The 2012 Capital Markets Conference
September 18-19, 2012
Role of State in Developing Debt Markets
Harun R. Khan
Reserve Bank of India
The importance of debt markets in growth of an economy is well
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
State intervention stabilized the financial system in recent global financial
State’s 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 kings.
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.
Trading procedures, guarantees and techniques became well known and
3 aided development of the market.
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
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.
Asian Bonds Funds (ABF) has played a role in the development of the
Government bonds market in the Asian region.
Indian bond market has made rapid strides in the last few years due to several
initiatives by the Central Bank, Government and other stake holders.
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 market
infrastructure, instruments diversification, fiscal responsibility legislation,
among others, have played a catalytic role.
Volume in Government Bond Market
Year Primary Secondary Market
* - Gross for Central & State Govts.
$ - Single side volume.
Turnover ratios of G-sec - Asian Bond
[During the quarter ending March 2012 - based on one-sided volume]
1 0.85 0.78
0.8 0.58 0.6
0.6 0.44 0.52
7 Source: AsianBondsOnline and Clearding Corporation of India Limited (CCIL)
Secondary Market Activity in GoI Dated Securities
Settlement Share in volume traded
Turnover of Top
Top 5 securities Top security
2003-04 14,58,665 2.1 39% 11% 14
2004-05 8,62,820 1.1 50% 29% 11
2005-06 6,57,213 0.8 64% 31% 11
2006-07 8,83,248 0.9 75% 36% 9
2007-08 14,67,704 1.3 66% 36% 10
2008-09 19,55,412 1.5 61% 44% 10
2009-10 24,80,850 1.4 61% 36% 9
2010-11 25,52,181 1.2 72% 39% 11
2011-12 30,99,108 1.2 86% 51% 10
Attributes of a developed bond market
Features of a well developed debt market
Depth - Extent to which it can handle large transactions without causing
Breadth - Diversity of participants and heterogeneity of their responses to
Width - Wider the bid-ask spread, the less the liquidity and vice-versa.
Resilience - speed with which price fluctuations, due to some shock,
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
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
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).
Provides requisite information and transparency, certainty and enables
market participants (investors) to plan their strategy for investment in
Government bonds market.
State as Issuer…2
Objectives of DMS: Cost minimization over medium term, subject to
prudent degree of risk.
Benchmark and portfolio indicators within the overall macroeconomic
Debt sustainability analysis - Debt to GDP ratio, interest payments to
revenue receipts ratio, rollover risk, etc.
Benchmarks - Share of internal and external funding, short-term 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
Interest/GDP (Right scale)
State as Issuer…3
Borrowing 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
To create Stable and Wide investor base
• Banks , Insurance companies, pension funds etc.
Focus on Transparency
• Issuance calendar.
Liability management operations
Market Borrowing of Government of India-
Stylised Facts .. I
Movement of weighted average yield and maturity
Year Weighted average Weighted average Weighted average Weighted average
maturity (yrs) yield (%) maturity (yrs) yield (%)
2001-02 14.30 9.44 8.20 10.84
42002-03 13.80 7.34 8.90 10.44
2003-04 14.94 5.71 9.78 9.30
2004-05 14.13 6.11 9.63 8.79
2005-06 16.90 7.34 9.92 8.75
2006-07 14.72 7.89 9.97 8.55
2007-08 14.90 8.12 10.59 8.50
2008-09 13.80 7.69 10.45 8.23
2009-10 11.16 7.23 9.82 7.89
2010-11 11.62 7.92 9.78 7.81
17 2011-12 12.66 8.52 9.74 7.88
Market borrowing of Government of India-
Stylised Facts .. II
Composition of the Central Government's Public Debt
6.4 6.2 5.9 5.7 5.4 5.5 5.2
(% of Total)
Internal Debt External Debt
Market Borrowing of Government of India -
Stylised Facts .. III
Share of Market Loans in Internal Debt
98 100 100 99
100 96 96
Market Borrowing of Government of India-
Stylised Facts .. IV
Composition of Central Governments' Market Borrowings
through Dated Securities
(% 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
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 securities.
Yield Curve in India
State as Issuer...5
Benchmark yield curve in India - Kink at 10/11 years point and few liquid
10 years benchmark is highly liquid and hence the demand for this
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
Gradual increase in investment limit for FIIs in G-Sec.
State as Issuer…6
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.
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
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
Institutional Framework for Market Efficiency
Regulator, Primary Dealers (PDs) and market makers, market
infrastructure, Clearing & Settlement system, Central Counter Parties
(CCPs), Self-regulatory Organizations (market associations), etc.
State as developer of debt market …2
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 market participants.
State as developer of debt market...3
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
Principles for Financial Market Infrastructure (CPSS-IOSCO) –
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
Draft Assessment Methodology – Public Consultation.
India - CCIL undertook a self-assessment based on draft assessment
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 principles have been
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-
Market access & efficiency
Enabling issuers and investors easy access both the primary and
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
Measures to enhance liquidity of bond markets, passive and active
consolidation, among others- buybacks/switches – building volumes in
Developing the related markets for funding/hedging
Money market, Repo market, Derivatives markets etc.
30 In India, market repo, CBLO, IRF, IRS, etc.
Share of market participants in Govt securitiers in
India (end-June 12)
3.6 Banking Sector
47.3 Financial Institutions
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).
To avoid market failures - Precluding any scope for asymmetric
To put in place reporting and disclosure norms for ensuring requisite
level of transparency.
To ensure consumer protection.
State as regulator of debt markets …2
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 markets.
Limits on short-sales, yield bands for secondary market transactions.
State as regulator of debt markets …3
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.
Market participants are regulated entities which ensures market discipline
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.