The Asian industry body ASIFMA has recommended that broad measures are needed to reform India’s bond markets.
ASIFMA has produced a report this week claiming that if its suggestions were to be implemented, Indian bond markets would develop, strengthen and become more appealing to investors.
The Hong Kong-based industry body construes that government and corporate bond markets in India are inferior not only to those in the developed world, but also in comparison to its neighbours within Asia.
The size of India’s market (the sum of government, financial institution and corporate debt), is approximately one-quarter the size of China’s bond market and about two-thirds that of Korea, according to ASIFMA. The size of India’s bond market, at 5.5% of GDP, is behind every country in Asia except for Indonesia.
The government fiscal deficit burdens the Indian banking system as banks must comply with a statutory liquidity ratio which contributes to the low depth of the Indian financial bond market. Indian banks are required to buy and hold a large portion of Indian government bonds under this ratio requirement. “Consequently, this negatively affects both infrastructure funding as well as the private corporate sector, which are ultimately crowded out as banks are required to fund government debt rather than invest in their development,” says ASIFMA.
ASIFMA believes that a more open and accessible government bond market, in tandem with a more active government futures market, would be beneficial for government financing and the real economy in India. There is also a perceived need for a municipal and local authority bond market as well as a well-regulated securitisation and covered bond market.
Interest rates is another area requiring improvement “One of the most important factors needed to create a vibrant, attractive and accessible bond market is the freeing of interest rates to reflect market conditions, without artificial caps and floors,” the report said. In this regard, ASIFMA added that it supports the effort made by the Reserve Bank of India in deregulating the interest rate on savings.
Work is also needed on the benchmark yield curve. In India, the 10-year, five-year and two-year government bonds are currently the main benchmarks in the bond market. “The establishment of a benchmark at every level of the yield curve would provide investors and issuers a better way to gauge both long-and short-term securities, as it would set a risk-free rate across the yield curve from which corporate and infrastructure bonds can be priced,” says the report.
Development of swap derivatives, creditor rights on close out netting and credit ratings that adhere to international best practice, are other issues that need attention in developing the bond markets. Additionally, the repo market in India differs from the classic model as the security title is not transferred between the counterparties but the security is pledged, tying the security to the agreement as collateral which cannot be re-used by the receiving counterparty. That prevents it from being used to provide liquidity in the cash market.
In pursuit of the goal of widening the investor base in Indian bonds and improving liquidity in secondary market trading, reforms and improvements may also be required to the taxation system, although ASIFMA praises India for its recent reduction of withholding tax to 5% on rupee denominated bonds or government securities for a period of two years.