Liquidity of any security such as stock, bond or any other financial instrument takes the centre stage when it comes to trading these instruments in the market. It is one of the most important drivers for any financial market. The reason you do not find many people talking about the bond market in India is the lack of liquidity in this market. And unlike Indian stock markets, bond markets in India have been facing more liquidity problems for a long time. And the lack of policy reforms keeps adding to the woes.
Why it is so? The reason lies back in 1992 when Harshad Mehta and his associates siphoned off funds from inter-bank transactions and bought shares heavily on Bombay Stock Exchange (BSE). This triggered a massive rally in the BSE-Sensex. However, the stock markets heavily collapsed after the scam broke out. As a result, financial instruments such as double ready forward contracts were banned by the Reserve Bank of India (RBI). Again in 2001, Indian stock markets witnessed another bad episode. Ketan Parekh, who can be described as the Pied Piper of Dalal Street, used bank and promoter funds to rig the markets. When the Securities and Exchange Board of India (SEBI) came to know this, many gaping loopholes in the market were plugged. SEBI banned short-selling in the market.
True, lethargic policy making, use of old technologies and lack of proper checks and balances helped increase these kinds of illegal activities. However, since then a decade has passed. Now the policy makers are definitely a lot more active. Regulatory agencies and stock exchanges are using new technologies. Several checks and balances are already in place. Short-selling was reintroduced by SEBI in the equity market.
However, regulatory paranoia continued in the bond market. Double ready forward contracts, very useful to facilitate liquidity, were never introduced again. Some of the regulatory reforms such as short-selling of government bonds and longer holding period of bonds in trading books have been denied the green signal. All of this hurts the bond market badly.
Time has come to introduce some reforms in the bond market as well. After all, all movements in interest rates, which are very important for any economy, are guided by the bond market only. In this light, exploring the reforms measures by a panel of regulators, bond houses and lenders is a welcome move. Otherwise, the capital market may feel a much bigger liquidity crunch.