Transcript Role of State in Developing Debt Markets

The 2012 Capital Markets Conference
Doha, Qatar
September 18-19, 2012
Role of State in Developing Debt Markets
Harun R. Khan
Deputy Governor
Reserve Bank of India
Introduction
 The importance of debt markets in growth of an economy is well
recognized.
 State, which implies both the Government, the Central Bank & other related
Public Sector stakeholders, has a role to play in fostering a sound and
diversified debt market, which efficiently performs the function of financial
intermediation.
 State intervention stabilized the financial system in recent global financial
crisis.
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Brief History
 State’s involvement in debt markets has a long history.
 The State started borrowing in the Middle Ages in Europe.
 The earliest loans - forced loans or personal borrowing of kings.
 Initial purpose to finance wars later for civil purposes such as public works
or food supply.
 Public debt became a tool of political economy and financed expenditure in
place of levying unpopular taxes.
 Trading procedures, guarantees and techniques became well known and
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aided development of the market.
Objectives of Debt Market Development
 To aid economic growth and development.
 To transfer capital from savers to borrowers / investors & savers.
 To improve allocative efficiency of resources in the economy.
 To enable sovereign to raise resources at reasonable cost on a sustainable
basis.
 To improve monetary policy transmission.
 To assist in financial stability.
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Bond Market in Asia and India
 The bond markets across the Asian region have witnessed substantial progress
after the Asian Financial Crisis (AFC) of 1997-98.
 AFC underscored importance of bond markets as excessive reliance on bank
lending may increase systemic risk.
 Asian Bonds Funds (ABF) has played a role in the development of the
Government bonds market in the Asian region.
 Indian bond market has made rapid strides in the last few years due to several
initiatives by the Central Bank, Government and other stake holders.
 Although activity in the corporate bonds market has picked up, the Indian
bonds market continues to be dominated by Government bonds market.
 Market determined interest rate, large issuances, improved market
infrastructure, instruments diversification, fiscal responsibility legislation,
among others, have played a catalytic role.
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Volume in Government Bond Market
(` billions)
Year
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
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Primary
Issuances*
1,527
1,668
2,238
3,911
5,821
5,410
6,686
* - Gross for Central & State Govts.
$ - Single side volume.
Secondary Market
$
Trades
8,648
10,215
16,539
21,602
29,139
28,710
34,882
Turnover ratios of G-sec - Asian Bond
Markets
7
2.23
1.28
0.6
Source: AsianBondsOnline and Clearding Corporation of India Limited (CCIL)
0.78
Thailand
0.58
Singapore
Malaysia
Korea
Japan
0.39
Indonesia
0.52
Hong Kong
0.44
0.85
Phillipines
0.96
China
2.4
2.2
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
India
(Ratio)
[During the quarter ending March 2012 - based on one-sided volume]
Secondary Market Activity in GoI Dated Securities
Year
Settlement
Volume
(` cr.)
Turnover
Ratio
Share in volume traded
Avg. tenor
of Top
security
(yrs)
Top 5 securities Top security
8
2003-04
14,58,665
2.1
39%
11%
14
2004-05
8,62,820
1.1
50%
29%
11
2005-06
6,57,213
0.8
64%
31%
11
2006-07
8,83,248
0.9
75%
36%
9
2007-08
14,67,704
1.3
66%
36%
10
2008-09
19,55,412
1.5
61%
44%
10
2009-10
24,80,850
1.4
61%
36%
9
2010-11
25,52,181
1.2
72%
39%
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2011-12
30,99,108
1.2
86%
51%
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Attributes of a developed bond market
 Features of a well developed debt market
 Depth - Extent to which it can handle large transactions without causing
sharp changes.
 Breadth - Diversity of participants and heterogeneity of their responses to
new information.
 Width - Wider the bid-ask spread, the less the liquidity and vice-versa.
 Resilience - speed with which price fluctuations, due to some shock,
finally dissipates.
 Choice of instruments (e.g. fixed rate bonds, floating rate bonds, inflation indexed
bonds, zero coupon bonds, etc.) to cater to the varied requirements of market
participants/ investors.
 Deep, broad markets are generally more resilient and tend to display greater
stability in responding to financial and economic disturbances.
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Role of State
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Role of State
 Issuer of debt
 Debt management strategy and framework .
 Developer of bond market
 institutional framework- market infrastructure - investor and instrument
universe.
 Regulator of bond market
 Systemic stability – market integrity – consumer protection.
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State as Issuer
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State as Issuer
 State, generally largest issuer.
 State borrows due to mismatches in revenue and spending.
 States also borrow even though they have surplus budgets for market
development (e.g. Australia, Norway, Hong Kong, Singapore, etc.).
 Reason:To nurture bond markets and develop benchmark yield curve.
 Debt Management Strategy (DMS), framework, funding instruments.
 Credible DMS creates confidence for investors.
 DMS comprises objectives, various benchmarks and portfolio
indicators, borrowing requirements, issuance strategy and liability
management operations (buybacks and switches).
 Provides requisite information and transparency, certainty and enables
market participants (investors) to plan their strategy for investment in
Government bonds market.
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State as Issuer…2
 Objectives of DMS: Cost minimization over medium term, subject to
prudent degree of risk.
 Benchmark and portfolio indicators within the overall macroeconomic
framework
 Debt sustainability analysis - Debt to GDP ratio, interest payments to
revenue receipts ratio, rollover risk, etc.
 Benchmarks - Share of internal and external funding, short-term debt,
instrument-wise share, etc.
 Portfolio indicators - Duration, weighted average life, weighted average
cost of borrowing, etc.
 Targets and risk limits for various benchmarks and portfolio indicators
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15
Interest/Revenue Receipts
Debt/GDP
2010-11
2008-09
2006-07
2004-05
2002-03
2000-01
1998-99
1996-97
1994-95
1992-93
1990-91
1988-89
1986-87
1984-85
1982-83
1980-81
(Per cent)
90
80
70
60
50
40
30
20
10
0
5
4
3
2
1
0
Interest/GDP (Right scale)
(Per cent)
India's Debt Indicators
7
6
State as Issuer…3
 Borrowing requirements - to be estimated based on projected budget
deficits, and funding from other sources.
 Issuance strategy - periodic quantum, external and domestic funding,
instruments, maturity structure, etc.
 Achieving a stable mix of borrowings in domestic and foreign currency
• India low level of debt denominated in foreign currency.
 Elongation of maturity to reduce rollover risk.
 Issuance of variety of instruments.
• Zero Coupon Bonds, STRIPs, Floating Rate Bonds, Inflation Index
Bonds (proposed)
 To create Stable andWide investor base
• Banks , Insurance companies, pension funds etc.
 Focus on Transparency
• Issuance calendar.
 Liability management operations
 Buybacks, switches.
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Market Borrowing of Government of IndiaStylised Facts .. I
Movement of weighted average yield and maturity
Borrowings
Year
17
Outstanding
Weighted average Weighted average Weighted average Weighted average
maturity (yrs)
yield (%)
maturity (yrs)
yield (%)
2001-02
14.30
9.44
8.20
10.84
42002-03
13.80
7.34
8.90
10.44
2003-04
14.94
5.71
9.78
9.30
2004-05
14.13
6.11
9.63
8.79
2005-06
16.90
7.34
9.92
8.75
2006-07
14.72
7.89
9.97
8.55
2007-08
14.90
8.12
10.59
8.50
2008-09
13.80
7.69
10.45
8.23
2009-10
11.16
7.23
9.82
7.89
2010-11
11.62
7.92
9.78
7.81
2011-12
12.66
8.52
9.74
7.88
5.7
2007-08
2008-09
Internal Debt
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5.4
5.5
5.2
2011-12
5.9
2010-11
6.2
2009-10
6.4
2006-07
100%
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
Composition of the Central Government's Public Debt
2005-06
(% of Total)
Market borrowing of Government of IndiaStylised Facts .. II
External Debt
Market Borrowing of Government of India Stylised Facts .. III
19
100
100
99
2009-10
2010-11
2011-12
96
2008-09
91
2007-08
96
2006-07
100
90
80
70
60
50
40
30
20
10
0
98
2005-06
(Per cent)
Share of Market Loans in Internal Debt
Market Borrowing of Government of IndiaStylised Facts .. IV
Fixed
20
Floating
2011-12
2010-11
2009-10
2008-09
2007-08
2006-07
2005-06
2004-05
2003-04
2002-03
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
2001-02
(% of Total)
Composition of Central Governments' Market Borrowings
through Dated Securities
State as Issuer...4
Developing a benchmark yield curve
 Absence of a risk-free term structure of interest rates makes it difficult to
price credit risk.
 It will be very difficult to establish a corporate bond market with credible
benchmark yield curve.
 For building yield curve a program of regular issues at the appropriate
maturities is required.
 India - large issuance of government securities to finance government
budgets .
 Increasing share of market borrowings in GFD funding - from 21 per cent
in 1991-92 to nearly 100 per cent in 2011-12 ensuring steady supply of
securities to the market.
 The issuance volumes attaining critical mass to enable robust trading.
 Result: Risk-free yield curve up to thirty years comparable to peers in
emerging markets; with regular auctions of securities.
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Yield Curve in India
8.80
8.70
8.60
(Per cent)
8.50
8.40
8.30
8.20
8.10
8.00
7.90
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
7.80
Maturity (Years)
22
Jun-12
Aug-12
State as Issuer...5
 Benchmark yield curve in India - Kink at 10/11 years point and few liquid
points.
 10 years benchmark is highly liquid and hence the demand for this
segment.
 Major recommendation of the Working Group (Chairman: R. Gandhi) to
improve liquidity in the G-Sec market:
 Consolidation with issuance of securities at various maturity points in
conjunction with steps like issuance of benchmark securities over a longer
term horizon, buybacks and switches.
 Specific market making obligations of the Primary Dealers.
 Simplification of access to G-Sec market for investors in retail and midsegment, e.g.Trusts, PFs, cooperative banks, corporate, etc.
 Preparation of a roadmap to gradually bring down the upper-limit on the
HTM portfolio.
 Gradual increase in investment limit for FIIs in G-Sec.
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State as Issuer…6
Debt Management Framework
 Institutional Arrangements for Debt Management
 DMO vs. Central Bank as debt manager
 Separation of debt management from Central Bank needs to be revisited, in
the wake of global financial crisis.
 Scholars like Charles Goodhart opine Central Banks should be encouraged
to revert to their role of managing the national debt.
 Indian Case: there may be a confluence of interest between monetary policy
and debt management in India.
 Need for wider debate.
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State as developer of debt market
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State as developer of debt market
Policy, Legal and Institutional Framework
 Pre-requisites for establishing an efficient debt market: sound fiscal and
monetary policies, effective legal and tax systems, efficient intermediaries and
adequate infrastructure.
 Legal Framework
 Laws that govern markets and judicial system to enforce contracts etc.
 In India - RBI Act, Govt Securities Act, Securities (Contracts) Regulation
Act, Indian Contract Act, Payment & Settlement Systems Act, Depositories
Act, etc.
 Institutional Framework for Market Efficiency
 Regulator, Primary Dealers (PDs) and market makers, market
infrastructure, Clearing & Settlement system, Central Counter Parties
(CCPs), Self-regulatory Organizations (market associations), etc.
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State as developer of debt market …2
PD System
 PDs function as market financial intermediary, provide liquidity in G-Sec
market (market makers), facilitate raising debt by Govt, promote efficient
price discovery, and educate investors about Government bonds.
 In India, PDs network was set up in 1996.
 Presently, there are 21 PDs, of which 8 are companies (called stand
alone PDs) and 13 are commercial banks.
 Some privileges & incentives (such as payment of underwriting
commission, availability of liquidity from the Central Bank, etc.) are
given to them.
 SROs - Code of conduct, regular interactions with regulators,
reporting/dissemination of information, establishment of best market
practices, accreditation of brokers, providing price for valuation, quasi
regulatory functions and arbitration among market participants.
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State as developer of debt market...3
Market Infrastructure
 State to play trail blazer role as cost of development is huge.
 Trading platforms (in India – anonymous screen based order matching
system (NDS-OM), NDS-Auction, andWeb-based Module).
 Clearing and settlement of Government securities and corporate bonds (in
India - CCIL serves as CCP).
 Safe and sound payment and settlement system (RTGS, and DvP Settlement
in Central Bank books).
 Central Depository (in India – For Government securities Reserve Bank of
India is depository: SGL system).
 Compliance with the ‘Principles for Financial Market Infrastructures’
(PFMI) finalized by CPSS-IOSCO.
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State as developer of debt market …4
CCP
 Principles for Financial Market Infrastructure (CPSS-IOSCO) –
New International Standards
 24 principles (April 2012) for harmonising the earlier 3 sets of standards.
 Three main principles: (a) Governance (principle 2); (b) Money
settlement (principle 9); and (c) Exchange of value settlement systems
(principle 12).
 Draft Assessment Methodology – Public Consultation.
 India - CCIL undertook a self-assessment based on draft assessment
methodology.
 Self-assessment results found to be satisfactory.
 FSAP has also evaluated the CCP and found the system to be robust.
 In India preliminary assessment shows that most principles have been
broadly observed.
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State as developer of debt market...5
 Introduction / development of financial products for trading & hedging.
 Widening the investor base
 Calibrated opening to foreign investors - promoting retail and mid-
segment investors.
 Market access & efficiency
 Enabling issuers and investors easy access both the primary and
secondary markets.
 Anonymous order-matching system with straight through processing
(STP), web-based module for primary and secondary market, noncompetitive segment for retail and mid-segment investors in primary
auctions.
 Measures to enhance liquidity of bond markets, passive and active
consolidation, among others- buybacks/switches – building volumes in
benchmark securities.
 Developing the related markets for funding/hedging
 Money market, Repo market, Derivatives markets etc.
30  In India, market repo, CBLO, IRF, IRS, etc.
Share of market participants in Govt securitiers in
India (end-June 12)
3.6
Banking Sector
Non-Bank PDs
Insurance Companies
17.6
Mutual Funds
47.3
7.3
0.9
Corporates
1.4
FIIs
0.3
0.3
Provident Funds
21.2
RBI
0.1
31
Financial Institutions
Others
State as regulator of debt market
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State as regulator of debt market
 To address systemic stability issues, which have implications for balance
sheets of the issuer (Govt), investors and the financial markets, through
regulation and supervision.
 To focus on “right” regulation rather than “more” or “less” regulation.
 To strike balance between financial innovation & systemic stabilityResponsible financialisation in sync with welfare enhancement goal.
 To ensure market integrity
 Delivery versus Payments (DvP).
 To avoid market failures - Precluding any scope for asymmetric
information.
 To put in place reporting and disclosure norms for ensuring requisite
level of transparency.
 To ensure consumer protection.
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State as regulator of debt markets …2
Indian Experience
 Reserve Bank has created a regulatory reporting structure, which enhances
transparency and improves disclosure.
 Financial innovation in products & processes in line with local needs-market
development without risks to financial stability.
 CBLO, NDS-OM, Web-based platform for primary & secondary markets.
 Market Integrity
 Limits on short-sales, yield bands for secondary market transactions.
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State as regulator of debt markets …3
Indian experience
 Market Surveillance
 Reserve Bank has created a regulatory reporting system which enhances
transparency and improves disclosure (Trade Repositories for OTC
derivatives, regulatory reporting of OTC outright and repo trades in Gsec in batch modes).
 Surveillance over cash and derivatives market for transactions, entities,
prices and volumes.
 Ensuring Delivery-versus-Payments (DVP)
 Penalty for failure of settlement.
 Consumer protection
 Market participants are regulated entities which ensures market discipline
 Yields’ band
 Awareness
 CCP for guaranteed settlement.
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Conclusions
 In conclusion, for development of deep, efficient & resilient debt markets,
each country has to focus on the role & responsibility of state (central bank
and government) keeping in view:
 Significance of debt markets, in particular government bonds market, in overall
economic development of the economy & the financial system even if a country
has budget surplus.
 Credible and efficient debt management strategy and framework within the
overall macroeconomic policy environment.
 Strategy for deeper, wider and resilient debt market.
 Safe and robust financial market infrastructure (FMI).
 Effective regulatory & supervisory framework focusing on financial stability,
market integrity, transparency and consumer protection.
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Thank You
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