FINANCIAL MARKETS AND FINANCIAL SERVICES

CHAPTER-10 DEBT MARKET

Chapter 10 DEBT Market

Public Debt
Public debt is raised by governments to meet the gap between budgeted receipts and payments. Public debt is government or state debt. The state generally borrows to: i. To meet budget deficits; ii. To cover other expenses; and iii. To finance development activities.

Classification of Public Debt Public debts have been classified into two broad groups internal and external debt. Internal debts are loans raised within the country. External debts are cumulative amount raised outside the country by the government and others.
Financial Markets and Financial Services Vasant Desai

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Chapter 10 DEBT Market

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

Gradual Emergence of Active Market for Debt Instruments

Policy measures initiated for providing market orientation to the debt market. Gradual deregulation of interest rates on money market instruments which are now market determined. Introduction of 364-Day Treasury Bills on auction basis with no predetermined amount and without any support from the RBI. Introduction of 91-Day Treasury Bills on auction basis with a predetermined amount and with RBI support at the cut-off yield. Offering market-related yields on Government securities. Phased reduction in the SLR requirements for commercial banks. Establishment to the National Stock Exchange with a separate debt raiding segment. Setting up of the Securities Trading Co-operation of India (STCI) aimed at improving the liquidity of the Government securities and thereby enhancing their attractiveness to the investors. STCI has been giving two way quotes for Government securities and Treasury Bills.
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Chapter 10 DEBT Market

Introduction of the system of Delivery versus Payment (DvP) in transactions of Government securities at the Public Debt Office of Reserve Bank of India in Bombay, to speed up process of transfer of securities by introducing transparency and eliminating counterparty risks. Introduction of a system of Primary Dealers (PDs) to strengthen the infrastructure in the Government securities market. PDs will perform the role of underwriters and will provide two way quotes in the secondary market. Construction of bond market indices by I-Sec (i-BEX) and credit Capital (GS 20). Presence of credit rating agencies to rate debt instruments.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

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Financial Markets and Financial Services Vasant Desai

Management of Public Debt Some Issues

Chapter 10 DEBT Market

The management of public debt of both the Centre and the States is the responsibility of the Reserve Bank as the Central Bank of the country and as a banker to the Government. This involves some problems: i. Transfer Problem: Firstly, the interest burden is borne by the Government through taxes which are paid mostly by the poorer sections, while the public debt is held by the institutions and the richer classes of people. This would involve an inequitable transfer of funds from the poor to the rich. ii. Equity Between Present and Future Generation: Secondly, public debt involves transfer of resources from the public to the Government, when loans are raised from the present generation but the repayment of loans may benefit only the future generations. This would involve some inequity as between the present and future generations, in the sense that the burden is borne by the present generation and the benefits will flow to the future generations.
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Chapter 10 DEBT Market

iii. Interest Rates Problem: Thirdly, the management of public debt involves the problem of interest rate structure through the open market operations. This means that the interest rates in the market can be influenced by the Reserve Bank through the prices at which it buys and sells the Government securities. iv. Problem of Liquidity in the Economy: Fourthly, the greater the public debt held by the RBI and the banks, the greater is the possibility of monetization of the debt. Money supply can be expanded and contracted by the open market purchase and sale of the government securities and through this process, the liquidity in the economy can be expanded or contracted. The holdings of government securities by the RBI provide the potential for money creation.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

Debt market reforms ongoing process i. Banks and institutions (mutual funds insurance companies, provident funds etc.) be permitted to set up primary dealer counters to broadbase holding of debt instruments at the retail level. ii. The Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) stipulations in inter-bank borrowings be abolished to encourage the emergence of a meaningful benchmark like the LIBOR. iii. Debt market intermediaries be given access to institutional finance. iv. FIIs be allowed to participate in the debt market. Repo transactions be reintroduced for listed debt securities with suitable safeguards. v. No restrictions be placed on the kinds of instruments in which Money Market Mutual Funds can invest. vi. There be a single regulatory authority, preferably SEBI, for the debt market. vii. A single TDS rate be developed for all debt instruments.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

viii. Private sector infrastructure companies be permitted to issue tax-free bonds. ix. Stamp duty on primary issues of debt securities need to be made uniform across all states. Stamp duty on secondary market transactions should be abolished. x. A municipal bond market be developed. Municipal bodies be given powers to set levels for user charges for the services provided. xi. Muncipal bond markets to be developed xii. Enhancement of the retail participation.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

Corporate Debt Market Primary Market

1. The stamp duty on debt instruments be made uniform across all the 2.

3. 4.

5.

States and linked to the tenor of securities. To increase the issuer base, the time and cost for public issuance and the disclosure and listing requirements for private placements be reduced and made simpler. Banks be allowed to issue bonds of maturities of 5 years and above for ALM purpose, in addition to infrastructure sector bonds. A suitable framework for market making be put in place. The disclosure requirements be substantially abridged for listed companies. For unlisted companies, rating rationale should form the basis of listing. Companies that wish to make a public issue should be subjected to stringent disclosure requirements. The privately placed bonds should be listed within 7 days from the date of allotment, as in the case of public issues. The role of debenture trustees should be strengthened. SEBI should encourage development of professional debenture trustee companies.
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Chapter 10 DEBT Market

6. To reduce the relative cost of participation in the corporate bond market, the tax deduction at source (TDS) rule for corporate bonds should be brought at par with the government securities. Companies should pay interest and redemption amounts to the depository , which would then pass them on to the investors through ECS/warrants. 7. For widening investors base, the scope of investment by provident /pension/gratuity funds and insurance companies in corporate bonds should be enhanced. Retail investors should be encouraged to participate in the market through stock exchanges and mutual funds. 8. To create large floating stocks, the number of fresh issuances by a given corporate in a given time period should be limited. Any new issue should preferably be a reissue so that there are large stocks in any given issue and issuers should be encouraged to consolidate various existing issues into a few large issues, which can then serve as benchmarks. 9. A centralized database of all bonds issued by corporate be created. Enabling regulations for settings up platforms for non-competitive bidding and electronic bidding process for primary issuance of bonds should be created.
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Chapter 10 DEBT Market

Secondary Market
The regulatory framework for a transparent and efficient secondary market for corporate bonds should be put in place by SEBI in a phased manner. To begin with, a trade reporting system for capturing information related to trading in corporate bonds and disseminating on a real time basis should be created. The market participants should report details of each transactions within a specified time period to the trade reporting system. 2. The clearing and settlement of trade should meet the standards set by IOSCO and global best practices. The clearing and settlement system should migrate within a reasonable time frame from gross settlement to net settlement. The clearing and settlement agencies should be given access to the RTGS system. For improving secondary market trading, repos in corporate bonds be allowed. 3. An online order matching platform for corporate bonds should be set up by the stock exchanges or jointly by regulated institutions such as banks, financial institutions, mutual funds, insurance companies, etc. In the final stage of development, the trade reporting system could migrate to STP-enabled order matching system and net settlement. 4. The Committee also recommended: (i) reduction in shut period for corporate bonds; (ii) application of uniform coupon conventions such as, 30/360 day count convention as followed by Government securities; (iii) reduction in minimum market lot from Rs. 10 lakh to Rs. 1 lakh, and (iv) introduction of exchange traded interest rate derivative products.
1.

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Chapter 10 DEBT Market

Securitised Debt Market

1. A consensus should evolve on the affordable rates and levels of stamp duty on debt assignment, pass-through certificates (PTCs) and security receipts (SRs) across States. 2. An explicit tax pass-through treatment to securitization SPVs/ Trust SPVs should be provided. Wholesale investors should be permitted to invest in and hold units of a close-ended passively managed mutual fund whose sole objective is to invest its funds in securitized paper. There should be no withholding tax on interest paid by the borrowers to the securitization trust and on distributions made by the securitization trust to its PTCs and/or SR holders. 3. PTCs and other securities issued by securitisation SPVs/Trust SPVs should be notified as securities under SCRA.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

4. Large-sized NBFCs and non-NBFCs corporate bodies established in India may be permitted to invest in SRs as QIBs. Private equity funds registered with SEBI as venture capital funds (VCFs) may also be permitted to invest in SRs within the limits that are applied for investment by VCFs into corporate bonds. 5. The Committee also recommended: (i) introduction of credit enhancement mechanism for corporate bonds; (ii) creation of specialized debt funds to cater to the needs of the infrastructure sector; and (iii) fiscal support, like tax benefits, bond insurance and credit enhancement, for municipal bonds and infrastructure SPVs.

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Financial Markets and Financial Services Vasant Desai

Chapter 10 DEBT Market

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Financial Markets and Financial Services Vasant Desai