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The 2012 Capital Markets Conference Doha, Qatar September 18-19, 2012

Role of State in Developing Debt Markets

Harun R. Khan Deputy Governor Reserve Bank of India

The importance of debt markets in growth of an economy is

well recognized.
State, which implies both the Government, the Central Bank &

other related Public Sector stakeholders, has a role to play in fostering a sound and diversified debt market, which efficiently performs the function of financial intermediation.
State intervention stabilized the financial system in recent

global financial crisis.

Brief History
States involvement in debt markets has a long history.

The State started borrowing in the Middle Ages in Europe.

The earliest loans - forced loans or personal borrowing of

Initial purpose to finance wars later for civil purposes such as

public works or food supply.

Public debt became a tool of political economy and financed

expenditure in place of levying unpopular taxes.

3 Trading procedures, guarantees and techniques became well

Objectives of Debt Market Development To aid economic growth and development.

To transfer capital from savers to borrowers / investors &

savers. To improve allocative efficiency of resources in the economy.

To enable sovereign to raise resources at reasonable cost on

a sustainable basis. To improve monetary policy transmission. To assist in financial stability.

Bond Market in Asia and India

The bond markets across the Asian region have witnessed

substantial progress after the Asian Financial Crisis (AFC) of 1997-98.

AFC underscored importance of bond markets as excessive

reliance on bank lending may increase systemic risk.


Bonds Funds (ABF) has played a role in the development of the Government bonds market in the Asian region. years due to several initiatives by the Central Bank, Government and other stake holders.

Indian bond market has made rapid strides in the last few

Although activity in the corporate bonds market has picked up,

the Indian bonds market continues to be dominated by Government bonds market.


Market determined interest rate, large issuances, improved

Volume in Government Bond Market (` billions)

2005-06 2006-07 2007-08

Primary Issuances*
1,527 1,668 2,238 3,911 5,821 5,410

Secondary Market $ Trades

8,648 10,215 16,539

2009-10 2010-11 2011-12

29,139 28,710 34,882

6,686 * - Gross for Central & State Govts. $ - Single side volume.

Turnover ratios of G-sec - Asian Bond Markets

[During the quarter ending March 2012 - based on one-sided volume]
2.4 2.2 2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0

1.28 0.96 0.44 0.85 0.58 0.6 0.78







Hong Kong

Source: AsianBondsOnline and Clearding Corporation of India Limited (CCIL)







Secondary Market Activity in GoI Dated Securities Avg. tenor of Top security (yrs) 14 11 11 9 10 10 9 11 10


Settlement Volume (` cr.)

Turnover Ratio

Share in volume traded

Top 5 securities Top security 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

14,58,665 8,62,820 6,57,213 8,83,248 14,67,704 19,55,412 24,80,850 25,52,181 30,99,108

2.1 1.1 0.8 0.9 1.3 1.5 1.4 1.2 1.2

39% 50% 64% 75% 66% 61% 61% 72% 86%

11% 29% 31% 36% 36% 44% 36% 39% 51%

Attributes of a developed bond market

Features of a well developed debt market Depth - Extent to which it can handle large transactions

without causing sharp changes. Breadth - Diversity of participants and heterogeneity of their responses to new information. Width - Wider the bid-ask spread, the less the liquidity and vice-versa. Resilience - speed with which price fluctuations, due to some shock, finally dissipates.
Choice of instruments (e.g. fixed rate bonds, floating rate

bonds, inflation indexed bonds, zero coupon bonds, etc.) to cater to the varied requirements of market participants/ investors.
Deep, broad markets are generally more resilient and tend to

display greater stability in responding to financial and economic disturbances.

Role of State


Role of State
Issuer of debt
Debt management strategy and framework .

Developer of bond market

institutional framework- market infrastructure - investor and

instrument universe.
Regulator of bond market
Systemic stability market integrity consumer protection.


State as Issuer


State as Issuer
State, generally largest issuer. State borrows due to mismatches in revenue and spending.

States also borrow even though they have surplus budgets

for market development (e.g. Australia, Norway, Hong Kong, Singapore, etc.). Reason: To nurture bond markets and develop benchmark yield curve. Debt Management Strategy (DMS), framework, funding instruments.
Credible DMS creates confidence for investors.

DMS comprises objectives, various benchmarks and

portfolio indicators, borrowing requirements, issuance strategy and liability management operations (buybacks and switches). 13 Provides requisite information and transparency,

State as Issuer2
Objectives of DMS: Cost minimization over medium term,

subject to prudent degree of risk.


and portfolio indicators within the overall macroeconomic framework Debt sustainability analysis - Debt to GDP ratio, interest payments to revenue receipts ratio, rollover risk, etc. Benchmarks - Share of internal and external funding, shortterm debt, instrument-wise share, etc. Portfolio indicators - Duration, weighted average life, weighted average cost of borrowing, etc. Targets and risk limits for various benchmarks and portfolio indicators


India's Debt Indicators


(Per cent)

90 80 70 60 50 40 30 20 10 0
1980-81 1982-83 1984-85 1986-87

1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03

Interest/Revenue Receipts
2006-07 2008-09 2010-11 0 1 2


(Per cent)

State as Issuer3

requirements - to be estimated based on projected budget deficits, and funding from other sources. Issuance strategy - periodic quantum, external and domestic funding, instruments, maturity structure, etc. Achieving a stable mix of borrowings in domestic and foreign currency India low level of debt denominated in foreign currency. Elongation of maturity to reduce rollover risk. Issuance of variety of instruments. Zero Coupon Bonds, STRIPs, Floating Rate Bonds, Inflation Index Bonds (proposed) To create Stable and Wide investor base Banks , Insurance companies, pension funds etc. Focus on Transparency Issuance calendar. Liability management operations Buybacks, switches.

Market Borrowing of Government of India- Stylised Facts .. I

Movement of weighted average yield and maturity
Borrowings Year Weighted average maturity (yrs) Weighted average yield (%) Outstanding Weighted average maturity (yrs) Weighted average yield (%)






2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11

14.13 16.90 14.72 14.90 13.80 11.16 11.62 12.66

6.11 7.34 7.89 8.12 7.69 7.23 7.92 8.52

9.63 9.92 9.97 10.59 10.45 9.82 9.78 9.74

8.79 8.75 8.55 8.50 8.23 7.89 7.81 7.88


Market borrowing of Government of India- Stylised Facts .. II

100% 95% 90% 85% 80% 75% 70% 65% 60% 55% 50%

Composition of the Central Government's Public Debt 6.4 6.2 5.9 5.7 5.4 5.5


(% of Total)






Internal Debt

External Debt



Market Borrowing of Government of India - Stylised Facts .. III

Share of Market Loans in Internal Debt
100 90 80 70 60 50 40 30 20 10 0








(Per cent)









Market Borrowing of Government of India- Stylised Facts .. IV

Composition of Central Governments' Market Borrowings through Dated Securities
100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12

(% of Total)



State as Issuer...4
Developing a benchmark yield curve Absence of a risk-free term structure of interest rates makes it difficult to price credit risk. It will be very difficult to establish a corporate bond market with credible benchmark yield curve. For building yield curve a program of regular issues at the appropriate maturities is required. India - large issuance of government securities to finance government budgets . Increasing share of market borrowings in GFD funding - from 21 per cent in 1991-92 to nearly 100 per cent in 2011-12 ensuring steady supply of securities to the market. The issuance volumes attaining critical mass to enable robust trading. Result: Risk-free yield curve up to thirty years comparable to peers in emerging markets; with regular auctions of 21 securities.

Yield Curve in India

8.80 8.70 8.60

(Per cent) 8.40 8.30 8.20 8.10 8.00 7.90 7.80


1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Maturity (Years)
Jun-12 Aug-12

State as Issuer...5
Benchmark yield curve in India - Kink at 10/11 years point and

few liquid points. 10 years benchmark is highly liquid and hence the demand for this segment. Major recommendation of the Working Group (Chairman: R. Gandhi) to improve liquidity in the G-Sec market: Consolidation with issuance of securities at various maturity points in conjunction with steps like issuance of benchmark securities over a longer term horizon, buybacks and switches. Specific market making obligations of the Primary Dealers. Simplification of access to G-Sec market for investors in retail and mid-segment, e.g. Trusts, PFs, cooperative banks, corporate, etc. Preparation of a roadmap to gradually bring down the upper-limit on the HTM portfolio. 23 Gradual increase in investment limit for FIIs in G-Sec.

State as Issuer6
Debt Management Framework Institutional Arrangements for Debt Management DMO vs. Central Bank as debt manager
Separation of debt management from Central Bank needs to

be revisited, in the wake of global financial crisis.

Scholars like Charles Goodhart opine Central Banks should

be encouraged to revert to their role of managing the national debt.

Indian Case: there may be a confluence of interest between

monetary policy and debt management in India.

24 Need for wider debate.

State as developer of debt market


State as developer of debt market

Policy, Legal and Institutional Framework Pre-requisites for establishing an efficient debt market: sound fiscal and monetary policies, effective legal and tax systems, efficient intermediaries and adequate infrastructure. Legal Framework Laws that govern markets and judicial system to enforce contracts etc. In India - RBI Act, Govt Securities Act, Securities (Contracts) Regulation Act, Indian Contract Act, Payment & Settlement Systems Act, Depositories Act, etc. Institutional Framework for Market Efficiency Regulator, Primary Dealers (PDs) and market makers, market infrastructure, Clearing & Settlement system, Central Parties (CCPs), Self-regulatory Organizations 26 Counter (market associations), etc.

State as developer of debt market 2

PD System PDs function as market financial intermediary, provide liquidity in G-Sec market (market makers), facilitate raising debt by Govt, promote efficient price discovery, and educate investors about Government bonds. In India, PDs network was set up in 1996. Presently, there are 21 PDs, of which 8 are companies (called stand alone PDs) and 13 are commercial banks. Some privileges & incentives (such as payment of underwriting commission, availability of liquidity from the Central Bank, etc.) are given to them. SROs - Code of conduct, regular interactions with regulators, reporting/dissemination of information, establishment of best market practices, accreditation of brokers, providing price for valuation, quasi regulatory functions and arbitration among 27 market participants.

State as developer of debt market...3

Market Infrastructure State to play trail blazer role as cost of development is huge. Trading platforms (in India anonymous screen based order matching system (NDS-OM), NDS-Auction, and Web-based Module). Clearing and settlement of Government securities and corporate bonds (in India - CCIL serves as CCP). Safe and sound payment and settlement system (RTGS, and DvP Settlement in Central Bank books). Central Depository (in India For Government securities Reserve Bank of India is depository: SGL system). Compliance with the Principles for Financial Market Infrastructures (PFMI) finalized by CPSS-IOSCO.

State as developer of debt market 4

CCP Principles for Financial Market Infrastructure (CPSSIOSCO) New International Standards 24 principles (April 2012) for harmonising the earlier 3 sets of standards. Three main principles: (a) Governance (principle 2); (b) Money settlement (principle 9); and (c) Exchange of value settlement systems (principle 12). Draft Assessment Methodology Public Consultation. India - CCIL undertook a self-assessment based on draft assessment methodology. Self-assessment results found to be satisfactory. FSAP has also evaluated the CCP and found the system to be robust.
In India

preliminary assessment shows that most 29 principles have been broadly observed.

State as developer of debt market...5

Introduction / development of financial products for trading &

hedging. Widening the investor base Calibrated opening to foreign investors - promoting retail and mid-segment investors. Market access & efficiency Enabling issuers and investors easy access both the primary and secondary markets. Anonymous order-matching system with straight through processing (STP), web-based module for primary and secondary market, non-competitive segment for retail and mid-segment investors in primary auctions. Measures to enhance liquidity of bond markets, passive and active consolidation, among others- buybacks/switches building volumes in benchmark securities. Developing the related markets for funding/hedging 30 Money market, Repo market, Derivatives markets etc. In India, market repo, CBLO, IRF, IRS, etc.

Share of market participants in Govt securitiers in India (end-June 12)

Banking Sector Non-Bank PDs

17.6 47.3

Insurance Companies Mutual Funds

0.9 1.4


Financial Institutions



21.2 0.1

Provident Funds RBI Others


State as regulator of debt market


State as regulator of debt market

To address systemic stability issues, which have implications

for balance sheets of the issuer (Govt), investors and the financial markets, through regulation and supervision. To focus on right regulation rather than more or less regulation. To strike balance between financial innovation & systemic stability- Responsible financialisation in sync with welfare enhancement goal. To ensure market integrity
Delivery versus Payments (DvP).


avoid market failures - Precluding any scope for asymmetric information. To put in place reporting and disclosure norms for ensuring requisite level of transparency. 33 To ensure consumer protection.

State as regulator of debt markets 2 Indian Experience

Reserve Bank has created a regulatory reporting structure,

which enhances transparency and improves disclosure.

Financial innovation in products & processes in line with local

needs-market development without risks to financial stability.

CBLO, NDS-OM, Web-based platform for primary & secondary

Market Integrity Limits on short-sales, yield bands for secondary market



Indian experience Market Surveillance Reserve Bank has created a regulatory reporting system which enhances transparency and improves disclosure (Trade Repositories for OTC derivatives, regulatory reporting of OTC outright and repo trades in G-sec in batch modes). Surveillance over cash and derivatives market for transactions, entities, prices and volumes. Ensuring Delivery-versus-Payments (DVP) Penalty for failure of settlement. Consumer protection Market participants are regulated entities which ensures market discipline Yields band Awareness 35 CCP for guaranteed settlement.

In conclusion, for development of deep, efficient & resilient

debt markets, each country has to focus on the role & responsibility of state (central bank and government) keeping in view:
Significance of debt markets, in particular government bonds

market, in overall economic development of the economy & the financial system even if a country has budget surplus. Credible and efficient debt management strategy and framework within the overall macroeconomic policy environment. Strategy for deeper, wider and resilient debt market. Safe and robust financial market infrastructure (FMI). Effective regulatory & supervisory framework focusing on financial stability, market integrity, transparency and consumer protection.

Thank You