SWOT analysis of Indian Bond Markets & way forward

Report
Indian Bond Markets
Assessment and Prospects
H R Khan
Reserve Bank of India
FIMMDA Network Event, September 17, 2010
Opening Thoughts
• Importance of bond markets
• Government Bond Market
– Provides a risk-free yield curve
– Liquid, deep, and broad-based market necessary to facilitate optimal
government borrowing
• Corporate Bond market
– Providing corporate sector a financing avenue complementary to bank finance
– Promote financial stability
• Two decades of market reform
– Covered a lot of ground but a lot still to be done
• Times have never been more interesting
• Global Crisis is an opportunity to look back and reflect on the road
travelled
• Look at the issues in a SWOT framework
GOVERNMENT SECURITIES MARKET (GSM)
GSM- Strengths (1)
• Large supply of securities
– Enabling creation of benchmark securities with
sufficient outstanding stock
• Issuances across the yield curve
• ‘State of the Art’ primary issuance process
– Electronic bidding
– Faster processing
– Flexibility to dispose of securities on the same day
GSM-Strengths (2)
• Well capitalised and efficient Primary Dealer System
– CRAR @ 15%, much above the Basel norms
– 100% of the notified amount underwritten
• Sound Depository system
– Proprietary and custodial accounts
– Complete dematerialization
• ‘State of the Art’ market infrastructure
–
–
–
–
–
Mandatory reporting –NDS
Trading systems – NDS-OM (above 80 percent of trades)
Real time price dissemination
Clearing and settlement system on DvP III
Guaranteed settlement through CCP (CCIL)
GSM-Strengths (3)
• Availability of instruments and processes
–
–
–
–
–
Short sale
‘When Issued’
STRIPS
FRBs
Security Financing
• Repo
• CBLO
– Derivatives
• IRS/FRA
• IRF
GSM-Strengths (4)
• Predominant holding by residents
– No default risk perception – a sovereign will not default on
debt in its own currency
– marginal susceptibility to exchange rate volatilities
• Sophisticated participants
– Enabling adoption of advanced techniques and processes
• Non participation of RBI in primary market
– Facilitating market based price discovery
• Close coordination between
– debt and monetary managements
– monetary and fiscal policies
Growth in Outright and repo settlement volumes (in Rs. Crore)
7000000
6000000
5000000
4000000
3000000
2000000
1000000
0
2002-03
2003-04
2004-05
2005-06
G-sec
Source: CCIL’s Rakshitra
2006-07
Repo
2007-08
2008-09
2009-10
Maturity and yield-Balancing Act
14
18
16
12
14
10
12
8
Yield %
years10
8
6
6
4
Wt. avg yield
Wt. avg maturity
4
2
2
Source: RBI’s Annual Report
2009-10
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
2001-02
2000-01
1999-00
1998-99
0
1997-98
0
GSM-Weaknesses (1)
• Fiscal dominance
– Supply outstripping demand
• Illiquidity
– HTM regime for SLR securities. Any alternative?
• Skewed investor base
– banks, Insurance Companies and RBI account for
sizeable portion of outstanding stock
• Active participants with similar IR exposures
– Herding
GSM-Weaknesses (2)
•
•
•
•
•
Absence of Term Money market
Lack of retail interest
Absence of market making
Skewed participation in IRS
Not much activity in
– Short selling
– When issued
– IRFs
• Participants’ inertia – Lazy treasuries?
– Participants do not come in till liquidity improves
– Liquidity will not improve till participants come
– Chicken and Egg problem
Holder Profile in Central Govt securities as on end Mar 2010
4%
12%
1. Commercial Banks
2. Bank- Primary Dealers
38%
7%
3. Non-Bank PDs
4. Insurance Companies
5. Mutual Funds
1%
6. Co-operative Banks
3%
7. Financial Institutions
0%
8. Corporates
3%
9. FIIs
10. Provident Funds
1%
11. RBI
12. Others
22%
9%
0%
Source: RBI monthly bulletin
Opportunities (1)
• Latecomer’s advantage - development can be
based on wider experience
• Tap latent investor base
– Nascent pension sector- a potential large investor
• Market G-secs as another investment product,
not as a mandated product
– Enhance liquidity
– Increase policy leeway
Opportunities (2)
• Innovate and introduce new products
– To suit diverse investor interests
• Inflation Indexed Bonds
• Interest Rate Options
• Scope for calibrated increase in FII
participation
– Reduce the load on domestic investors and free
domestic resources
– To be considered in light of other implicationsinterest rate and exchange rate volatility
Threats (1)
• Low volume markets susceptible to manipulation
• Underdeveloped domestic markets for hedging
products may encourage migration off-shore
– Opacity of off-shore markets and difficulty of
monitoring and regulation
• Lack of sophistication by certain participants
• Shallowness of the market
– Rapid opening may cause excessive volatility
– Slower opening results in losses due to missed
opportunities
Threats (2)
• Pressure for rapid opening of rupee debt
market to foreign participation
– Sovereign insulated from exchange risk
– But the market exposed to Interest Rate and
Exchange Rate volatility
• Migration to IFRS – implications for valuation
and recognition of P & L
CORPORATE BOND MARKET (CBM)
CBM- Strengths
– Jurisdictional clarity
– Increased regulatory focus
– Dematerialized holding
– DvP settlement of OTC trades
– Reporting and dissemination of OTC data
– Availability of repo facility
– Secondary market activity on the rise
Source: SEBI
Jul/10
Apr/10
Jan/10
Oct/09
Jul/09
Apr/09
Jan/09
Oct/08
Jul/08
Apr/08
Jan/08
Oct/07
Jul/07
Apr/07
Jan/07
Trend in corproate bond trades
80000
70000
60000
50000
40000
30000
20000
10000
0
CBM-weaknesses
– Historically a bank based financial system
– Too few public issuances
• Preference for bank loans, ECBs or Private Placements
– Illiquidity
• Predominantly buy and hold investors - cause
• Lack of exit options dissuades potential investors- effect
CBM-Opportunities and Threats
• Opportunities
– Enormous scope for expansion of this market
• Investment demands of a growing economy particularly
huge infrastructure investments
• Growing pension sector
– Tapping latent investors with innovative products
– IFRS norms- symmetrical treatment to loans and
bonds
• Threats
– Shallow markets- risk of volatility, manipulation and
unreliable price discovery
Bond markets- Way forward
Way forward: G-sec market
• Widen the investor base
– By fine-tuning the delivery channels
• Direct access to retail segment in primary issuance
– By fine-tuning the trading infrastructure
• Direct access to retail segment in secondary market
– By active and concerted market making
• Banks and PDs to actively undertake market making
Way forward: G-sec market
• Market G-secs as an investment class
– As part of overall portfolio management by
participants
– Reduce the reliance on regulatory mandates and
concessions
– Benefits
• Increase in market activity
• Increased policy leeway
Way forward: G-sec market
• Enhance activity and broadbase participation in
–
–
–
–
IRF
Floaters
STRIPS
‘When issued’ and short sale
• Introduce new instruments and products
– Inflation Indexed Bonds
– Interest Rate Options
• To complete markets
Way forward: G-sec market
• Prepare for migration to new accounting
framework
• Calibrated opening for foreign participation
– Reducing the burden on domestic investors
Way forward: Corporate Bonds
• Higher activity in corp bonds
– To meet the funding gap for corporates and infra
sector
• Repo in corporate bonds
– Review of haircuts and settlement cycle
• Introduction of CDS
– Expected to encourage participation
• Widening of the menu of IRFs
– To enable hedging IR risk
Parting thoughts
Role of FIMMDA in the changing times
• More proactive and coordinating role
• Higher responsibilities
– Reporting platforms for corporate bonds (outright
and repo) and CPs, CDs
– Introduction of CDS
• Feedback on policies
• Facilitation of active participation by members
• FIMMDA as an SRO?
Role of market participants
• Market liquidity is a result of active
participation from members
– Look within
• Regulator only facilitates
• Market development is a cycle of conception
introduction, feedback and review
– Participants’ active role is indispensible
• New products need more nurturing in the
early stages before they become self sufficient
Thought for Food
“One of the very nicest things about life is the
way we must regularly stop whatever we are
doing and devote our attention to eating” - Luciano Pavarotti & William Wright
Because
“There is no love sincerer than the love of food”
- George Bernard Shaw
Thank you

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