Bonds can be defined as debt obligations and a form of borrowing. For instance, if a company issues a bond, the returns on the given sum must be repaid overtime. The issuer of the bond has to pay the principal amount, also known as the face value, along with a specified rate of interest during the life of the bond, until its maturity. Bonds are fixed-income security investments, as the lender can anticipate a steady cash flow in till the bond matures.
Before 1994, the price of government bonds was not market driven. The government used to fix low rate of interest to reduce the cost of borrowing. Hence, banks had little incentive to purchase government bonds, thus the statutory liquidity ratio was continually raised.
In June 1994, the Wholesale Debt Market (WDM) of the National Stock Exchange (NSE) started functioning. This initiative saw the emergence of primary dealers. From September 1995 to October 1999, short-medium term bonds (with three years or less to maturity) were traded more often than long-term bonds (with more than three years to maturity). However, there has been an increase in the number of trades involving long-term bonds since January 1999. This shows that the market participants are willing to trade in bonds of longer tenure that carry more inflation and interest rate risk.
The government bond market in India has experienced steady growth over the years as there is a need to finance the fiscal deficit. When it comes to government bonds, RBI is the major investor; in comparison, only a small percentage is invested by the corporate sector. The Indian bond market is dominated by a handful of major players—the banks, insurance companies, and large mutual fund corporations. Hence, an increase in the volume of trade may merely imply that major nationalised banks have sold the additional bonds to one large mutual fund corporation and do not show the real picture as to how other investors have or have not contributed to an increase at all. This leads to mispricing bonds, and the probability of mispricing bonds results in market inefficiency, therefore, decreasing the number of participants in the market. If trade takes place online, everyone, including marginal players, can exploit the various opportunities available to them. Hence, the demand increases. The only other way to increase the size and depth of the market is to increase the number of trade during a particular period. This will automatically improve the efficiency of the bond market.
Although the bond market in India has come a long way, the government has been implementing various reforms and policies to improve it. The Government of India decided in 2007 that each agency/institution needs to have private functions in order to make the market more efficient. It was decided that the Securities Exchange Board of India (SEBI) will be responsible for primary and secondary market, while the Reserve bank of India (RBI) will be responsible for the corporate repos and reverse repos market. To simplify the requirements for debt securities, SEBI put in place the simplified listing for debt securities in May 2009. One of the critical recommendations of the Patil Committee was that the trades have to be reported to the reporting systems to make the system transparent. Currently, the secondary market trades in corporate bonds are being published on the Fixed Income Money Market and Derivatives Association (FIMMDA). New debt instruments have been created by both SEBI and RBI to facilitate the development of the secondary market. One of the significant new debt instruments was the bond index. A bond index is a method of measuring the value of a section of the market. It is formulated from the prices of selected bonds, usually identified by a weighted average. Financial managers and investors use it as a tool to describe the market as well as compare returns on specific investments.
Despite a variety of measures adopted by the authorities over the last few years, the Indian bond market has been lagging in developing the debt market, when compared to other developed as well as emerging economies. The development of the bond market is essential for economic stability in a country. But, it is crucial to understand if the regulators have the willingness to shift away from a loan-driven, bank-dependent economy and also whether the corporations themselves have strong incentives to help develop a bond market. Only a combination of the two can pave way for the systematic development of a well-functioning bond market.
It is also vital to develop the long-term debt markets as it is critical for the mobilisation of funds which are required to finance potential businesses as well as infrastructure expansion. A challenge like crowding of government securities cannot be addressed by market participants and regulators alone. Efficient and careful management of public debt and cash would result in the reduction of the debt requirement of the government, thereby providing more market space and creating higher demand for corporate debt securities. These measures only widen the market.
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