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History and Overview of Debt Market
History and Overview of Debt Market
The corporate bond market, broadly comprises of corporate sector raising debt through public
issuance in capital market and also through private placement basis.
The Debt Market plays a very critical role for any growing economy which needs to employ a large amount of
capital and resources for achieving the desired industrial and financial growth. The Indian economy which has
grown at more than 7% p.a. in the last decade and is on the take off stage for double digit growth would have to
meet its resources requirements from a robust and an active debt market in India.
The Government Securities market, called 'G-Sec' market, is the oldest and the largest component of the Indian
debt market in terms of market capitalization, outstanding securities and trading volumes. The G-Secs market
plays a vital role in the Indian economy as it provides the benchmark for determining the level of interest rates in
the country through the yields on the government securities, which are referred to as the risk-free rate of return in
any economy.
Besides G-Sec market, there is an active market for corporate debt papers in India which trades in short term
instruments, such as commercial papers and certificate of deposits issued by banks and long term instruments,
such as debentures, bonds, zero coupon bonds and step up bonds.
Role of govt and central on developing debt market
In most emerging market economies, both governments and central banks are active in sovereign
bond markets. Governments issue debt of various maturities to finance fiscal deficits. Central banks
issue their own securities to finance the acquisition of assets (particularly foreign exchange
reserves). They also conduct open market operations, which involve sales and purchases of
government debt. As a result, both the government and the central bank directly influence the mix
of short- and long-term securities held by the public.
The continued integration and deepening of financial markets is a significant issue for the policy-
makers, and, particularly for the central banks, entrusted with the formulation and implementation
of monetary policy, since well-integrated and efficient financial markets are crucial in ensuring a
smooth transmission of monetary impulses to the economy. Besides the state (government) having
a ‘market-completion’ role, its role in the development of the debt market stems from the fact that
well developed debt market is essential for providing stable and cost effective funding to the various
sectors, including public sector, of the economy. The Reserve Bank of India, like many other Central
Banks has taken a proactive role in the development of debt markets. In performing this function,
the RBI played multifarious roles as central bank, debt manager to the government and regulator of
debt markets. In the above backdrop, the role of state in developing the debt market can be
analysed through following three channels: ¾ Issuer of debt o Debt management strategy and
framework ¾ Developer of bond markets o Institutional framework- market infrastructure- investor
and instrument universe ¾ Regulator of bond markets o Systemic stability- market integrity-
consumer protection
The primary interest of the RBI in the development of financial markets, especially the money and
government securities markets, arises out of their critical role in the transmission of monetary
policy, especially with the move towards reliance on indirect instruments. The money market is the
focal point for the payment and settlement system and the equilibrating mechanism for short-term
liquidity flows, with greater linkages with the foreign exchange market. Globalisation requires
efficient market integration, in particular of money and foreign exchange markets. The government
securities market becomes the focal point for the entire debt market due to the following
considerations: it is the largest debt market and the fiscal deficit continues to be fairly high, it
serves as a benchmark for pricing in other debt markets, and it provides an efficient transmission
channel for monetary policy. Several initiatives towards the development of money and government
securities markets in the 1990s, and especially since 1997, have taken them into a high growth
trajectory in terms of depth, liquidity, turnover, participants, instruments, etc. These initiatives have
assisted large government borrowings, besides contributing to increasing depth in other debt
market segments in recent years. The growth in the government securities market, however, has
perhaps not been adequately reflected in the depth of the market as the main investors continue to
be commercial banks, insurance companies and provident funds. Consequently, the retail segment
of the market has not developed. At present, many non-bank finance companies and urban
cooperative banks are required by law to maintain a certain portion of their deposits in government
securities. Although the government’s market borrowing programme each year exceeds the
requirements of the statutory pre-emptions of institutions, the above institutions are experiencing
difficulties in acquiring government securities because of an inadequate distribution mechanism. In
order to facilitate this mid-retail segment, a scheme for non-competitive bidding up to a certain
proportion within the notified amount has been introduced. Specialised gilt funds have been
promoted to provide the ideal vehicle for small retail investors. With the commencement of the CCIL
and the national dealing system in February 2002, the technological infrastructure has been in place
to facilitate large-scale nationwide retailing. The RBI is both debt manager and regulator, and the
current challenge is to evolve mechanisms by which it encourages the development of the debt
market while at the same time crafting appropriate roles as manager of public debt. In that process,
the RBI faces challenges, issues and often dilemmas in ensuring the transition process is smooth,
stable and less vulnerable to problems such as moral hazard, conflicts of interest and regulatory
forbearance and arbitrages. An attempt is made here to trace such issues and experiences.
Also, the equity holders get ownership rights and they become one of the owners of the
company.
When the company faces bankruptcy, then the equity holders can only share the residual
interest that remains after debt holders have been paid.
Companies also regularly give dividends to their shareholders as a part of earned profits
coming from their core business operations.
2. Debt Securities:
Debt Securities can be classified into bonds and debentures:
1. Bonds:
Bonds are fixed-income instruments that are primarily issued by the centre and state
governments, municipalities, and even companies for financing infrastructural development
or other types of projects.
It can be referred to as a loaning capital market instrument, where the issuer of the bond is
known as the borrower.
Bonds generally carry a fixed lock-in period. Thus, the bond issuers have to repay the
principal amount on the maturity date to the bondholders.
2. Debentures:
Debentures are unsecured investment options unlike bonds and they are not backed by any
collateral.
The lending is based on mutual trust and, herein, investors act as potential creditors of an
issuing institution or company.
3. Derivatives:
Derivative instruments are capital market financial instruments whose values are determined
from the underlying assets, such as currency, bonds, stocks, and stock indexes.
The four most common types of derivative instruments are forwards, futures, options and
interest rate swaps:
Forward: A forward is a contract between two parties in which the exchange occurs at the
end of the contract at a particular price.
Future: A future is a derivative transaction that involves the exchange of derivatives on a
determined future date at a predetermined price.
Options: An option is an agreement between two parties in which the buyer has the right to
purchase or sell a particular number of derivatives at a particular price for a particular period
of time.
Interest Rate Swap: An interest rate swap is an agreement between two parties which
involves the swapping of interest rates where both parties agree to pay each other interest
rates on their loans in different currencies, options, and swaps.
4. Exchange-Traded Funds:
Exchange-traded funds are a pool of the financial resources of many investors which are used
to buy different capital market instruments such as shares, debt securities such as bonds and
derivatives.
Most ETFs are registered with the Securities and Exchange Board of India (SEBI) which
makes it an appealing option for investors with a limited expert having limited knowledge of
the stock market.
ETFs having features of both shares as well as mutual funds are generally traded in the stock
market in the form of shares produced through blocks.
ETF funds are listed on stock exchanges and can be bought and sold as per requirement
during the equity trading time.