Development of Local Currency Bond Markets: The Indian Experience

1. Development of Local Currency Bond Markets:The Indian Experience Shyamala Gopinath Reserve Bank of India March 6-7, 2007 London

2. 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

5. Central Government

6. Trends in Centre’s 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 Centre’s 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

9. Centre’s 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

10. 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

11. 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

12. Reforms in the Central G-Sec Market (Cont’d) • 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

13. Reforms in the Central G-Sec Market (Concl’d) • 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

14. Snapshot of the Central G-Sec Market • Increase in Stock and Turnover

15. Maturity and Yield • Elongation of Maturity Profile • General Reduction in Weighted Average Yield

16. Yield Curve • Development of a Smooth Yield Curve

17. Ownership Pattern of Central G-Secs • More Diversification

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

19. Measures to Deal with External Account Pressures • India Development Bonds (IDBs) (1991): US$1.6 billion • Resurgent India Bonds (RIBs) (1998): US$4.2 billion • India Millennium Deposits (IMDs) (2000): US$5.5 billion

20. Original Sin? • India • Low Share of External Liabilities in Sovereign Borrowing • Sovereign Borrowings only from Multilateral/Bilateral 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

21. India’s 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

22. State Governments

23. 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

24. Financing Pattern of Fiscal Deficit • Share of Central Loans has reduced • Share of Market Loans has increased since early 1990s • NSSF continues to predominate

25. 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

26. 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

27. 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

28. Corporate Bond Market

29. 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

30. 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

31. 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

32. 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

33. Thank You