Asia and largest in South Asia. It has relatively big size in terms of market capitalization, trading volumes and outstanding securities. Debt market movement works as a leading indicator since it provides risk free rate of interest which has multiplier impact in the market.

It basically comprises two categories Government Securities market and Non Government Securities market. In the G-Sec, securities are mainly issued by central and state government to finance its deficit. In Non G-Sec market public sector bonds, financial institution and corporate bonds are major instruments. The G-Sec are the most dominant category of debt markets and form a major part of the market in terms of outstanding issues, market capitalization and trading value. It sets a benchmark for the rest of the market.

Issuer	Instrument	Maturity	Major Investors
Central Government	Dated Securities Treasury Bills	1-30 years 91/182/364 days	Banks, Insurance Companies, Provident Funds, Mutual Funds, PDs, Individuals
State Government	Dated Securities	5-10 years	Banks, Insurance Companies, Provident Funds
PSUs (Centre and States)	Bonds	5-10 years	Same as T bills except PD
Corporate	Bonds/Debentures Commercial Paper	1-10 years 15 days to1 year	Banks, Mutual Funds, Corporates, Individuals
Primary Dealers (PDs)	Commercial Paper	15 days to1 year	Banks, Corporate, Financial Institutions, Mutual Funds, Individuals
Banks	Bonds issued for Tier II capital Deposit	Minimum 5 year	Banks, Corporates

Source: RBI

The above table showing various participant, participants and various instrument issued by them.

Source: nseindia.com as on 5^th sep 2010

In terms of trading, the Indian debt primarily consists of wholesale debt market(WDM) and retail debt market(RDM). In the last 6 year the retail debt market diminish where as WDM segment performed very well which is shown above.

The market capitalization in WDM segment showing clearly an upward trend where as average daily turnover showing upward trend 2006-07 onwards.

The figure of retail debt market shown lackluster performance shown in the table below:-

Month/Year	No of trades	Traded quantity	Traded Value (Rs.lakhs)
2003-2004	912	372,820	464.41
2004-2005	31	122,390	149.27
2005-2006	0	0	0
2006-2007	4	12,120	13.69
2007-2008	0	0	0
2008-2009	0	0	0
2009-2010	5	50	0.06
2010-2011	0	0	0

Source: nseindia.com as on 5^th Sep, 2010

Why there is need of debt market

The latest report by the Planning Commission of India on infrastructure development estimated that India need huge amount of investments in infrastructure as high as $495b. It will be difficult for only by commercial banks and financial institutions to finance this amount because of high gestation periods of infra financing. Even if commercial banks provide then, it will crowd out interest sensitive small investment resulting from low availability of loanable funds with banks to disburse. The international long term sources of finance like ECB and FCCB are no longer viable because of liquidity crunch. If there is efficient domestic bond market, then it will be an attractive for large corporations for funding and banks will also have available resources to finance small companies. Other benefits are also:-

• With the increasing depth of market, it will reduce the borrowing costs for the issuer (Government and others) and to channelization of resources at reasonable costs.
• Development of variety of participants and leads to greater diversification opportunities.

If we compare the Indian bond market with global bond market, then the size of the Indian market is insignificant.

Corporate debt market accounts for 3.9% of GDP

Corporate debt market accounts for 61% in Korea

Corporate debt market accounts for 37.5% in Malaysia.

Source: ADB working paper (2008)

The placement of bonds is also skewed towards private placement which is around 92%.In other countries the size of the debt market is many times of equity market but in India the case is totally different. The following table depicting the development of equity and debt market clearly reflecting that equity market had grown huge in size as compare to debt market.

	1996	2008
Equity M-cap/GDP	32.10%	108%
Debt M-cap/GDP	21.30%	40%

Source: NSE handbook

Obstacle in developing debt market

Regulatory framework

There are many regulations which prohibit the demand of bond market. For example the pension fund, a potential source of buyer for bonds, cannot investment more than 10% of the funds collected in corporate bonds that are investment grade. And if they subscribe, they have to hold them till maturity. Other funds organization like provident fund of both state and central government, EPFO, PPO are restricted by other regulations.

Foreign investors are restricted to invest of total $15 billion. Considering the liquidity condition of the debt market which is very limited, they are not even interested in available quota.

Risk management

There is not much product available in the derivative market for both issuer and investor to hedge their risk in the bond market. Though SEBI has paved the way for interest rate future and interest rate swap, but the market for both the product in derivative market is not much deep and there are limited participant. As a result both investor and issue are not able to hedge their interest rate risk in the bond market.

Other factors

There is also, absence of an autonomous body catered to particularly debt market which leads to less reliable system for resolving financial distress issues. As a result investors are not willing to invest in unsecured debt instrument.

Another contributing factor is not enough amounts of corporate bonds outstanding that may create liquidity in the market. Costly procedure for issuing new bonds and lack of effective price discovery mechanism shattered the confidence of both issuer and investor.

Recent initiative taken by RBI and SEBI to develop Debt Market

· RBI puts out draft guidelines on repo in corporate debt securities in public domain, for comments/views.

· Clearing and Settlement of trades in corporate bonds to be done through National Securities Clearing Corporation or the Indian Clearing Corporation

· SEBI further simplifies Debt Listing Agreement for Debt Securities

· SEBI set up an advisory committee - “Corporate Bonds and Securitization Advisory Committee” (CoBoSAC)

What more can be done to develop market

· Some of the new products can be introduced such as foreign exchange derivative contracts, Credit default swaps exchange traded interest rate products.

· There should be steps to encourage public offers by further improving the listing criteria and lowering the cost for the same.

· The tax rate should also be changed to attract more capital. In India, the rule of 20 % withholding tax on interest earned by foreign investor should be lowered to attract foreign capital. We have the example of South Korea which removes withholding tax resulting in increase foreign capital by 300% within one month.

· In most of the developed countries main resource for debt market are pensions and provident funds which is not the case in India due to regulatory framework as mentioned above. There is need for change in regulations to attract these funds.

· Another major thing required is to pave the way for securitization products though banks and financial institution done a commendable job but the market has not developed because of regulation. ARCs and NHBs even though allowed in securitization but that does not come under the picture of Securities Contract Regulation Act (SCRA) and hence cannot be listed. So there is need of introducing of securitization and also bring them under SCRA.

· Steadily we can increase the foreign investment limit in corporate bonds.

During last one year we have seen most of the companies went for ECB and FCCB for their funding requirement.We can avoid this situation if we well developed bond market.

Ankur Singla

Member,FEF