Debt market

Chapter Objectives
To understand:
1. Meaning, history and characteristics of Debt market
2. Participants in the Debt Market
3. The Private Corporate Debt Market
4. The Public Sector Undertaking Bond Market
5. The Government Securities Market
6. Tools for managing liquidity in the Government
Securities Market
7. Measures to strengthen the Government Securities
Market Infrastructure
8. Impact of Reforms on the Government Securities
Market
Debt market: Long term fixed
income securities market
Segment: Private Corporate Debt market
Public Sector Undertaking Bond Market
Government Securities Market
Importance: Helps in
- Mobilisation and allocation of resources
-Financing development activities
-Facilitating liquidity management
-Pricing of non-government securities
Regulation: Government Securities Market and repo market in
corporate debt securities RBI
Corporate Debt Market - SEBI
Participants in the Debt Market
Participants in the Debt market
- Central and State Governments
- Primary Dealers
- Public Sector Undertakings
- Corporates
- Banks
- Mutual funds
- Foreign Institutional Investors
- Provident Funds
- Charitable Institutions and trusts
Types of instruments traded in
the Debt Market
The Private Corporate Debt
Market
Primary Market: Funds raised through prospectus or
private placement
Debt issues compromise debentures
and
bonds
Dominant investors: Mutual funds, Insurance companies,
banks
Secondary market: Securities traded on the WDM
segment of NSE, OTCEI and on the
BSE.
Factors inhibiting the growth of
Private Corporate Debt Market
Private corporate debt market
- Narrow issuer and investor base
- Primary issuance through private placement
- Lack of transparency
- Absence of a benchmark rate
- Absence of Market Making
- Dull secondary market
- Accessible only to high rated borrowers
-Foreign funds not allowed to invest
- Differential stamp duties levied by different states inhibiting the
growth of primary market
Public Sector Undertaking
Bonds Market
- A phenomenon of late eighties
- Two types of bonds: Tax free and Taxable
- Preferred route: Private Placement
- Level of activity quite low
The Government Securities
Market (GSM)
- Gilt edged securities and SLR securities
- Constitutes the principal segment of the debt market
- Issuers: Central government
State government
Semi-government authorities including local
government authorities
- Investors: Nationalised banks
Insurance companies
State Governments
Provident funds and trusts
Individuals
Corporates, NBFCs, Primary dealers, FIs, FIIs and NRIs

- Types: Treasury bills

Government dated securities
GSM in the pre- 1991 period
1930s - Cheap money policy
1950s - Programme of borrowing stepped up
- Interest rates stepped up
- Brokers and Jobbers carried out OMOs
- Government securities more popular with
individuals
1960s and 1970s - GSM dormant
1980s - Volume of debt expanded
Maturity structure skewed in favour of long-
term debt
Passive internal debt management
Objectives of Reforms in the
GSM
- Increase operational autonomy of RBI
- Improve institutional infrastructure
- Improve breadth and depth of the market
- Enable sound legal framework
- Bring in technology related improvements
- Improve transparency
Some policy measures
undertaken in 1990s
- Introduction of Repos
- Introduction of auction system
- Elimination of ad hoc T-bills
- Introduction of delivery v/s payment system
- Introduction of scheme of Ways and Advances
- FIIs permitted to invest
- Setting up of an electronic Negotiated Dealing System (NDS) and
Clearing Corporation of India Ltd (CIL)
- Introduction of the system of publishing a calender by RBI
- Introduction of Screen based order driven trading on stock exchanges
- Introduction of Retail trading
- Debt buy-back scheme
- Interest rate derivatives
- Introduction of Real time Gross Settlement (RTGS)
STRIPS
- Conversion of one underlying security into a number
of zero coupon securities
- Improves liquidity
- Benefits both issuers and investors
The System of Ways and Means
Advances (WMA) for the Centre
- Financing of Ad hocs led to: increase in money supply
inflation
passive internal debt management
- Elimination of ad hocs in 3 stages:
- through limits on creation of ad-hocs
- through a transtition period of 2 years
- the full- fledged system of WMA
- Ways and Means advances:
- Accomodates temporary mismatches
in government receipts and payments
- Charged at market related interest rates
- Limit for WMA and interest rate mutually agreed
between the RBI and government from time to time.
Primary Market of Government
Securities
Types: Treasury bills 91- day
- 182-day
- 364- day
Government dated securities
Issue Mechanism: (a) Auctions Uniform Price Auction
Multiple Price Auction
Competitive bidding
Non-competitive bidding
(b) Sale
(c) Private Placement with the Reserve Bank
Market Borrowings, Ownership
pattern, Maturity structure and
Interest rates
- Market borrowing increased more than ten-
fold
- Captive investors are banks and insurance
companies
- Maturity structure tilted at the short end but
now shifted to long term
- Weighted Average coupon rates on a
declining trend
- Yield spread narrowed
Government Dated Securities
Secondary Market
Two segments : Wholesale institutional segment
Retail segment
Trading system: Earlier on telephone
Now screen based order- driven system
Trades: Outright trades
Repo transactions
Settlements: Physical form
Dematerialised SGL form: SGL I and SGL II
DVP system of settlement
-DVP III system allows netting of transactions
- Improves liquidity
Order Matching System (OMS) for
trading in Government Securities
OMS is an anonymous platform on the
NDS of RBI
Banks and Primary dealers allowed to
trade
Allows sellers and buyers to interface by
placing quotes. Transactions executed by
matching quotes.
Bond brokers will be out of business
Secondary Market Transactions
in Government Securities
- Turnover increased
- Outright transactions predominant
- Factors inhibiting the growth:
- Hardening interest rates
- A long only market( cannot short
sell)
- Higher inflation
- Rigid regulations
- A bearish outlook
Tools for Managing liquidity in
GSM
Open market Operations:- Sale/Purchase of
government securities by the Central Bank
Uses: Neutralises excess liquidity
: Contains wide fluctuations in money and foreign
exchange markets
Types: Open market sales
Open market purchase
Infrastructure Development of
the GSM
Primary dealer system : Act as market makers
: At present 19 PDs
: Subsidiaries of banks and FIs
: Categorised as NBFCs
Obligations of PDs and Facilities extended to them
- Underwrite primary issues
- Offer two-way prices
Facilities
-Provision of current account and SGL
- A favoured access to the Repo market
-Access to LAF
Guidelines Capital adequacy
- Brought under the purview of the Board for
Financial Supervision
- Permitted to borrow upto 200 % of their funds
- Guidelines for non- government securities
Measures to strengthen GSM
infrastructure
- Negotiated Dealing System (NDS)
- Screen based electronic dealing and reporting of
transactions
- Clearing Corporation of India Limited
- Acts as the Central counterparty in the settlement of all
trades
- Manages various risks
- Clears all transactions in government securities and repos
reported on NDS
- Recognised as a systemically important payment system
Impact of Reforms on GSM
- Increased operational autonomy of RBI
- Introduction of a new instrument
- Improvement of infrastructure
- Increase in transparency
- Increase in trading volumes
- Retail participation encouraged
- Improvement in clearing and settlement systems