Development of Local Currency Bond Markets: The Indian Experience

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Development of Local Currency Bond MarketsThe
Indian Experience

• Shyamala Gopinath
• Reserve Bank of India
• March 6-7, 2007
• London

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Outline of Presentation

• Structure of Bond Markets in India
• Institutional Arrangements with RBI
• Central Government
• Trends in Budget Deficits and Debt
• Fiscal and Debt Market Reforms
• Impact of Reforms on the Debt Market
• Measures to Deal with External Account Pressures
• State Governments
• Trends in Budget Deficits and Debt
• Fiscal and Debt Market Reforms
• Issues in Development of State Government
  Securities
• Corporate Bond Market
• The Way Ahead

3
Structure of Bond Markets in India

• Central Government Securities
• State Government Securities
• Corporate Bond Market
• Securitised Debt

4
Institutional Arrangements with RBI

• Banker and Debt Manager to Central Government by
  Statute
• Banker to 26 State Governments and Debt Manager
  to 28 State Governments by Voluntary Agreements

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• Central Government

6
Trends in Centres Budget Deficit

• Three Phases
• 1991-92 to 1996-97 Sharp Fiscal Correction
• 1997-98 to 2001-02 Deterioration
• 2002-03 onwards Fiscal Correction Resumed

7
Financing Pattern of Centres Gross Fiscal
Deficit

• Low Share of External Borrowings
• Substantial Increase in Share of Domestic Open
  Market Borrowings

8
Trends in Government Debt-GDP Ratio

• Similar to the Trends in Budget Deficit

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Centres Fiscal Responsibility Act

• Enactment of FRBM Act August 26, 2003
• Came into force from July 5, 2004
• Elimination of RD by 2008-09 (3.6 in 2003-04)
  and revenue surplus thereafter
• Containment of GFD to 3 of GDP by 2008-09 (4.5
  in 2003-04)
• RD and GFD placed at 2.0 and 3.7 of GDP in
  2006-07 (RE)
• RD and GFD budgeted to decline to 1.5 and 3.3
  of GDP in 2007-08
• RBI prohibited from Participation in Primary
  Issuances of G-Secs

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Central G-Sec Market Pre-Reform Period

• Features
• Administered and Low Interest Rates
• High Statutory Liquidity Ratio (SLR)
• Automatic Monetisation of Budget Deficit
• High Cash Reserve Ratio (CRR)
• Impact
• Preemption of Financial Savings
• No possibility of Price Discovery
• Dormant Debt Market

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Reforms in the Central G-Sec Market

• Three Phases
• First Phase (1992-95)
• Creation of Enabling Environment
• Elimination of Automatic Monetisation
• Introduction of Auctions
• SLR reduced
• Second Phase (1995-2000)
• Institutional Development
• DvP
• Primary Dealers
• FIMMDA and PDAI
• Instrument Diversification
• Floating Rate Bonds
• Capital Indexed Bonds

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Reforms in the Central G-Sec Market (Contd)

• Third Phase
• Enhance Liquidity and Efficiency
• Indicative Auction Calendar
• Non-Competitive Bidding Facility
• Liquidity Adjustment Facility
• Repo and collateralised borrowing lending system
• Negotiated Dealing System (NDS), STP and CCP
• Interest Rate derivatives
• Market Stabilisation Scheme
• Foreign investment in local currency debt
  instruments
• Conversion of special securities into marketable
  debt

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Reforms in the Central G-Sec Market (Concld)

• Reforms undertaken in the context of FRBM Act
• Functional Separation of Debt and Monetary
  Management Creation of FMD
• Extension of PD business to Banks
• Revised Scheme of Underwriting by PDs 100
  Underwriting by PDs
• NDS-OM
• Short-Sale
• When Issued market
• Considering Active Consolidation

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Snapshot of the Central G-Sec Market

• Increase in Stock and Turnover

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Maturity and Yield

• Elongation of Maturity Profile
• General Reduction in Weighted Average Yield

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Yield Curve

• Development of a Smooth Yield Curve

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Ownership Pattern of Central G-Secs

• More Diversification

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External Borrowings

• Low Share of External Debt
• External Borrowings only from Multilateral and
  Bilateral Sources

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Measures to Deal with External Account Pressures

• India Development Bonds (IDBs) (1991) US1.6
  billion
• Resurgent India Bonds (RIBs) (1998) US4.2
  billion
• India Millennium Deposits (IMDs) (2000) US5.5
  billion

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Original Sin?

• India
• Low Share of External Liabilities in Sovereign
  Borrowing
• Sovereign Borrowings only from Multilateral/Bilate
  ral Sources
• States not permitted to raise external debt
  directly
• Foreign investment allowed in locaL currency
  bonds but within an overall ceiling
• Issues
• pros and cons of sovereign foreign currency
  borrowing
• Rationale for calibrating foreign investment in
  domestic currency bonds

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Indias External Debt

• Cautious approach
• Sovereign, corporates, financial intermediaries
• Total External debt 132 bn as at end Sept 2006
• Long-term debt 126 bn
• Rise in external debt ECBs, NRI, short-term

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State Governments
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Trends in Budget Deficit

• Strong Improvement since early part of this
  decade
• Build up of Surplus Cash Balance in Recent Years
  Buyback of Securities by some States

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Financing Pattern of Fiscal Deficit

• Share of Central Loans has reduced
• Share of Market Loans has increased since early
  1990s
• NSSF continues to predominate

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Fiscal Reforms

• Twelfth Finance Commission
• Fiscal Restructuring Plan Fiscal Discipline
• Incentivised Enactment of FRL through Debt
  Consolidation and Relief Facility (DCRF)
• Financial Disintermediation by Centre
• Experience
• FRL Enactment 24 States
• RD to be nearly eliminated and GFD-GDP ratio to
  decline to 2.7 in 2006-07

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Market Borrowings of State Governments

• Till 1998-99 Tap Issuances
• States encouraged to adopt auction route
• 100 of market borrowing in 2006-07 so far as
  against 48.5 in 2005-06 and 2 in 2004-05
  conducted through auctions
• Auction calendar proposed to be issued by States

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State Government Securities - issues

• Negligible Secondary Market Liquidity
• Low level of outstanding stock
• Predominance of buy-and-hold investors
• Disconnect between the uniform coupon fixed in
  tap issues and secondary market yield
• Fragmentation across issuers and securities
• Proposed Measures
• Non-competitive bidding
• Issuance calendar
• Use for Liquidity adjustment facility

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Corporate Bond Market
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Corporate Bond Market

• Corporate Bond markets historically late to
  develop
• Access to bank credit
• Access to external sources of finance
• Require well developed accounting legal and
  regulatory systems
• Rating agencies
• Rigorous disclosure standards and effective
  governance of corporations
• Payment and settlement systems
• Secondary markets

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Reforms in Corporate Bond Market

• Four Rating agencies operating in India
• De-materialisation and electronic transfer of
  securities
• Initial focus reform of private placement
  market by encouraging rating of issues
• Further reforms needed
• Appointment of a High Powered Committee

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High-powered committee recom

• Enhance the issuer base and investor base
  including measures to bring in retail investors
• Listing of primary issues and creation of a
  centralized database of primary issues
• Electronic trading system
• Comprehensive automated trade reporting system
• Safe and efficient clearing and settlement
  standards
• Repo in corporate bonds
• Promote credit enhancement
• Specialized debt funds to fund infrastructure
  projects
• Development of a municipal bond market

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The Way Ahead

• Build upon the Strong Macroeconomic Performance
• Adherence to FRL
• Stability of Inflation Rate
• -external debt management policy
• Pension reforms
• Active Consolidation
• Floating Rate Bonds and Inflation-Indexed Bonds
• STRIPS
• Corporate Bonds
• Bond Insurance Institutions
• Institutional Investors Credit Enhancers
• Securitised paper to be traded on exchanges
• Municipal Bonds, Mortgage Backed Securities,
  General Securitised Paper

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