Development of Local

Currency Bond Markets:

The Indian Experience
Shyamala Gopinath
Reserve Bank of India
March 6-7, 2007
London
 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
Structure of Bond Markets in India
• Central Government Securities

• State Government Securities

• Corporate Bond Market

• Securitised Debt
 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
Central Government
 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
1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 2006-
91 92 96 01 02 03 04 05 06 07
(RE) (BE)
Gross Fiscal 7.85 5.56 5.07 5.64 6.18 5.92 4.47 4.01 4.14 3.76
Deficit

Revenue Deficit 3.26 2.49 2.50 4.01 4.39 4.40 3.56 2.51 2.60 2.14

Gross Primary 4.07 1.49 0.86 0.93 1.47 1.11 -0.03 -0.06 0.46 0.22
Deficit
 Financing Pattern of Centre’s
Gross Fiscal Deficit
• Low Share of External Borrowings
• Substantial Increase in Share of Domestic
Open Market Borrowings

1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 2006-
91 92 96 01 02 03 04 05 06 07
(RE) (BE)
External 7.1 14.9 0.5 6.3 4.0 -8.2 -10.9 11.8 5.1 5.6
Finance

Market 17.9 20.7 56.4 61.8 64.4 71.8 72.1 40.7 69.2 76.5
Borrowing

Others 49.5 45.5 26.8 32.9 32.7 35.2 42.0 54.0 15.4 17.9
Borrowing
 Trends in Government Debt-GDP
Ratio
• Similar to the Trends in Budget Deficit
90
80
70
60
Per cent

50
40
30
20
10
0
1980-81 1990-91 1996-97 2000-01 2004.05 2006-07
(BE)

Centre States Total

 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
 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
Reforms in the Central G-Sec
Market
• Three Phases
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
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
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
 Snapshot of the Central G-Sec
Market
• Increase in Stock and Turnover

1992 1996 2002 2003 2004 2005 2006

Outstanding stock (Rs. in billion) 769 1375 5363 6739 8,243 8,953 9,767
Outstanding stock as ratio of GDP (per 14.68 14.2 27.89 27.29
cent) 29.87 28.69 27.67
Turnover / GDP (per cent) -- 34.21 157.68 202.88 217.3 239.9 212.9
Average maturity of the securities
issued during the year (in Years) -- 5.7 14.3 13.8 14.94 14.13 16.9
Weighted average cost of the securities
issued during the year (Per cent) 11.78 13.77 9.44 7.34 5.71 6.11 7.34
Minimum and maximum maturities of
stock issued during the year (in Years) N.A. 2-10 5-25 7-30 4-30 5-30 5-30
 Maturity and Yield
• Elongation of Maturity Profile
• General Reduction in Weighted Average Yield

18
16
14
12
Per cent / Years

10
8
6
4
2
0
1995-96

1996-97

1997-98

2003-04
1998-99

1999-00

2000-01

2001-02

2002-03

2004-05

2005-06
Weighted Average Yield (per cent) Weighted Average Maturity (years)
 Yield Curve
• Development of a Smooth Yield Curve

16
14
12
10
Per cent

8
6
4
2
0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
Maturity (Years)

Mar-97 Mar-04 Jan-07

 Ownership Pattern of Central G-
Secs
• More Diversification
Chart 5: Ownership Pattern of Central G-Secs:
1991
R es e rve B a nk o f Ind ia (o wn a c co unt )

0% 5%
1%
0% C o mme rcia l B anks

13% 25%
Life Ins ura nce C o rp o rat io n o f Ind ia #

Unit Trus t o f Ind ia

NAB AR D

Emp lo yee s P ro vid e nt F und S cheme

C o al M ines P ro vid e nt F und S c he me

P rimary d e a lers
56%
Ot he rs

Chart 6: Ownership Pattern of Central G-Secs:

0% 2005
Res erve Bank of India
0% (own account)
7% Com m ercial Banks
2% 16%
Life Ins urance
0% Corporation of India #
Unit Trus t of India
0%
NABARD

Em ployees Provident
20%
Fund Schem e
53% Coal Mines Provident
Fund Schem e
Prim ary dealers

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

100.0

80.0
Per cent

60.0

40.0

20.0

0.0
1950-51 1980-81 1990-91 2000-01 2006-07
(BE)

Domestic Liabilities External Liabilities

 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
 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
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
State Governments
 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

1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 2006-
91 92 96 01 02 03 04 05 06 07
(RE) (BE)
GFD 3.3 2.89 2.65 4.25 4.21 4.17 4.46 3.5 3.23 2.68

Revenue Deficit 0.93 0.87 0.69 2.54 2.59 2.25 2.22 1.17 0.49 0.05

Gross Primary 1.78 1.22 0.8 0.09 -0.15 -0.61 -0.75 -1.65 -2.03 -2.47
Deficit
 Financing Pattern of Fiscal Deficit
• Share of Central Loans has reduced
• Share of Market Loans has increased since
early 1990s
• NSSF continues to predominate
1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 2006-
91 92 96 01 02 03 04 05 06 07
(RE) (BE)
Loan From 53.1 49.6 47.1 9.4 11.4 -0.9 11.5 -15.1 2.3 4.8
Central Gov.

Market 12.0 17.5 18.7 14.0 18.0 27.9 38.4 30.1 15.7 21.0
Borrowing

NSSF - - - 36.4 37.1 51.2 16.9 66.5 65.0 53.5

Others 33.3 32.9 34.2 40.2 33.5 21.9 33.2 18.5 17.0 20.7
 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
 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
 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
Corporate Bond Market
 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
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
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
 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