Development of Local Development of Local Currency Bond Currency Bond

Markets:Markets:The Indian The Indian ExperienceExperienceShyamala GopinathShyamala Gopinath

Reserve Bank of IndiaReserve Bank of IndiaMarch 6-7, 2007

London

Outline of PresentationOutline of Presentation• Structure of Bond Markets in IndiaStructure of Bond Markets in India• Institutional Arrangements with RBIInstitutional Arrangements with RBI• Central GovernmentCentral Government

Trends in Budget Deficits and DebtTrends in Budget Deficits and Debt Fiscal and Debt Market Reforms Fiscal and Debt Market Reforms Impact of Reforms on the Debt MarketImpact of Reforms on the Debt Market Measures to Deal with External Account PressuresMeasures to Deal with External Account Pressures

• State GovernmentsState Governments Trends in Budget Deficits and DebtTrends in Budget Deficits and Debt Fiscal and Debt Market ReformsFiscal and Debt Market Reforms Issues in Development of State Government SecuritiesIssues in Development of State Government Securities

• Corporate Bond MarketCorporate Bond Market• The Way AheadThe Way Ahead

Structure of Bond Markets Structure of Bond Markets in Indiain India• Central Government SecuritiesCentral Government Securities

• State Government SecuritiesState Government Securities

• Corporate Bond MarketCorporate Bond Market

• Securitised DebtSecuritised Debt

Institutional Arrangements Institutional Arrangements with RBIwith RBI

• Banker and Debt Manager to Central Banker and Debt Manager to Central Government by StatuteGovernment by Statute

• Banker to 26 State Governments and Banker to 26 State Governments and Debt Manager to 28 State Debt Manager to 28 State Governments by Voluntary Governments by Voluntary AgreementsAgreements

Central Central GovernmentGovernment

Trends in Centre’s Budget Trends in Centre’s Budget DeficitDeficit• Three PhasesThree Phases

1991-92 to 1996-97: Sharp Fiscal 1991-92 to 1996-97: Sharp Fiscal CorrectionCorrection

1997-98 to 2001-02: Deterioration1997-98 to 2001-02: Deterioration2002-03 onwards: Fiscal Correction 2002-03 onwards: Fiscal Correction

ResumedResumed 1990-91

1991-92

1995-96

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

(RE) (BE) Gross Fiscal Deficit

7.85 5.56 5.07 5.64 6.18 5.92 4.47 4.01 4.14 3.76

Revenue Deficit 3.26 2.49 2.50 4.01 4.39 4.40 3.56 2.51 2.60 2.14

Gross Primary Deficit

4.07 1.49 0.86 0.93 1.47 1.11 -0.03 -0.06 0.46 0.22

Financing Pattern of Centre’s Financing Pattern of Centre’s Gross Fiscal DeficitGross Fiscal Deficit

• Low Share of External BorrowingsLow Share of External Borrowings• Substantial Increase in Share of Substantial Increase in Share of

Domestic Open Market BorrowingsDomestic Open Market Borrowings

1990-91

1991-92

1995-96

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

(RE) (BE) External Finance

7.1 14.9 0.5 6.3 4.0 -8.2 -10.9 11.8 5.1 5.6

Market Borrowing

17.9 20.7 56.4 61.8 64.4 71.8 72.1 40.7 69.2 76.5

Others Borrowing

49.5 45.5 26.8 32.9 32.7 35.2 42.0 54.0 15.4 17.9

Trends in Government Debt-Trends in Government Debt-GDP RatioGDP Ratio• Similar to the Trends in Budget DeficitSimilar to the Trends in Budget Deficit

0102030405060708090

1980-81 1990-91 1996-97 2000-01 2004.05 2006-07(BE)

Per c

ent

Centre States Total

Centre’s Fiscal Centre’s Fiscal Responsibility ActResponsibility Act

• Enactment of FRBM Act : August 26, 2003Enactment of FRBM Act : August 26, 2003• Came into force from July 5, 2004Came into force from July 5, 2004• Elimination of RD by 2008-09 (3.6% in 2003-04) Elimination of RD by 2008-09 (3.6% in 2003-04)

and revenue surplus thereafterand revenue surplus thereafter• Containment of GFD to 3 % of GDP by 2008-09 Containment of GFD to 3 % of GDP by 2008-09

(4.5% in 2003-04)(4.5% in 2003-04)• RD and GFD placed at 2.0% and 3.7% of GDP in RD and GFD placed at 2.0% and 3.7% of GDP in

2006-07 (RE)2006-07 (RE)• RD and GFD budgeted to decline to 1.5% and RD and GFD budgeted to decline to 1.5% and

3.3% of GDP in 2007-083.3% of GDP in 2007-08• RBI prohibited from Participation in Primary RBI prohibited from Participation in Primary

Issuances of G-Secs Issuances of G-Secs

Central G-Sec Market: Pre-Central G-Sec Market: Pre-Reform PeriodReform Period• FeaturesFeatures

– Administered and Low Interest RatesAdministered and Low Interest Rates– High Statutory Liquidity Ratio (SLR) High Statutory Liquidity Ratio (SLR) – Automatic Monetisation of Budget DeficitAutomatic Monetisation of Budget Deficit– High Cash Reserve Ratio (CRR)High Cash Reserve Ratio (CRR)

• ImpactImpact– Preemption of Financial SavingsPreemption of Financial Savings– No possibility of Price DiscoveryNo possibility of Price Discovery– Dormant Debt MarketDormant Debt Market

Reforms in the Central G-Reforms in the Central G-Sec Market Sec Market • Three PhasesThree Phases

• First Phase (1992-95)First Phase (1992-95)– Creation of Enabling EnvironmentCreation of Enabling Environment

• Elimination of Automatic MonetisationElimination of Automatic Monetisation• Introduction of AuctionsIntroduction of Auctions• SLR reducedSLR reduced

• Second Phase (1995-2000)Second Phase (1995-2000)– Institutional DevelopmentInstitutional Development

• DvPDvP• Primary DealersPrimary Dealers• FIMMDA and PDAIFIMMDA and PDAI

– Instrument DiversificationInstrument Diversification• Floating Rate BondsFloating Rate Bonds• Capital Indexed BondsCapital Indexed Bonds

Reforms in the Central G-Sec Reforms in the Central G-Sec Market (Cont’d)Market (Cont’d) • Third PhaseThird Phase

– Enhance Liquidity and EfficiencyEnhance Liquidity and Efficiency• Indicative Auction CalendarIndicative Auction Calendar• Non-Competitive Bidding FacilityNon-Competitive Bidding Facility• Liquidity Adjustment FacilityLiquidity Adjustment Facility• Repo and collateralised borrowing lending system Repo and collateralised borrowing lending system • Negotiated Dealing System (NDS), STP and CCPNegotiated Dealing System (NDS), STP and CCP• Interest Rate derivatives Interest Rate derivatives • Market Stabilisation SchemeMarket Stabilisation Scheme• Foreign investment in local currency debt Foreign investment in local currency debt

instruments instruments • Conversion of special securities into marketable debtConversion of special securities into marketable debt

Reforms in the Central G-Sec Reforms in the Central G-Sec Market (Concl’d)Market (Concl’d)• Reforms undertaken in the context of FRBM Reforms undertaken in the context of FRBM

ActAct– Functional Separation of Debt and Monetary Functional Separation of Debt and Monetary

Management: Creation of FMDManagement: Creation of FMD– Extension of PD business to BanksExtension of PD business to Banks– Revised Scheme of Underwriting by PDs: 100% Revised Scheme of Underwriting by PDs: 100%

Underwriting by PDsUnderwriting by PDs– NDS-OMNDS-OM– Short-SaleShort-Sale– When Issued marketWhen Issued market– Considering Active ConsolidationConsidering Active Consolidation

Snapshot of the Central G-Snapshot of the Central G-Sec MarketSec Market

• Increase in Stock and TurnoverIncrease in Stock and Turnover

1992 1996 2002 2003 2004 2005 2006Outstanding stock (Rs. in billion) 769 1375 5363 6739 8,243 8,953 9,767Outstanding stock as ratio of GDP (per cent)

14.68 14.2 27.89 27.2929.87 28.69 27.67

Turnover / GDP (per cent) -- 34.21 157.68 202.88 217.3 239.9 212.9Average maturity of the securities issued during the year (in Years) -- 5.7 14.3 13.8 14.94 14.13 16.9Weighted average cost of the securities issued during the year (Per cent) 11.78 13.77 9.44 7.34 5.71 6.11 7.34Minimum and maximum maturities of stock issued during the year (in Years) N.A. 2-10 5-25 7-30 4-30 5-30 5-30

Maturity and YieldMaturity and Yield• Elongation of Maturity ProfileElongation of Maturity Profile• General Reduction in Weighted Average General Reduction in Weighted Average

YieldYield

0

2

4

6

8

10

12

14

16

18

1995

-96

1996

-97

1997

-98

1998

-99

1999

-00

2000

-01

2001

-02

2002

-03

2003

-04

2004

-05

2005

-06

Per c

ent /

Yea

rs

Weighted Average Yield (per cent) Weighted Average Maturity (years)

Yield CurveYield Curve• Development of a Smooth Yield CurveDevelopment of a Smooth Yield Curve

02468

10121416

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29

Maturity (Years)

Per c

ent

Mar-97 Mar-04 Jan-07

Ownership Pattern of Ownership Pattern of Central G-SecsCentral G-Secs

• More DiversificationMore Diversification Chart 5: Ownership Pattern of Central G-Secs:

1991

25%

56%

13%0%0%1%0%0%5%

Reserve Bank of India (own account)

Commercial Banks

Life Insurance Corporation of India #

Unit Trust of India

NABARD

Employees Provident Fund Scheme

Coal M ines Provident Fund Scheme

Primary dealers

Others

Chart 6: Ownership Pattern of Central G-Secs: 2005

7%

53%20%

0%

0%

2%

0%

0%

16%

Reserve Bank of India(own account)Commercial Banks

Life InsuranceCorporation of India #Unit Trust of India

NABARD

Employees ProvidentFund SchemeCoal Mines ProvidentFund SchemePrimary dealers

Others

External BorrowingsExternal Borrowings• Low Share of External DebtLow Share of External Debt• External Borrowings only from External Borrowings only from

Multilateral and Bilateral SourcesMultilateral and Bilateral Sources

0.0

20.0

40.0

60.0

80.0

100.0

Per

cen

t

1950-51 1980-81 1990-91 2000-01 2006-07(BE)

Domestic Liabilities External Liabilities

Measures to Deal with Measures to Deal with External Account PressuresExternal Account Pressures

• India Development Bonds (IDBs)India Development Bonds (IDBs) (1991): (1991): US$1.6 billionUS$1.6 billion

• Resurgent India Bonds (RIBs) (1998): US$4.2 Resurgent India Bonds (RIBs) (1998): US$4.2 billionbillion

• India Millennium Deposits (IMDs) (2000): India Millennium Deposits (IMDs) (2000): US$5.5 billionUS$5.5 billion

Original Sin?Original Sin?• IndiaIndia

– Low Share of External Liabilities in Sovereign Low Share of External Liabilities in Sovereign BorrowingBorrowing

– Sovereign Borrowings only from Sovereign Borrowings only from Multilateral/Bilateral SourcesMultilateral/Bilateral Sources

– States not permitted to raise external debt States not permitted to raise external debt directly directly

– Foreign investment allowed in locaL currency Foreign investment allowed in locaL currency bonds but within an overall ceilingbonds but within an overall ceiling

• Issues Issues – pros and cons of sovereign foreign currency pros and cons of sovereign foreign currency

borrowingborrowing– Rationale for calibrating foreign investment in Rationale for calibrating foreign investment in

domestic currency bondsdomestic currency bonds

India’s External DebtIndia’s External Debt• Cautious approachCautious approach• Sovereign, corporates, financial Sovereign, corporates, financial

intermediariesintermediaries• Total External debt $132 bn as at Total External debt $132 bn as at

end Sept 2006end Sept 2006• Long-term debt $126 bnLong-term debt $126 bn• Rise in external debt –ECBs, NRI, Rise in external debt –ECBs, NRI,

short-termshort-term

State GovernmentsState Governments

Trends in Budget DeficitTrends in Budget Deficit• Strong Improvement since early part Strong Improvement since early part

of this decadeof this decade• Build up of Surplus Cash Balance in Build up of Surplus Cash Balance in

Recent Years: Buyback of Securities by Recent Years: Buyback of Securities by some Statessome States

1990-91

1991-92

1995-96

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

(RE) (BE) GFD 3.3 2.89 2.65 4.25 4.21 4.17 4.46 3.5 3.23 2.68

Revenue Deficit 0.93 0.87 0.69 2.54 2.59 2.25 2.22 1.17 0.49 0.05

Gross Primary Deficit

1.78 1.22 0.8 0.09 -0.15 -0.61 -0.75 -1.65 -2.03 -2.47

Financing Pattern of Fiscal Financing Pattern of Fiscal DeficitDeficit• Share of Central Loans has reducedShare of Central Loans has reduced

• Share of Market Loans has increased Share of Market Loans has increased since early 1990ssince early 1990s

• NSSF continues to predominateNSSF continues to predominate 1990-91

1991-92

1995-96

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

(RE) (BE) Loan From Central Gov.

53.1 49.6 47.1 9.4 11.4 -0.9 11.5 -15.1 2.3 4.8

Market Borrowing

12.0 17.5 18.7 14.0 18.0 27.9 38.4 30.1 15.7 21.0

NSSF - - - 36.4 37.1 51.2 16.9 66.5 65.0 53.5

Others 33.3 32.9 34.2 40.2 33.5 21.9 33.2 18.5 17.0 20.7

Fiscal ReformsFiscal Reforms• Twelfth Finance CommissionTwelfth Finance Commission

Fiscal Restructuring Plan: Fiscal DisciplineFiscal Restructuring Plan: Fiscal DisciplineIncentivised Enactment of FRL through Debt Incentivised Enactment of FRL through Debt

Consolidation and Relief Facility (DCRF)Consolidation and Relief Facility (DCRF)Financial Disintermediation by Centre Financial Disintermediation by Centre

• ExperienceExperienceFRL Enactment – 24 States FRL Enactment – 24 States RD to be nearly eliminated and GFD-GDP ratio to RD to be nearly eliminated and GFD-GDP ratio to

decline to 2.7% in 2006-07decline to 2.7% in 2006-07

Market Borrowings of State Market Borrowings of State GovernmentsGovernments

• Till 1998-99: Tap IssuancesTill 1998-99: Tap Issuances• States encouraged to adopt auction States encouraged to adopt auction

route: route: – 100 % of market borrowing in 2006-07 so 100 % of market borrowing in 2006-07 so

far as against 48.5% in 2005-06 and 2% far as against 48.5% in 2005-06 and 2% in 2004-05 conducted through auctionsin 2004-05 conducted through auctions

• Auction calendar proposed to be Auction calendar proposed to be issued by Statesissued by States

State Government State Government Securities - issuesSecurities - issues

• Negligible Secondary Market LiquidityNegligible Secondary Market Liquidity– Low level of outstanding stock Low level of outstanding stock – Predominance of buy-and-hold investors Predominance of buy-and-hold investors – Disconnect between the uniform coupon fixed in Disconnect between the uniform coupon fixed in

tap issues and secondary market yieldtap issues and secondary market yield– Fragmentation across issuers and securitiesFragmentation across issuers and securities

• Proposed MeasuresProposed Measures– Non-competitive biddingNon-competitive bidding– Issuance calendar Issuance calendar – Use for Liquidity adjustment facility Use for Liquidity adjustment facility

Corporate Bond MarketCorporate Bond Market

Corporate Bond MarketCorporate Bond Market• Corporate Bond markets historically late to Corporate Bond markets historically late to

developdevelop• Access to bank creditAccess to bank credit• Access to external sources of financeAccess to external sources of finance• Require well developed accounting legal Require well developed accounting legal

and regulatory systemsand regulatory systems• Rating agenciesRating agencies• Rigorous disclosure standards and Rigorous disclosure standards and

effective governance of corporations effective governance of corporations • Payment and settlement systemsPayment and settlement systems• Secondary marketsSecondary markets

Reforms in Corporate Bond Reforms in Corporate Bond MarketMarket

• Four Rating agencies operating in IndiaFour Rating agencies operating in India• De-materialisation and electronic De-materialisation and electronic

transfer of securities transfer of securities • Initial focus – reform of private Initial focus – reform of private

placement market by encouraging rating placement market by encouraging rating of issuesof issues

• Further reforms neededFurther reforms needed• Appointment of a High Powered Appointment of a High Powered

CommitteeCommittee

High-powered committee High-powered committee recom recom • Enhance the issuer base and investor base including Enhance the issuer base and investor base including

measures to bring in retail investorsmeasures to bring in retail investors• Listing of primary issues and creation of a centralized Listing of primary issues and creation of a centralized

database of primary issues database of primary issues • Electronic trading systemElectronic trading system• Comprehensive automated trade reporting systemComprehensive automated trade reporting system• Safe and efficient clearing and settlement standards Safe and efficient clearing and settlement standards • Repo in corporate bonds Repo in corporate bonds • Promote credit enhancementPromote credit enhancement• Specialized debt funds to fund infrastructure projects Specialized debt funds to fund infrastructure projects • Development of a municipal bond market Development of a municipal bond market

The Way AheadThe Way Ahead• Build upon the Strong Macroeconomic PerformanceBuild upon the Strong Macroeconomic Performance

– Adherence to FRLAdherence to FRL– Stability of Inflation RateStability of Inflation Rate-external debt management policy Pension reforms

• Active ConsolidationActive Consolidation• Floating Rate Bonds and Inflation-Indexed BondsFloating Rate Bonds and Inflation-Indexed Bonds• STRIPSSTRIPS• Corporate BondsCorporate Bonds

– Bond Insurance InstitutionsBond Insurance Institutions– Institutional Investors: Credit EnhancersInstitutional Investors: Credit Enhancers– Securitised paper to be traded on exchangesSecuritised paper to be traded on exchanges– Municipal Bonds, Mortgage Backed Securities, General Municipal Bonds, Mortgage Backed Securities, General

Securitised PaperSecuritised Paper