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 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
1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 200691 92 96 01 02 03 04 05 06 07 (RE) (BE) 7.85 5.56 5.07 5.64 6.18 5.92 4.47 4.01 4.14 3.76

Gross Fiscal Deficit Revenue Deficit Gross Primary Deficit

3.26 4.07

2.49 1.49

2.50 0.86

4.01 0.93

4.39 1.47

4.40 1.11

3.56 -0.03

2.51 -0.06

2.60 0.46

2.14 0.22

Financing Pattern of Centres Gross Fiscal Deficit

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

External Finance Market Borrowing Others Borrowing

1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 200691 92 96 01 02 03 04 05 06 07 (RE) (BE) 7.1 14.9 0.5 6.3 4.0 -8.2 -10.9 11.8 5.1 5.6

17.9

20.7

56.4

61.8

64.4

71.8

72.1

40.7

69.2

76.5

49.5

45.5

26.8

32.9

32.7

35.2

42.0

54.0

15.4

17.9

Trends in Government Debt-GDP Ratio

Similar to the Trends in Budget Deficit
90 80 70 60 50 40 30 20 10 0 1980-81 1990-91 1996-97 2000-01 2004.05 2006-07 (BE)

Per cent

Centre

States

Total

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

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

Second Phase (1995-2000)

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

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

Snapshot of the Central G-Sec Market

Increase in Stock and Turnover
Outstanding stock (Rs. in billion) Outstanding stock as ratio of GDP (per cent) Turnover / GDP (per cent) Average maturity of the securities issued during the year (in Years) Weighted average cost of the securities issued during the year (Per cent) Minimum and maximum maturities of stock issued during the year (in Years) 1992 769 14.68 --11.78 N.A. 1996 1375 14.2 34.21 5.7 13.77 2-10 2002 5363 27.89 157.68 14.3 9.44 5-25 2003 6739 27.29 202.88 13.8 7.34 7-30 2004
8,243 29.87 217.3 14.94

2005
8,953 28.69 239.9 14.13

2006
9,767 27.67 212.9 16.9

5.71 4-30

6.11 5-30

7.34 5-30

 Elongation of Maturity Profile General Reduction in Weighted Average Yield

18 16 14
Per cent / Years

Maturity and Yield

12 10 8 6 4 2 0
1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 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 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

Per cent

Ownership Pattern of Central G-Secs

More Diversification
Chart 5: Ownership Pattern of Central G-Secs: 1991
Reserve B ank o f Ind ia (o wn acco unt )

0% 5% 1% 0% 13% 25%

Co mmercial B anks Lif e Insurance Co rp o rat io n o f Ind ia # Unit Trust o f Ind ia NA B A RD Emp lo yees Pro vid ent Fund Scheme Co al M ines Pro vid ent Fund Scheme Primary d ealers

56%
Ot hers

0% 0% 2% 0% 0%

Chart 6: Ownership Pattern of Central G-Secs: 2005

16% 7%

Res erve Bank of India (own account) Com m ercial Banks Life Ins urance Corporation of India # Unit Trus t of India NABARD

20% 53%

Em ployees Provident Fund Schem e 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 pros and cons of sovereign foreign currency borrowing Rationale for calibrating foreign investment in domestic currency bonds

Issues

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, shortterm

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- 200691 92 96 01 02 03 04 05 06 07 (RE) (BE) 3.3 2.89 2.65 4.25 4.21 4.17 4.46 3.5 3.23 2.68 0.93 1.78 0.87 1.22 0.69 0.8 2.54 2.59 2.25 2.22 1.17 0.49 0.05

GFD Revenue Deficit Gross Primary Deficit

0.09 -0.15 -0.61 -0.75 -1.65 -2.03 -2.47

Financing Pattern of Fiscal Deficit

Share of Central Loans has reduced Share of Market Loans has increased since
early 1990s NSSF continues to predominate
Loan From Central Gov. Market Borrowing NSSF Others 33.3

1990- 1991- 1995- 2000- 2001- 2002- 2003- 2004- 2005- 200691 92 96 01 02 03 04 05 06 07 (RE) (BE) 53.1 49.6 47.1 9.4 11.4 -0.9 11.5 -15.1 2.3 4.8

12.0

17.5

18.7

14.0

18.0

27.9

38.4

30.1

15.7

21.0

32.9

34.2

36.4 40.2

37.1 33.5

51.2 21.9

16.9 33.2

66.5 18.5

65.0 17.0

53.5 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 200405 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