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  • MARCH 4, 2002

Debt market: Time to evolve

Debt markets over the last one-year have witnessed healthy volumes. The depth of the markets widened with the aggressive entry of debt mutual funds and also heavy investments by banks in government securities. Retail participation in the primary market was also encouraged by allocating them up to 5% of issue on a non-competitive basis.

Significant steps have been taken to develop the debt markets. This includes the recent launch of Clearing Corporation of India (CCIL) and negotiated dealing systems (NDS). CCIL and NDS are expected to address the need for efficient securities settlement system covering money, government securities and forex markets. NDS will facilitate electronic bidding in auctions and secondary market transactions in government securities. It will also help in dissemination of information on trades on a real time basis, which was hitherto not available. These systems are also expected to facilitate extension of repo market to non-Government securities and enlargement of market participants.

Fixed rate instruments dominated the markets over the past few years. The introduction of floating rate bonds on uniform auction basis has widened the scope for a flexible interest rate regime in tune with the trends prevailing in the international markets. The Central government issued two floating rate bonds (FRB) on the basis of uniform price auction in the current year.

In the current budget, the government has proposed to link the interest rates of administered instruments (NSC, PPF) to yields on government securities on an annual basis. The 10-year benchmark yield for G-sec is currently near 7%, while interest rate on small saving schemes (after a 50 basis points cut in rates) is 9%. Benchmarking small savings rates to G-Sec yield would remove the structural rigidities in interest rate administration for the economy as a whole. This will also open the way for a flexible interest rate regime and will also help the government in reducing its debt burden.

The RBI has also prepared a road map for developing Separate Trading of Registered Interest and Principal of Securities (STRIPS). This would allow trading principal of the instrument separately, stripping out the coupon (interest payment). These instruments are traded actively in the global markets.

Volumes in the gilt markets to a large extent are dependent on the government’s borrowing program. Just to put things in perspective consider this. The gross borrowing of the government for FY02 is expected to be at Rs 1,189 bn as against Rs 1,177 bn in FY01. Till December 28, 2001, Rs 1,160 bn or 98% of the budgeted amount was already borrowed. 85% was borrowed through dated securities and the remaining 15% through 364 days Treasury bills. Fiscal deficit of the country is widening (estimated to be 5.3% of GDP) and the government is expected to again borrow a similar amount in FY03 to fund this deficit.

On the one hand, it would offer liquidity to the markets. This could keep interest rates under pressure, as it would be a difficult task for the government to raise funds at rates lower than the current 7% G-Sec yield. Once the credit growth picks up, banks are unlikely to make higher investments in G-Secs (at relatively lower yields as their spread on industrial credit is much higher). Retail participation in the debt markets is however expected to increase once the investors are conversant with these new systems. Also, liquidity in G-Secs is much higher than that of small saving schemes. Its worth to note that interest rates on small saving schemes in the coming years will be linked to G-Sec yields. Consequently, investors would not be able to earn higher returns by locking their funds in small saving schemes for long term. This could encourage retail participation in the G-Sec market and widen market volumes.

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