harun r. khan deputy governor reserve bank of india the 2012 capital markets conference doha, qatar...

Harun R. KhanDeputy Governor

Reserve Bank of India

The 2012 Capital Markets Conference Doha, Qatar

September 18-19, 2012Role of State in Developing Debt Markets

IntroductionIntroduction

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 HistoryBrief HistoryState’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 aided development of the market.3

Objectives of Debt Market Objectives of Debt Market DevelopmentDevelopmentTo 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 Bond Market in Asia and IndiaIndiaThe 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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Year Primary Issuances*

Secondary Market Trades$

2005-06 1,527 8,648

2006-07 1,668 10,215

2007-08 2,238 16,539

2008-09 3,911 21,602

2009-10 5,821 29,139

2010-11 5,410 28,710

2011-12 6,686 34,882

* - Gross for Central & State Govts. $ - Single side volume.

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Volume in Government Bond Volume in Government Bond MarketMarket (` billions)

Turnover ratios of G-sec - Turnover ratios of G-sec - Asian Bond MarketsAsian Bond Markets[During the quarter ending March 2012 - based on one-sided volume]

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Top 5 securities Top security

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% 11

2011-12 30,99,108  1.2 86% 51% 10

Secondary Market Activity in GoI Dated Securities

YearTurnover

Ratio

Share in volume tradedAvg. tenor

of Top security

(yrs)

Settlement Volume (` cr.)

Attributes of a developed Attributes of a developed bond marketbond 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 StateRole of State

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Role of StateRole of StateIssuer of debt

Debt management strategy and framework .

Developer of bond market institutional framework- market infrastructure - investor

and instrument universe.

Regulator of bond marketSystemic stability – market integrity – consumer

protection.

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State as IssuerState as Issuer

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State as IssuerState as IssuerState, 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…2State as Issuer…2Objectives 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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India's Debt India's Debt IndicatorsIndicators

State as Issuer…3State as Issuer…3Borrowing 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 and Wide investor base• Banks , Insurance companies, pension funds etc.

Focus on Transparency• Issuance calendar.

Liability management operations Buybacks, switches.16

Market Borrowing of Government Market Borrowing of Government of India- Stylised Facts .. Iof India- Stylised Facts .. I

Movement of weighted average yield and maturity

Year

Borrowings Outstanding

Weighted average maturity

(yrs)

Weighted average yield (%)

Weighted average maturity

(yrs)

Weighted average 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

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Market borrowing of Market borrowing of Government of India- Stylised Government of India- Stylised Facts .. IIFacts .. II

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Market Borrowing of Market Borrowing of Government of India - Stylised Government of India - Stylised Facts .. IIIFacts .. III

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MarketMarket Borrowing of Government Borrowing of Government of India- Stylised Facts .. IVof India- Stylised Facts .. IV

State as Issuer...4State as Issuer...4Developing a benchmark yield curveAbsence 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 Yield Curve in IndiaIndia

State as Issuer...5State as Issuer...5Benchmark 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 mid-segment, 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…6State as Issuer…6

Debt Management FrameworkInstitutional 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.24

State as developer of State as developer of debt marketdebt market

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State as developer of debt State as developer of debt marketmarket

Policy, Legal and Institutional FrameworkPre-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 EfficiencyRegulator, 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 State as developer of debt market …2market …2

PD SystemPDs 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 State as developer of debt market...3market...3

Market InfrastructureState 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, and Web-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 State as developer of debt market …4market …4

CCPPrinciples 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.29

State as developer of debt State as developer of debt market...5market...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, non-competitive 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. In India, market repo, CBLO, IRF, IRS, etc.30

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47.3

0.1

21.20.3

0.31.4

0.97.3

17.6

3.6

Share of market participants in Govt securitiers in India (end-June 12)

Banking Sector

Non-Bank PDs

Insurance Companies

Mutual Funds

Financial Institutions

Corporates

FIIs

Provident Funds

RBI

Others

State as regulator of debt State as regulator of debt marketmarket

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State as regulator of debt State as regulator of debt marketmarket

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 stability- Responsible 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.33

State as regulator of debt State as regulator of debt markets …2markets …2

Indian ExperienceReserve 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 State as regulator of debt markets …3markets …3

Indian experienceMarket 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 G-sec 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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ConclusionsConclusions

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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