Development of Local Currency Bond Markets The Indian

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 Ø Ø 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 Ø Ø Ø Trends in Budget Deficits and Debt Fiscal and Debt Market Reforms Issues in Development of State Government Securities • State Governments • 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 Ø 1991 -92 to 1996 -97: Sharp Fiscal Correction Ø 1997 -98 to 2001 -02: Deterioration Ø 2002 -03 onwards: Fiscal Correction Resumed

Financing Pattern of Centre’s Gross Fiscal Deficit • Low Share of External Borrowings • Substantial Increase in Share of Domestic Open Market Borrowings

Trends in Government Debt-GDP Ratio • Similar to the Trends in Budget Deficit

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 • First Phase (1992 -95) – Creation of Enabling Environment • Elimination of Automatic Monetisation • Introduction of Auctions • SLR reduced • Second Phase (1995 -2000) – Institutional Development • Dv. P • 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

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

Yield Curve • Development of a Smooth Yield Curve

Ownership Pattern of Central GSecs • More Diversification

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

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 loca. L 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, 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

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

Fiscal Reforms • Twelfth Finance Commission ØFiscal Restructuring Plan: Fiscal Discipline ØIncentivised Enactment of FRL through Debt Consolidation and Relief Facility (DCRF) ØFinancial Disintermediation by Centre • Experience ØFRL Enactment – 24 States ØRD 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