RBI governor Y.K. Reddy: Reviving the debt market

The government-more specifically, the Finance Ministry and the Reserve Bank of India (RBI)-is planning a course of steroids to inject some life into the somnolent debt market. The aim: enable it to cruise onto the same high speed lane that the equity markets are on at present.

The first dose was administered in the form of the NDS-OM (Negotiated Dealing System for Order Matching) in the government securities (g-sec) market. This involves the introduction of anonymous screen-based trading for the G-secs. Traditionally, the debt market, dominated largely by government bonds, has been a closed one; most transactions taking place over telephone between brokers who generally know each other. The new system is expected to deal a death blow to this "telephone-based market", which is one of the factors responsible for keeping trading volumes small. Despite the presence of as many as 111 central government securities, of which 44 have outstanding amounts of Rs 10,000 crore or more, a mere 10-12 securities are traded on a daily basis, and only half this number on an active basis. Consequently, price discovery is often imperfect and yield curve distorted by extraneous factors. Following the entry of insurance entities and mutual funds, provident funds and pension funds into the NDS-OM system, the depth of the market is likely to increase.

The RBI is taking other steps as well to improve liquidity and interest rate risk management. It has initiated the process of introducing intra-day short sales and a "when issued" market for government securities which are being reissued. This last allows trading in securities prior to their issue and enables easier price discovery.

Further, the provision in the Fiscal Responsibility and Budget Management (FRBM) Act 2005 specifying that undersubscribed G-sec auctions will no longer devolve on the RBI, will change the dynamics of the market forever. "Though RBI intervention was rare, the FRBM mandate will now make interest rates more market-linked," says Sushil Muhnot, Managing Director and Chief Executive Officer, IDBI Capital. Efforts are also on to get state governments to offer market-linked interest rates on their bonds.

The other area that is attracting attention is the virtually non-existent corporate bond market. Here, the government is pushing for a single, unified exchange-traded market. The idea, obviously, is to make these attractive to the retail investor. "Retail investors should also be encouraged to participate in the corporate bond market through mutual funds," the R.H. Patil Committee on Corporate Bonds and Securitisation has said. But this will be a tough nut to crack.

The impact of these measures, however, will not be immediately visible as the debt market is currently in a bear phase. Parthasarthy Mukherjee, Head (Treasury), UTI Bank, expects it to recover by 2007. Policy makers are using this lead time to put in place reforms which will lead to a more robust bond market by then. The equity markets benefited from the structural changes introduced in the 90s. Debt market reform, though slow, is expected to replicate that success. When that happens, make sure you get in on the ground floor.