Till 1991, money was collected and lent according to Plan. If planning went awry, the government approached RBI, its banker. The central bank made a few phone calls to the heads of banks and bonds were issued and the money arranged. No questions asked, no explanations given. If anybody wanted a loan, they approached the banks to borrow money at fixed rates. That, in short, was the debt market in India ten years ago.

From the rudimentary form of a debt market then to the threshold of vibrant, real-time trading in a range of debt instruments, the journey has been long but rapid. These are discussed earlier in the project on Financial sector reforms under the project "Indian Banking Today & Tomorrow"

The contours of the debt market began taking shape in the late 1990s when the government started borrowing at market rates. Slowly, but steadily, the market grew, adding fresh players and novel instruments. The growth of the debt market, in terms of participation, competition, depth and range, has been phenomenal.

Recent years have seen significant transformation in the debt market in India with far reaching implications. As the process of reform continues, the role of financial markets in the economy gets significantly enhanced. While this process essentially involves domestic liberalisation, the decision to open up the economy adds urgency and complexity to the process of developing financial markets in India. The Reserve Bank of India has been taking special efforts to develop the various segments of financial markets, in particular, money, Government securities and forex markets. Government securities market constitutes a predominant portion of debt markets in India. The relative share of non-Government bonds has also picked up in recent years, as a logical extension of reforms in the Government securities markets and opening up of the financial sector. Even so, given the size of the sovereign debt, central to the development of debt market is the development of the Government securities market.

Today, the size of the Indian debt market is a mammoth Rs 6.5 lakh crore, including outstanding government debt, and is gradually attaining a level of sophistication comparable to some of the other world markets.

While in 1996 there were around six PDs (primary dealers), today there are 18. The debt market is growing and deepening and this is also indicated by the fact that it has given benchmarks to other money market instruments such as the CPs and inter-corporate deposits. With proper infrastructure in place, our markets will truly be integrated with international markets in future. The apex bank issued floating rate bonds of short maturities which were an instant hit in the market.

While the first phase of reforms in 1991 addressed issues in the equity market, it is only in the second half of the decade that the development of debt markets was given due consideration. The focus of the reforms was on setting up a comprehensive system of primary dealers, adoption of the DVP system for settlement of government securities transactions, abolition of tax deductions at source on G-secs, permitting foreign institutional investors to invest in debt instruments, including government stock and allowing them to hedge their foreign currency risk in the forward market, and placing investments of banks in preference shares, debentures and bonds of corporates outside the 5 per cent limit. The relaxation of restrictions was the first step that spurred the development of the debt market with private placements gaining prominence among corporates. The Discount and Finance House of India (DFHI), which was set up by the RBI along with public sector banks in the late 1980s to develop the money market, was accredited as a Primary Dealer in 1996, along with the Securities Trading Corporation of India (STCI). The RBI is pulling out of DFHI and STCI to get over any conflicts of interest.

The Narasimham Committee recommended that the Government must borrow at market related rates. Only then a need was felt for Primary Dealers to enable price discovery, a debt market analyst said. While DFHI was instituted for short-term instruments such as commercial paper, STCI was floated for the development of G-secs. This was followed by the gradual induction of other players, local and foreign, and PD operations gathered momentum. According to dealers, one of the vital aspects of the development of debt markets has been the increase in the number of active participants and the turnover. Earlier, while this segment was dominated by nationalised banks, today commercial banks, mutual funds and PDs are among the most important players.

The share of PDs in primary issuances of dated securities of the Central Government rose four-fold in 2000-01 from Rs 11,916 crore in 1997-98. In the treasury bills market, the share of PDs was 85 per cent of the total issues of treasury bills in 2000-01, as per RBI data. Between August 1999 and August 2001, State governments raised Rs 4,680 crore from 18 auctions. The share of PDs in the State government auction issues held so far, including purchases due to underwriting commitments, amounted to 36 per cent of total issues. The central banks focus is also on the development of the money market and to this end several strategies are being adopted ranging from the Liquidity Adjustment Facility operations to the phased withdrawal of non-bank participants that lend in the call money market.

Sector-specific refinance support is being rationalised and the additional recourse to the standing liquidity facilities of the RBI is being made increasingly market-based. Repo markets are being developed with lending and borrowing access to non-banks in these markets.Background and Role of RBI.

Recent years have seen significant transformation in the debt market in India with far reaching implications. As the process of reform continues, the role of financial markets in the economy gets significantly enhanced. While this process essentially involves domestic liberalisation, the decision to open up the economy adds urgency and complexity to the process of developing financial markets in India. The Reserve Bank of India has been taking special efforts to develop the various segments of financial markets, in particular, money, Government securities and forex markets. Government securities market constitutes a predominant portion of debt markets in India. The relative share of non-Government bonds has also picked up in recent years, as a logical extension of reforms in the Government securities markets and opening up of the financial sector. Even so, given the size of the sovereign debt, central to the development of debt market is the development of the Government securities market.

There are three main segments in the debt markets in India, viz.,

• Government Securities,

• Public Sector Units (PSU) bonds and

• corporate securities.

The market for Government Securities comprises the Centre, State and State-Sponsored securities. The PSU bonds are generally treated as surrogates of sovereign paper, sometimes due to explicit guarantee and often due to the comfort of public ownership. Some of the PSU bonds are tax free while most bonds, including government securities are not tax free. The Government Securities segment is the most dominant among these three segments. Many of the reforms in pre-1997 period were fundamental, like introduction of auction systems and PDs. The reform in the Government Securities market which began in 1992, with Reserve Bank playing a lead role, entered into a very active phase since April 1997, with particular emphasis on development of secondary and retail markets.

Since the sixties and until the nineties, the Government Securities market remained dormant since the government was borrowing at preannounced coupon rates from basically a captive group of investors, such as banks. In a way, we had a passive internal debt management policy. This, coupled with automatic monetisation of budget deficit prevented development of a deep and vibrant Government Securities market. As long as automatic monetisation existed, it was difficult to assure a framework for Government securities market in terms of matching demand and supply through a price discovery mechanism. Hence, a most significant development has been the elimination of the practice of automatic monetisation of the Central Government budget deficit through Ad hoc Treasury Bills with effect from April 1, 1997 and the introduction of a new scheme of Ways and Means Advances (WMA). In the nineties, several other measures were taken for creating an enabling environment for efficient market conditions. For instance, the total effective statutory pre-emptions of the banking system has been progressively brought down, the administrative structure of interest rates has almost been dismantled, prudential norms have been introduced gradually in line with international best practices, banking supervision has been strengthened, transparency and disclosure standards were enhanced to be on par with international standards, and risk management practices have been prescribed.

There are several ways of analysing market development, and perhaps a convenient way is to track measures in regard to instruments, institutions and participants.

From the investor point of view, a range of Treasury Bills give a variety of options for managing cash surpluses. At the same time, for Government spending long-term funds are needed to be raised in a cost-effective manner. Keeping these in view, over the reform period, a variety of Treasury Bills of 14-day, 91-day, 182-day and 364-day maturity have been introduced. In the long-term segment, the vanilla or the fixed coupon bonds are the most commonly issued instruments. However, over the years, given the large market borrowing programme of the Government and a large variety of investors, we have tried to innovate and issued zero coupon bonds, floating rate bonds, and capital indexed bonds. Government dated securities have been issued in a maturity range of 2 to 20 years depending on prevailing conditions in the market. Currently, the weighted average maturity of outstanding marketable debt is 7.75 years.

The non-Government debt market has a wider variety of bonds from very short-term to long-term maturity. These bonds have many innovative features like step-up, call and put options, and include structured obligations, etc. Much of the PSU bonds and corporate securities are privately placed.

Repos are permitted in Government securities. It has also been decided to extend repos in PSU bonds and private corporate debt securities, provided they are held in dematerialised form in a depository and the transactions are done in recognised stock exchanges. The system is yet to be fully operationalised.