Wednesday, December 26, 2012

Developing debt markets – Lessons to be learned from a India

I have recently come across some interesting transcripts from presentations by Harun R. Khan about the Indian debt markets. They not only describe very well the state of Indian debt markets today but also provide some useful insights into how debt markets work and why this is important. If you don’t have much time, you can read my summary below. Otherwise, you will find the transcripts at the end of this post.

What is the current shape of Indian debt markets?

Today, India’s financial markets are dominated by equities. The debt market is underdeveloped.

In addition, as regards corporate debt issues, 93 % of them are private placements, due to extensive disclosure requirements, higher cost, plain vanilla character, and lower speed in case of a public debt issue. Publicly traded debt is, therefore, still dominated by government bonds.

What is a developed debt market?

Four main criteria measure the efficiency of debt markets:

  • Diversity of financial instruments
  • Diversity of participants and the heterogeneity of their responses to new information (“Breadth”)
  • Capacity of the market to dissipate price fluctuations (“Resilience”)
  • Capacity of the market to handle large transactions without causing sharp price changes (“Depth”)

Why is it imperative to develop functioning debt markets?

Developing debt markets fosters economic growth and development:

  • Debt markets transfer capital from savers to borrowers. Thus, they attribute funds efficiently.
  • Debt markets help transferring, pooling, and sharing of risks.
  • Government debt markets shape a yield curve that is essential for pricing other financial assets.

In addition to the above general rationales, India has specific reasons to develop its debt markets:

  • The country has substantial future funding requirements that cannot be met by bank financing alone. This is especially true for long-term financing, which banks cannot stem alone, due to increasing asset liability mismatch dilemmas over longer periods of time. For example, infrastructure funding requirements currently amount to 10 % of India’s annual GDP.
  • Functioning debt markets promote financial inclusion for small and medium-sized enterprises and retail investors.
  • Healthy domestic debt markets will reduce the dependency of Indian firms on external commercial borrowings in foreign currency. This will ultimately lead to stronger corporate balance sheets as currency exchange risk and volatility decrease. As the Rupee exchange rate volatility has grown significantly in recent years, RBI considers this raison d’être for domestic debt markets as substantial.
  • Functioning debt markets are safeguards for financial stability in India. The argument is that external commercial funding can be, in case of severe external shocks, very quickly drawn off from the Indian financial system. This actually happened in 2008, when India’s capital account dropped substantially due to liquidity requirements in the lending countries.

Major initiatives for developing Indias debt markets

Major initiatives by RBI and the Indian government concern the following:

  • Promote transparency by developing an imperative bond reporting platform
  • Allow REPO transactions in corporate bonds to make investing in corporate bonds more attractive to institutional investors
  • Alleviate exposure norms for primary dealers, market makers, and central counterparties to enable them to play a larger role in the corporate bond market
  • Introduce credit default swaps and interest rate swaps to facilitate hedging credit risk and market risk associated with holding bonds
  • Reform India’s legal system (bankruptcy framework, enforcement of creditors’ rights, etc.)
  • Introduce suitable credit enhancement mechanisms to allow SMEs to issue high quality bonds
  • Open up investment regulation for pension funds and insurance companies to allow them more extensive investments in corporate bonds
  • Open local debt markets gradually to foreign investors and reduce withholding taxes on coupon payments
  • Stimulate wider participation of retail investors in the market through bond exchanges and mutual funds


  • Address by Harun R. Khan „Corporate Debt Market: Developments, Issues & Challenges“ dated October 12, 2012
  • Presentation by Harun R. Khan “Role of State in Developing Markets” dated September 18, 2012.