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The importance of the debt market in an emerging economy cannot be
overemphasised. In the presence of uncertainty and prudential norms,
banks often decline to lend for long term projects, and borrowing
from overseas markets may be constrained by country risk
perceptions and restrictions on capital mobility. At the same time,
businesses in these countries are often closely held within families
and communities, and the fear of loss of power often keep such
companies away from the primary market for equities. In such cases,
the market for debt securities may emerge as the mainstay of the
credit and capital markets. Even in a fairly well developed emerging
financial market like that in India, only INR 58.92 billion, INR 36.78
billion and INR 98.55 billion respectively were raised by way of
equity shares during 1997-98, 1998-99 and 1999-2000. The amounts
raised through non-convertible debentures during the corresponding
years were INR 265.39 billion, INR 286.98 billion and INR 363.93
Besides, the debt market allows appropriate evaluation of non-
systematic risk, and dissemination of the perception of the investors
about firm specific risk by way of the spreads that the corporate bonds
command over the benchmark rates. Finally, the debt market helps
generate the (zero coupon) yield curve which reflects the expectations
of the investors about future interest rates, and thereby becomes an
invaluable analytical tool for both monetary authorities and investors
in instruments like financial derivatives.

Recent research on the bond market has focussed primarily on the
term structure of interest rate. For example, attempts have been made
to bridge the gap between stylised models like those by Cox, Ingersoll
and Ross, and Heath, Jarrow and Morton . Others have used non-
parametric techniques to estimate the term structures of specific
countries (Jiang, 1998) and specific types of securities (Briys and de
Varenne, 1997; Duffie and Singleton, 1999). And yet others have
explored the covariance between the prices of futures contracts and
the cost-of-carry relationship that is determined by the underlying
interest rates (de Roon, Nijman and Veld, 1998).
However, analyses of the structure of the debt market are few and far

Indeed, the literature on the impact of market structures on
the price discovery mechanism and market efficiency has largely been
limited to the equity market, with special emphasis on the market for
limit orders. But it is safe to hypothesise a priori that market
structures have a definitive impact on the price discovery process in
the debt markets, and hence on their efficiency. The endeavour of this
paper would be twofold: it would trace the evolution of the Indian
bond market, and draw conclusions about the nature of the market
itself from the available data. Given that the market for dated
government securities is much deeper and wider than the market for
corporate bonds, the empirical analysis will be restricted to the data
available from the market for dated securities.


As we shall see later, the data indicates that while the market for
government bonds in India has matured significantly during the
1990s, the structure of the market still fosters illiquidity and, as a
consequence, perverse pricing of government securities.
The paper has been structured as follows. In the second section of the
paper, we trace the evolution of the Indian market for government
securities. Some preliminary observations about the market are
presented in the following section, using data made available by the
Reserve Bank of India (RBI). The fourth section takes a closer look at
the bond market, and highlights certain peculiarities in the behaviour
of the market participants that can explain pricing anomalies. Finally,
section five sums up the findings of this paper, and explores policy
options that can make the market more liquid and the pricing process
less perverse.
The Market for Government Securities
The most pervasive feature of the Indian bond market is that while a
large number of financial institutions, banks and corporate entities
issue bonds on a regular basis, trading in the secondary market is
overwhelmingly dominated by government securities. Indeed, the
fraction of the turnover in the secondary market that is accounted for
by treasury bills (T-bills) and dated government securities

from 90.6 per cent in 1996-97 to 96.5 per cent during the first three
quarters of 1999-2000.

The corresponding increase in the share of the
latter was from 64.7 per cent to 93.1 per cent.


Hence, as mentioned above, we shall focus on the structure of the
market for dated government securities.
Prior to April 1993, the prices/yields of government securities were
not market driven. The government fixed the yields (and coupons) at
low levels in the primary market, so as to reduce its cost of
borrowing. As a consequence, banks had little incentive to purchase
government securities, and hence the statutory liquidity ratio (SLR)
was continually raised during the 1970s and 1980s. Since banks
purchased government securities largely (if not wholly) to meet their
SLR requirements, transactions in the secondary market were few and
infrequent. Further, the secondary market remained an over-the-
counter (OTC) market with scheduled commercial banks as the main
market participants. Hence, there were significant barriers to
dissemination of information about prices and yields in the secondary
market, and it was marked by absence of market makers. The
resultant informational problems, and the ability of large buyers and
sellers to influence prices added to the unattractiveness of trading in
the secondary market for government securities.
The years 1994 and 1995 were marked by developments that are
likely to shape the future of Indias debt market. In June, 1994, the
wholesale debt market (WDM) of the National Stock Exchange
(NSE) commenced operation with 224 securities carrying an
outstanding debt value of INR 135 billion.


The WDM provides a fully automated screen-based trading platform
that is order driven. It matches best buy and sell orders on a price-time
priority, while maintaining complete anonymity. Though most market
participants have not graduated to this trading mechanism and prefer
the OTC platform, OTC trades are usually reported to the WDM
segment and this helps disseminate data on intra-day prices and traded
The initiative taken by the NSE found official support in March, 1995
when the government and the RBI oversaw the emergence of primary
dealers. The emergence of primary dealers (PDs)

coincided with
auction-based sale of government securities in the primary market,
replacing the earlier system whereby government securities were
wholly underwritten by the RBI at some pre-determined price-yield.
More importantly, the PDs were in a position to make markets

provide two-way quotes to participants in the secondary market.

Screen based trading, together with two-way quotes for securities,
was expected to alleviate the informational problems in the secondary
market. Further, the SLR requirements were reduced to 30 per cent in
March 1995, from 37.5 per cent in 1992, thereby releasing
government securities for price-driven trade in the secondary market.


In 1995, the RBI also introduced the delivery-against-payment system
for all government securities. Apart from making it difficult for
traders to manipulate prices with uncovered long or short positions,
which could be netted out before actual delivery, the system was
aimed at eliminating counterparty risk. This system, which mandated
that all trades in government securities be routed through the
subsidiary general ledger (SGL) accounts with the RBI, was followed,
in 1998, by the establishment of custodial and depository services for
these securities by National Securities Depository Limited (NSDL),
Stock Holding Corporation of India Limited (SHCIL) and National
Stock Clearing Corporation Limited (NSCCL). The establishment of
these services significantly reduced the probability of bad deliveries,
and therefore encouraged trading in the secondary market. Further
encouragement came from the government in 1998, in the form of
elimination of stamp duty on trades in debt securities.
It is evident that the Indian market for government securities has
come a long way since the days of financial repression which
persisted till the early 1990s. However, several problems continue to
persist. First, the market continues to lack in width. On any given day,
only about 20 government securities are traded in the secondary
market, and even two-way quotes are available for about 25 securities,
the total number of dated government securities outstanding being
about 120. The securities that are frequently traded during any time
period are commonly known as benchmark securities.


Further, while the depth of the market has increased considerably in
terms of rupee turnover, the number of trades per security continues to
be low on average. Indeed, most of the trades in the government
securities market be traced back to asset-liability mismatch of
participating institutions or in their statutory obligations (Nag and
Ghose, 2000). As we shall see later, rupee turnover is not a good
indicator of competitive trading in the secondary market, especially
when the market is OTC and is dominated by large players like State
Bank of India (SBI), Life Insurance Corporation of India (LIC) and
Unit Trust of India (UTI). As a result, trading in the secondary market
for government securities does not yet take place in a competitive
price-searching environment, and hence the pricing of securities in the
market is often perverse.
Unlike stock prices, bond prices have precise relationships with an
important macroeconomic variable: the interest rate.

Hence, while a
stock market is deemed to be efficient if the stock prices are a random
walk, efficiency in the bond market would imply that, given a well-
defined term structure of interest rates, bonds of similar maturities and
characteristics would have similar prices, i.e., all market participants
are informed about, and have endogenised all information about, the
term structure.


However, if a market is largely OTC in nature, and is characterised by
a few trades among a handful of traders, the probability of market
manipulation and mispricing increases manifold, and prices may be
determined more by relative bargaining powers of the buyer and the
seller rather than by expectations about the future interest rates.
Alternatively, the possibility of mispricing, and hence market
inefficiency, decreases if there is an increase in the number of
participants and trades in the market, and if the trades take place
online such that the buy and sell orders are available to all market
participants in real time. In such a situation, if the market has
mispriced bonds, even marginal players are able to identify arbitrage
opportunities, and can exploit such opportunities successfully. The
ability of market participants to engage in competitive price searching
activity increases manifold if, not surprisingly, there are a large
number of buyers and sellers, a good proxy for which is the number of
trades recorded during a particular time period. The monotonically
increasing relationship between the number of trades and the
efficiency of the bond market, in an environment of transparent
trading, is, therefore, obvious. Further, if an efficient bond market
characterised by theoretically consistent relationships between bond
prices and expected interest rates, there should be little variance
among yields of plain vanilla bonds with similar maturity structures.


Towards the eighteenth century, the borrowing needs of Indian
Princely States were largely met by Indigenous bankers and
financiers. The concept of borrowing from the public in India was
pioneered by the East India Company to finance its campaigns in
South India (the Anglo French wars) in the eighteenth century. The
debt owed by the Government to the public, over time, came to be
known as public debt. The endeavors of the Company to establish
government banks towards the end of the 18th Century owed in no
small measure to the need to raise term and short term financial
accommodation from banks on more satisfactory terms than they were
able to garner on their own.

Public Debt, today, is raised to meet the Governments revenue deficits
(the difference between the income of the government and money
spent to run the government) or to finance public works (capital
formation). Borrowing for financing railway construction and public
works such irrigation canals was first undertaken in 1867.

The First World War saw a rise in India's Public Debt as a result of
India's contribution to the British exchequer towards the cost of the
war. The provinces of British India were allowed to float loans for the
first time in December, 1920 when local government borrowing rules
were issued under section 30(a) of the Government of India Act,
1919. Only three provinces viz., Bombay, United Provinces and
Punjab utilised this sanction before the introduction of provincial
autonomy. Public Debt was managed by the Presidency Banks, the
Comptroller and Auditor-General of India till 1913 and thereafter by
the Controller of the Currency till 1935 when the Reserve Bank
commenced operations.
Interest rates varied over time and after the uprising of 1857 gradually
came down to about 5% and later to 4% in 1871. In 1894, the famous
3 1/2 % paper was created which continued to be in existence for
almost 50 years. When the Reserve Bank of India took over the
management of public debt from the Controller of the Currency in
1935, the total funded debt of the Central Government amounted to
Rs 950 crores of which 54% amounted to sterling debt and 46% rupee
debt and the debt of the Provinces amounted to Rs 18 crores.


Broadly, the phases of public debt in India could be divided into the
following phases.
Upto 1867: when public debt was driven largely by needs of
financing campaigns.
1867- 1916: when public debt was raised for financing railways and
canals and other such purposes.
1917-1940: when public debt increased substantially essentially out
of the considerations.
1940-1946: when because of war time inflation, the effort was to
mop up as much a spossible of the current war time incomes
1947-1951: represented the interregnum following war and partition
and the economy was unsettled. Government of India failed to
achieve the estimates for borrwings for which credit had been taken in
the annual budgets.
1951-1985: when borrowing was influenced by the five year plans.
1985-1991: when an attempt was made to align the interest rates on
government securities with market interest rates in the wake of the
recommendations of the Chakraborti Committee Report.


1991 to date: When comprehensive reforms of the Government
Securities market were undertaken and an active debt management
policy put in place. Ad Hoc Treasury bills were abolished;
commenced the selling of securities through the auction process; new
instruments were introduced such as zero coupon bonds, floating rate
bonds and capital indexed bonds; the Securities Trading Corporation
of India was established; a system of Primary Dealers in government
securities was put in place; the spectrum of maturities was broadened;
the system of Delivery versus payment was instituted; standard
valuation norms were prescribed; and endeavours made to ensure
transparency in operations through market process, the dissemination
of information and efforts were made to give an impetus to the
secondary market so as to broaden and deepen the market to make it
more efficient.
In India and the world over, Government Bonds have, from time to
time, have not only adopted innovative methods for rasing resources
(legalised wagering contracts like the Prize Bonds issued in the 1940s
and later 1950s in India) but have also been used for various
innovative schemes such as finance for development; social
engineering like the abolition of the Zamindari system; saving the
environment; or even weaning people away from gold (the gold bonds
issued in 1993).


Normally the sovereign is considered the best risk in the country and
sovereign paper sets the benchmark for interest rates for the
corresponding maturity of other issuing entities. Theoretically, others
can borrow at a rate above what the Government pays depending on
how their risk is perceived by the markets. Hence, a well developed
Government Securities market helps in the efficient allocation of
resources. A countrys debt market to a large extent depends on the
depth of the Governments Bond Market. It in in this context that the
recent initiatives to widen and deepen the Government Securities
Market and to make it more efficient have been taken.


The Indian Bond Market has been traditionally dominated by the
Government securities market. The reasons for this are:
The high and persistent government deficit and the need to
promote an efficient government securities market to finance
this deficit at an optimal cost.
A captive market for the government securities in the form of
public sector banks which are required to invest in government
securities a certain per cent of deposit liabilities as per statutory
The predominance of bank lending in corporate financing and
Regulated interest rate environment that protected the banks
balance sheets on account of their exposure to the government
While these factors ensured the existence of a big Government
securities market, the market was passive with the captive
investors buying and holding on to the government securities till
they mature. The trading activity was conspicuous by its
The scenario changed with the reforms process initiated in the early
nineties. The gradual deregulation of interest rates and the
Governments decision to borrow through auction mechanism and at
market related rates.


Debt Market
Debt market as the name suggests is where debt instruments or bonds
are traded. The most distinguishing feature of these instruments is that
the return is fixed i.e. they are as close to being risk free as possible, if
not totally risk free. The fixed return on the bond is known as the
interest rate or the coupon rate. Thus, the buyer of a bond gives the
seller a loan at a fixed rate, which is equal to the coupon rate. Debt
Markets are therefore, markets for fixed income securities issued by:
Central and State Governments
Municipal Corporations
Entities like Financial Institutions, Banks, Public Sector Units,
and Public Ltd. companies.
The money market also deals in fixed income instruments. However,
difference between money and bond markets is that the instruments in
the bond markets have a larger time to maturity (more than one year).
The money market on the other hand deals with instruments that have
a lifetime of less than one year


Segments of Debt Markets
There are three main segments in the debt markets in India,
Government Securities,
Public Sector Units (PSU) bonds and
Corporate securities.
The market for Government Securities comprises the Centre, State
and State-Sponsored securities. The PSU bonds are generally treated
as surrogates of sovereign paper, sometimes due to explicit guarantee
and often due to the comfort of public ownership. Some of the PSU
bonds are tax free while most bonds, including government securities
are not tax free. The Government Securities segment is the most
dominant among these three segments.


Many of the reforms in pre-1997 period were fundamental, like
introduction of auction systems and PDs. The reform in the
Government Securities market which began in 1992, with Reserve
Bank playing a lead role, entered into a very active phase since April
1997, with particular emphasis on development of secondary and
retail markets.


There is no single location or exchange where debt market
participants interact for common business. Participants talk to each
other, conclude deals, send confirmations etc. on the telephone, with
clerical staff doing the running around for settling trades. In that
sense, the wholesale debt market is a virtual market.
In order to understand the entirety of the wholesale debt market we
have looked at it through a framework based on its main elements.
The market is best understood by understanding these elements and
their mutual interaction. These elements are as follows:
Instruments - the instruments that are being traded in the debt
Issuers - entity which issue these instruments.
Investors - entities which invest in these instruments or trade in
these instruments.
Interventionists or Regulators - the regulators and the
regulations governing the market.
It is necessary to understand microstructure of any market to identify
processes, products and issues governing its structure and
development. In this section a schematic presentation is attempted on
the micro-structure of Indian corporate debt market so that the issues
are placed in a proper perspective. Figure gives a birds eye view of
the Indian debt market structure.


The Structure of the Indian Debt Market


As is well known, a large participant base would result in lower cost
of borrowing for the Government. In fact, retailing of Government
Securities is high on the agenda of further reforms.
Banks are the major investors in the Government Securities markets.
Traditionally, banks are required to maintain a part of their net
demand and time liabilities in the form of liquid assets of which
Government Securities have always formed the predominant share.
Despite lowering the Statutory Liquidity Ratio (SLR) to the minimum
of 24 per cent, banks are holding a much larger share of Government
Stock as a portfolio choice. Other major investors in Government
Stock are financial institutions, insurance companies, mutual funds,
corporate, individuals, non-resident Indians and overseas corporate
bodies. Foreign institutional investors are permitted to invest in
Treasury Bills and dated Government Securities in both primary and
secondary markets.
Often, the same participants are present in the non-Government debt
market also, either as issuers or investors. For example, banks are
issuers in the debt market for their Tier-II capital. On the other hand,
they are investors in PSU bonds and corporate securities. Foreign
Institutional Investors are relatively more active in non-Government
debt segment as compared to the Government debt segment.


Central Governments, raising money through bond issuances, to
fund budgetary deficits and other short and long term funding
Reserve Bank of India, as investment banker to the government,
raises funds for the government through bond and t-bill issues, and
also participates in the market through open-market operations.
Primary Dealers, who are market intermediaries appointed by the
Reserve Bank of India who underwrite and make market in
government securities, and have access to the call markets and repo
markets for funds.
State Governments, municipalities and local bodies, which issue
securities in the debt markets to fund their developmental projects, as
well as to finance their budgetary deficits.
Public Sector Units are large issuers of debt securities, for raising
funds to meet the long term and working capital needs. These
corporations are also investors in bonds issued in the debt markets.
Public Sector Financial Institutions regularly access debt markets
with bonds for funding their financing requirements and working
capital needs. They also invest in bonds issued by other entities in the
debt markets.
Banks are the largest investors in the debt markets, particularly the
treasury bond and bill markets. They have a statutory requirement
to hold a certain percentage of their deposits (currently the
mandatory requirement is 24% of deposits) in approved securities


Mutual Funds have emerged as another important player in the
debt markets, owing primarily to the growing number of bond
funds that have mobilized significant amounts from the investors.
Foreign Institutional Investors FIIs can invest in Government
Securities upto US $ 5 billion and in Corporate Debt up to US $ 15
Provident Funds are large investors in the bond markets, as the
prudential regulations governing the deployment of the funds they
mobilise, mandate investments pre-dominantly in treasury and PSU
bonds. They are, however, not very active traders in their portfolio,
as they are not permitted to sell their holdings, unless they have a
funding requirement that cannot be met through regular accruals
and contributions.
Corporate treasuries issue short and long term paper to meet the
financial requirements of the corporate sector. They are also
investors in debt securities issued in the debt market.
Charitable Institutions, Trusts and Societies are also large
investors in the debt markets. They are, however, governed by their
rules and byelaws with respect to the kind of bonds they can buy
and the manner in which they can trade on their debt portfolios.


The instruments traded can be classified into the following segments
based on the characteristics of the identity of the issuer of these

Commercial Paper (CP): They are primarily issued by corporate
entities. It is compulsory for the issuance of CPs that the company be
assigned a rating of at least P1 by a recognized credit rating agency.
An important point to be noted is that funds raised through CPs do not
represent fresh borrowings but are substitutes to a part of the banking
limits available to them.

Certificates of Deposit (CD): While banks are allowed to issue CDs
with a maturity period of less than 1 year, financial institutions can
issue CDs with a maturity of at least 1 year. The prime reason for an
active market in CDs in India is that their issuance does not warrant
reserve requirements for bank.
Treasury Bills (T-Bills): T-Bills are issued by the RBI at the behest
of the Government of India and thus are actually a class of
Government Securities. Presently T-Bills are issued in maturity
periods of 91 days, 182 days and 364 days. Potential investors have to
put in competitive bids. Non-competitive bids are also allowed in
auctions (only from specified entities like State Governments and
their undertakings, statutory bodies and individuals) wherein the
bidder is allotted T-Bills at the weighted average cut off price.
Long-term debt instruments: These instruments have a maturity
period exceeding 1year. The main instruments are Government of
India dated securities (GOISEC), State Government securities (state
loans), Public Sector Undertaking bonds (PSU bonds) and corporate
bonds/debenture. Majority of these instruments are coupon bearing
i.e. interest payments are payable at pre specified dates.


Government of India dated securities (GOISECs): Issued by the
RBI on behalf of the Central Government, they form a part of the
borrowing program approved by Parliament in the Finance Bill each
year (Union Budget). They have a maturity period ranging from 1
year to 30 years. GOISECs are issued through the auction route with
the RBI pre specifying an approximate amount of dated securities that
it intends to issue through the year. But unlike T-Bills, there is no
preset schedule for the auction dates. The RBI also issues products
other than plain vanilla bonds at times, such as floating rate bonds,
inflation-linked bonds and zero coupon bonds.
State Government Securities (state loans): Although these are
issued by the State Governments, the RBI organizes the process of
selling these securities. The entire process, 17 right from selling to
auction allotment is akin to that for GOISECs. They also form a part
of the SLR requirements and interest payment and other modalities
are analogous to GOISECs. Although there is no Central Government
guarantee on these loans, they are believed to be exceedingly secure.
One important point is that the coupon rates on state oans are slightly
higher than those of GOISECs, probably denoting their sub-sovereign
Public Sector Undertaking Bonds (PSU Bonds): These are long-
term debt instruments issued generally through private placement.
The Ministry of Finance has granted certain PSUs, the right to issue
tax-free bonds. This was done to lower the interest cost for those
PSUs who could not afford to pay market determined interest rates.

Bonds of Public Financial Institutions (PFIs): Financial Institutions
are also allowed to issue bonds, through two ways - through public
issues for retail investors and trusts and secondly through private
placements to large institutional investors.
Corporate debentures: These are long-term debt instruments issued
by private companies and have maturities ranging from 1 to 10 years.
Debentures are generally less liquid as compared to PSU bonds.


Securities Settlement System: Settlement of government securities
and funds is being done on a gross trade-by-trade Delivery vs.
Payments (DvP) basis in the books of Reserve Bank, since 1995. A
Special Funds Facility from Reserve Bank for securities settlement
has also been in operation since October 2000 for breaking gridlock
situations arising in the course of DvP settlement.
With the introduction of Clearing Corporation of India Ltd (CCIL) in
February 2002, which acts as clearing house and a central
counterparty, the problem of gridlock of settlements has been
reduced. To enable Constituent Subsidiary General Ledger (CSGL)
account holders to avail of the benefits of dematerialised holding
through their bankers, detailed guidelines have been issued to ensure
that entities providing custodial services for their constituents employ
appropriate accounting practices and safekeeping procedures.
Negotiated Dealing System: A Negotiated Dealing System (NDS)
(Phase I) has been operationalised effective from February 15, 2002.
In Phase I, the NDS provides on line electronic bidding facility in
primary auctions, daily LAF auctions, screen based electronic dealing
and reporting of transactions in money market instruments, facilitates
secondary market transactions in Government securities and
dissemination of information on trades with minimal time lag.


In addition, the NDS enables "paperless" settlement of transactions in
government securities with electronic connectivity to CCIL and the
DvP settlement system at the Public Debt Office through electronic
SGL transfer form.
Clearing Corporation of India Limited: The Clearing Corporation
of India Limited (CCIL) commenced its operations in clearing and
settlement of transactions in Government securities (including repos)
with effect from February 15, 2002. Acting as a central counterparty
through novation, the CCIL provides guaranteed settlement and has in
place risk management systems to limit settlement risk and operates a
settlement guarantee fund backed by lines of credit from commercial
banks. All repo transactions have to be necessarily put through the
CCIL, while all outright transactions up to Rs.200 million have to be
settled through CCIL (Transactions involving larger amounts are
settled directly in RBI).
Transparency and Data Dissemination : To enable both
institutional and retail investors to plan their investments better and
also to providing further transparency and stability in the Government
securities market, an indicative calendar for issuance of dated
securities has been introduced in 2002. To improve the information
flow to the market Reserve Bank announces auction results on the day
of auction itself and all transactions settled through SGL accounts are
released on the same day by way of press releases/on RBI website.


Statistical information relating to both primary and secondary market
for Government securities is disseminated at regular interval to ensure
transparency of debt management operations as well as of secondary
market activity. This is done through either press releases or Banks
publications viz., (e.g., RBI monthly Bulletin, Weekly Statistical
Supplement, Handbook of Statistics on Indian Economy, Report on
Currency and Finance and Annual Report).
The Bond Market in India with the liberalization has been
transformed completely. The opening up of the financial market at
present has influenced several foreign investors holding upto 30% of
the financial in form of fixed income to invest in the bond market in
The bond market in India has diversified to a large extent and that is a
huge contributor to the stable growth of the economy. The bond
market has immense potential in raising funds to support the
infrastructural development undertaken by the government and
expansion plans of the companies. Sometimes the unavailability of
funds become one of the major problems for the large organization.
The bond market in India plays an important role in fund raising for
developmental ventures. Bonds are issued and sold to the public for


Bonds are interest bearing debt certificates. Bonds under the bond
market in India may be issued by the large private organizations and
government company. The bond market in India has huge
opportunities for the market is still quite shallow. The equity market
is more popular than the bond market in India. At present the bond
market has emerged into an important financial sector.
He different types of bond market in India
Corporate Bond Market
Municipal Bond Market
Government and Agency Bond Market
Funding Bond Market
Mortgage Backed and Collateral Debt Obligation Bond Market
The major reforms in the bond market in India
The system of auction introduced to sell the government securities.
The introduction of delivery versus payment (DvP) system by the
Reserve Bank of India to nullify the risk of settlement in securities
and assure the smooth functioning of the securities delivery and
The computerization of the SGL.
The launch of innovative products such as capital indexed bonds and
zero coupon bonds to attract more and more investors from the wider
spectrum of the populace.


Sophistication of the markets for bonds such as inflation indexed
The development of the more and more primary dealers as creators of
the Government of India bonds market.
The establishment of the a powerful regulatory system called the trade
for trade system by the Reserve Bank of India which stated that all
deals are to be settled with bonds and funds.
A new segment called the Wholesale Debt Market (WDM) was
established at the NSE to report the trading volume of the
Government of India bonds market.
Issue of ad hoc treasury bills by the Government of India as a funding
instrument was abolished with the introduction of the Ways And
Means agreement.


In 2012, the size of the Indian bond market was approximately
equivalent to 27% of the Chinese bond market and 69% of the Korean
bond market. Towards the end of 2012, the total volume of
outstanding bonds accounted for roughly USD 1 trillion, reflecting an
overall increase of 24% from the previous year which both
government securities and corporate bonds contributed.
Government securities comprise 79% of the total amount of
outstanding bonds, a larger percentage than government securities in
China, which is 73%, and in Korea, which accounts for only 39%.
Last year, the amount of outstanding government securities increased
more steeply, at a growth rate of 23% and reaching USD 792 billion,
compared to the average rate of 18% per year over the period
spanning from 2000 to 2012.


The percentage of outstanding corporate bonds to GDP indicates the
small size of the Indian corporate bond market. The total share
accounts for 5.48% representing an extremely small proportion of the
total. In the Asia-Pacific region, the corporate bond markets of
namely Malaysia, South Korea, Thailand, Singapore and China,
exceeds that of India as a percentage of GDP. Only Indonesia has a
weaker corporate bond market in the region. Although it is very small
in size as a share of GDP, the corporate bond market is actually one of
the largest in East Asia outstripping most of these emerging bond
markets, with the notable exceptions of China and Korea. However,
the non-financial corporate sector is not actively represented in the
Indian bond market. In fact, financial institutions, such as banks and
non-bank financial, together comprise 72% of the overall amount of
outstanding corporate bonds.
As of end 2012, government securities and government bonds
accounted for the largest proportion of the market at approximately
USD 543 billion or 68%. By contrast, state government as well as
municipal bonds amounted to 20% of the total securities, growing on
average at an annual rate of 22% from 2000 to 2012. The steady pace
of growth can be explained by the increasing need to fund and finance
several large-scale infrastructure plans.


The different types of bonds in the Indian bond market can be
categorized into the following:
1- Government bonds: issued directly by the government of India, the
so called G-Sec;
2- Borrowing by state governments: made by single states within
3- Tax free bonds: issued directly by quasi-sovereign companies
allow market expansion for investors and, in particular, embody retail
interest into the market;
4- Corporate bonds: this market must be further developed as proved
by the ratio of outstanding government bonds to total outstanding
5- Banks and other financial institutions bonds: they are
6- Tax-savings bonds: issued directly by the government of India,
they provide investors with tax rebates, in addition the normal rate of
7- Tax-saving infrastructure bonds: issued directly by infrastructure
companies approved by the government, they offer tax rebates along
with a decent rate of interest.


The Indian bond market has matured significantly during the past
decade. The amount raised by the government, public sector and
quasi-government entities and corporate organisations from the
market for fixed income securities far outstrip the amount raised by
way of equity. This has been matched by an increase in the depth and
width of the secondary market for bonds, both in terms of the face
value of the bonds traded and in terms of the average frequency of
trading per bond. At the same time, the fixed income instruments have
become increasingly sophisticated. Both the government and
corporate organisations issue floating rate bonds, and bonds with
embedded options have made their appearance. Indeed, with the
abolition of stamp duty, and the introduction of rupee denominated
interest rate derivatives, the bond market may be poised for a take off.
However, the growth of the secondary market for bonds has been held
back by three factors that continue to haunt the Indian market. First,
while there has been a significant improvement of the Indian economy
in so far as macroeconomic stability is concerned, high fiscal deficit
and the need to frequently change the short-term stance of monetary
policy still make it difficult to form accurate expectations about future
short-term interest rates. Second, the market is dominated by large
buyers and sellers like the UTI and SBI who can influence the market
price significantly, and many of the large buyers and sellers are
commercial banks who buy and sell bonds largely to mitigate
problems associated with asset-liability mismatch.

Finally, the market is largely OTC in nature, and hence, despite the
existence of the primary dealers, the WDM of the NSE, and Reuters
and Bloomberg terminals, dissemination of information about bond
prices (and hence interest rate expectations) is neither spontaneous
nor widespread. In brief, on the one hand, market making is limited
and, on the other hand, informational asymmetry continues to be a
dominant feature of the market.
Macroeconomic stability is a goal that is desirable by its own right,
and its discussion lies outside the scope of this paper. Other than
enhancement of such stability, the need of the hour is not only online
trading, or at least real time reporting of prices negotiated in OTC
trades, but also a manifold increase in the number of active portfolio
managers who would roll over their bond portfolios often, and who
would collectively provide two way quotes for a wide array of
securities. Given that a two way quote is a proxy for a trade, albeit
imperfect, the depth of the bond market can then increase sufficiently,
thereby increasing the markets efficiency. However, as suggested by
experience, the governments attempt to increase the depth of the
bond market by allowing foreign institutional investors (FIIs) to trade
in both T-bills and dated government securities is unlikely to be a
panacea. The exposure of the FIIs to Indian debt instruments is
marginal at best. The liberalisation of the insurance industry would,
hopefully, act as a panacea for the Indian bond market.


The study, though pioneering in nature, suffers from the shortcoming
that some of the arguments have not been adequately backed up by
data. This is, in part, the consequence of a conscious attempt to reduce
the time taken for analysis, given that market structures in a country
like India, which is in transition, can change fast, thereby rendering
carefully done analysis anachronistic. Hence, stylized facts like the
dominance of large traders like UTI in the bond market has not been
sunstantiated with data. In part, the analysis manifests the fragmented
nature of data of the Indian bond market which makes statistical and
econometric analysis difficult if not impossible. The challenge in the
future would, therefore, be to rigorously evaluate the hypotheses that
have been explicisstly and implicitly generated by the above analysis,
as the depth and width of the bond market increase over time.