Money and Capital Market 83

undertaking bond market. This market is able to maintain the liquidity of the financial market. It provides
fnance to the government tor developmental activities. However, the principal function of this
channelize the surplusfund of the savers to the productive sectors of the market is to
economy.
2.18.1/Features of Debt Market
Deb market is one of the most important concepts of the financial system. In
developed economies, debt
market is to be considered as the mnost critical component of the financial market.
However, in
economies, due to various reasons the importance of the debt market is relatively limited. We havedeveloping
identified
the following features of the debt market:
Channelization offunds The debt market channelizes the funds to the productive sectors of the
economy. Thus, continuous flow of the productive activities is ensured.
y Connectivity with money market Adeveloped money market is the precondition for the exist
ence of the debt market. As we know, money market deals with short-termn debt instruments, whereas
debt market involves long-term debt instruments with tenure of more
than one year.
c) Competitive market structure A competitive market set up is required for the flourish of the
debt market. The competitive environment ensures the proper allocation of
resources.
Low transaction cost An efficient debt market is associated with low transaction cost. It reduces
the borrowing cost of the government, if operated optimally.
e
Heterogeneous market participants Adebt market is characterized by heterogeneity of the
market participants. Among the participants, central and state government, corporate, primary
dealers, mutual funds, and public sector undertakings are notable.
Mobilization f resources Debt market provides opportunities to the investors to invest
optimally. The investors are backed with an alternative avenue to invest with the presence of debt
market.
g Safety Debt market is a quite safe and secured place for investment due to the presence of strong
and prominent regulatory bodies which act as watchdogs in the debt market.
ý4 Lower volatility Debt market is characterized by lower volatility which attracts the investors to
invest in it. The market provides returns which are compatible with the risk involved.
2.18.2 Historyof Indian Debt Market
We can discuss the debt market in Indiaon the basis of two regimes pre-reformregime and post-reform
regime. Naturally, there are marked differences between the debt markets in these twO regimes which can be
established through the following facts.
1. Pre-reform regime The debt market in India in the pre-reform regime was underdeveloped. The
government failed to realize the importance of a healthy bond market. The market in that regime had
the following features:
Traditional wholesale market with limited participants
Prevalence of strong statutory requirements which were responsible for the existence of only few
institutional players
Existence of administered rate instead of market rate made the market ill-developed
Presence of alternative sources of investment which were suppOsed to provide greater returns
institutions
Banks were the main players among the financial
Low turn over
 84 Indian Financial System

Post-reform regime The underdevelopednature of debt market acted as one of the hindrances for
development of the fnancial market. In the early nineties, the attitude of the government had changed
and the market experienced the following events:
Requirement of huge fund for investmnent in the infrastructure sector
The government took serious initiatives for the establishment of a healthy, sound, efficient, and organ
ized debt market for effective mobilization of funds
Huge development of government securities market due to relentless efforts from RBI
Relatively lesser amount of development in public sector undertaking bond markets and private cor
porate debt market
Among the regulatory bodies, RBI has been given the responsibility of handling the government
securities market
The corporate debt market has been regulated by the Security and Exchange Board of India (SEBL
2.18.3 Participants/Players in Indian Debt Market
The participants in Indian debt market and their nature are represented in Table 2.7.
Table 2.7 Participants of Indian debt market
Participants Nature/Activities
Central government/RBI Issues dated securities and treasury bills
State government and bodies Issue securities to finance budget deficits and for funding
investment projects
Public sector undertakings (PSUs) Issue securities for generating long-term working capital and
invest in debt securities
Banks (nationalized and private sector) Issue certificate of deposits, commercial papers, bonds,
debentures, etc.
Primary dealers Appointed by RBl and establish links between government
securities and money market
Corporate sector Issues detbentures,bonds for expansion, modernization, and
diversification
Provident funds
Invest in government securities and public sector bonds
Foreign institutional investors (Flls) Allowed to invest in the government security and corporate
bonds market
Mutual funds
Active participants and traders in the debt market
Insurance companies Active players in the debt market

Debt Market Instruments

There are a variety of debt instruments in Indian debt market. Some of
the important instruments are as
follows:
1. Treasury bills These refer to commercial bills or financial instruments issued by
the central bank o
behalf of the governmentto meet short-term liquidity problems. These are issued by RBI.
2. Long- and medium-term bonds These bonds with fixed or foating rates are issued by financtal
institutions and corporate entities.
 Money and Capital Market 85

Certificate of deposits Certificate of deposits (CDs), which

3.
development financial institutions in bcarer forms, refer are issued by commercial banks and
instruments. to the short-term and unsecured negotiable
Commercial bills Now
4. commercial bills refer to the bills against which the industrial and business
concers receive short-term loans from the Commercial banks. This short-term loans are received to
meet the requirement of the
circulating capital.
5 Commercial papers The commercial paper, which is
negotiable in
romissory note issued by the big and highly rated companies. These are nature, implies a short-term
the short-term fund required for working capital. issued by companies to raise
Debentures They are medium- or long-term debt instruments which are
of interest. They can be fully converted associated with a fixed rate
debentures (FCDs) which can be converted into equity shares.
Debentures can also be partially converted debentures (PCDs), a part of
equity or preference shares. which can be converted into
- MIBOR linked bonds MIBOR stands for
Mumbai
which one bank borrows unsecured funds from others in Inter-Bank Offered Rate. It refers to the rate at
the interbank market. The bonds related to this
rate are known as MIBOR related bonds. This is treated as the
yardstick of the Indian call money market.
8. Repo transactions Repo or repurchase agreement is the
transaction in which a financial institution
or a bank receives funds immediately by selling securities with an
agreement to repurchase the same at
a specified pre-determined price after a specific time period. Hence, repo is
short-term crisis of funds.
applicable only if there is a
9. Secured premium notes (SPN) These are issued by listed companies subject to the
approval of the
central government. They are redeemable after a certain period.
10. Callmoney market Callmoney market refers to the sub-market of money market in which the
transactions of different commercial banks' day-to-day surplus occur. The maturity period in this market
varies between overnight/one day and fortnight.
I1. Zero coupon bonds (ZCB) ZCBs are thedebt securities where the face value is repaid at the timeof
maturity. Itdoes not pay interest and is traded at a deep discount.
12. Collateralized borrowing and lending obligation (CBLO) This is developed by Clearing
Corporation of India Limited (CCIL) and RBI. Introduced in 2003, this is an agreement between bor
rower and lender.

2.18.5 Segments of Indian Debt Market

Ihe Indian debt market can be classified into three segmentson the basis of nature and other characteristics:
I. Government securities market
Fublic sector undertaking bond market
3. Corporate debt market
Let us now discuss them in detail.
overnment securities market (GSM)(The government of any economy has to undertake various
developmental and non-developmental projects to run the econom. It has to provide various public
serVices, maintain law and order, regulate he financial and
umonetary sector, establish physical infra
Structure, etc. This calls for the requirement of huge amount of funds. The government meets some of
these CXpenses through thetax revenues collected. However, as this is not sutticient. it has to borrow rom
 86 Indian Financial System

financial institutions, and public and international organizations for pursuing regular programmes ahd
sourçes of borrowing funds L
activities. The government securities market is one of the important knos
fund. These securities are
government issues securities in order to raise short-term and long-term
as gilt-edged securitics as the governnment provides the guaranty of the repayment ol the principal along
with the interest.
mar
GSNM is the principal component of the debt market. It often acts as the benchmark for other
kets. The noveltv of theGSM is its ability to facilitate government borrowings at a moderate cost. Some
of the quantitative credit control measures are quite compatible with the essenceof the GSM. Thus we
observe a significant role of this market in the transmission nmechanism of the monetary policy.
The GSM can be subdivided intotwo segmentsprimary market and secondary market.
a Primary market This is a wholesale credit market where the RBI takes the responsibility of
banker of the government. It issues government securitieson behalf of the government. The RBI
focuses on funding the fiscal deficit in the market.
The primary market instruments are treasury bills (details in Chapter 2, Part A) and govern
ment datedsecurities) Treasury bills are short-term obligations of the government which are issued
by RBI on behalf of the gOvernment. Treasury bill refers to a commercial bill or a financial instru
ment issued by the central bank on behalf of the government to meet the short-term liquidity
problem. The market in which the transactions of treasury bills occur is known as the treasury bill
market. In India, RBI has the power to issue treasury bills. In India the government mobilizes funds
by issuing treasury bills for 91 days and 364 days.
The government dated securities are medium- and long-term obligations of the government
which are also issued by RBI in order to meet the deficit and also to maintain the public sector
development programmes.
The main investors in this market are different financial institutions like commercial banks, pri
mary dealers, insurance, companies, foreign institutional investors and mutual funds.
Secondary market The secondary segment of the GSM can be categorized into two further seg
ments, which are wholesale institutional segment and retail segment. The wholesale segment
banks, mutual funds, primarydealers, insurance companies, and others. The retail comprises
segnment comprises
cooperative banks, provident funds, pension funds, and non-banking finance
The Government of India has recognized the importance of companies.
ing the primary market. As a result different steps were adopted to secondary GSM in complement
fact, an efficient secondary market fosters the growth in the develop the secondary market. ln
primary
transparency is ensured through the introduction of subsidiary generalmarket. A greater amount o
Securities Trading Corporation of India was established, which actuallyledger transactions. In 199t,
segment of GSM. Apart from this, the retailing of government securitiesstrengthened
with the
the secondary
was also conducive to thedevelopment of the non-bank clhens
secondary segment. Moreover, the
market-related rate of interest from administered rate of interest also acted as a movement towar
the secondary segment of GSM. boost in developis
After realizing the importance of GSM, the
reform measures consistent with the new economicGovernment
of India has undertaken variou
policy of 1991. The movement towards
Table 2.8 Secondary market transactions of
government securities (outright) ( in bilions)
Year Central Govt State Govt
2014-15 92071.7
Treasury Bills Total
1892.2 8336.2 102300.1
2015-16 85886.4 3313.3 97834.5
8634.8
2016-17 89021.9 4944.4 104870.1
10903.8
 Money and Capital Market 87

rgmeof market rate of

iterest led to greater market
tobroadenthe instiutional ownership as around 85% ofabsOrption.
The eflorts securities
the total gOvernment have beenin made
India
are inthe hands of only three types of institutions RBI, comnercial banks, and Life Insuranc
Corporation of India. Theintroduction of auction system with the objective of raising funds
cdeve-
opedthe bidding skills of the investors. The establishment of a retail investor base can also be treated
as anecessityfor developing GSM in India. The increment of the autonomy of RBI was responsi-
blefor balanced growth of GSM. The introduction of various instruments like T-bills of different
maturities and fioating rate bonds actually widened the market
opportunities and scope. Someof spe-
cihc quantitative credit control measures were found to be useful in maintaining the stability the
oncialand foreign exchange market. The rise in trading volumes in the secondary segrnent depicts
the depth of GSM in the post-reform period. The establishment of different regulatory bodies was
also found to be benefiial for the growth of GSM.
L:o sector undertaking bond marketThe second segment of the Indian debt market is public
Krtor which includes public sector undertakings (PSUs) and development financial institutions DEl:
which issue government guaranteed bonds, PSUbonds, and commercial papers.
These bonds, which are medium- and long-term obligations, are mainly issued by PSUs. Initially
there was an allocation of the funds in the central budget of the government. However, from late-eight
ies, the allocation was either reduced or stopped. Then PSUs started to operate in the primary market
in order to raise funds) Generally, the infrastructure companies started to issue bonds for the purpose of
collecting working cafital for their operations. The maturity period of these bonds usually varies from 5
to 10years. PSUs issue both taxable and tax-free bonds. They are permitted to issue different varieties
of bonds like deep discount bonds and floating rate bonds. Banks, insurance companies, different other
financial institutions, provident funds, mutual funds, and non-banking finance companies are notable
inyestors in this market.
(The secondary market of PSU bonds is extremely important because these bonds are generally
issued and traded in the form of promissory nates ar stock certificates)s\The trades of these bonds are
done by brokers. As far as liquidity is concerned, it is more liquid th¥n the government-guaranteed
bonds.
Corporate debt market
Corporate
debt market refers to the market which ensures the issue and
trading of corporate debt securities. In India, this sector covers only a small part of the debt marke.
The private corporate sector requires huge funds for modernization, divÁrsification, expansion, mar
keting, etc. Moreover, sometimes funds are needed for restructuring theconcern and also for merger or
acquisitions. In order tÍ diversify the sourcesof funding, the corporate sector can raise the funds both by
isuing equity and debi) They have the options of raising capital by either issuing debenturesor bonds
in the deht market oradhered to the policy of long-term borrogings from banks and other inanciat
Table 2.9 Tax-free and taxable bonds of public sector undertakings ( in billions)
Year Tax-free Bonds Taxable Bonds Total

2009-10 19.26 464.83 484.09

2010-11 587.91 604.33

16.42
880.65
2011-12 280.82 599.83
527.17
2012-13 148.60 378.57
508.65
2013-14 342.44 166.21
372.83
2014-15 372.83
525.05
2015-16 435.00 90.05
 88 Indian Financial System

are in se-t
in bonds as they can scll them when they
institutions.) However, banks alwavs prefer to invest secondar.
requirement of money: The corporate debt market also has two segments primary and
ous banks are
institutional investors, financial institutions, and
Large companies, mutual funds, toreign
main plavers in this market. private placement route and public offering
route i
The corporate sector has a choice between private sector companies issue debentures an2
connection with the issue of debentures and bonds. The
non-convertibledebentures (NCD) orcan be converter
raise funds from this. These debentures are either
into equity. has several problens. First. the
Although corporate debt market has enormous potential to grow, it
in the
intormation in this market is limited, which is one of the obstacles in enhancing transparencyrelatively Jow
with
market. Second. the issuers having high ratings can easily raise funds but the issuers reference rate is
or the
ratings are unable to collect adequate funds. Third, the absence of the benchmark
one of the constraints for the introduction of securities in the market. Fourth, inconsistency in the stamn
duty structure led to various operational complications.
The Government of India is aware of the great potential of this market and hence adopted
some steps tor its growth. Primarily, the interest rate ceiling on corporate debt was abolished, which
ensured flexibility in the market. The banks are allowed to stipulate margin on loans against prefer
ence shares, bonds,etc. The corporate debttrading was made visible in screen-based systems. The
ready forward transactions in the instruments were permitted by RBIwhich facilitated the growth
of secondary segment of the corporate debt market. The entry of money market mutual funds and
foreign institutional investors in the debt market has widened the scope and opportunities of the
market.

Table 2.10 Trading in corporate bonds ( in crores)

Year No. of Amount No. of Amount No.of Amount No. of Amount
Traders (BSE) Traders (NSE) Traders (FIMMDA) Traders (Total)
(BSE) (NSE) (FIMMDA)
2007-08
(Total)
11203 40957.5 3787 31453.1 4089 23479 19079 95889.7
2008-09 8327 37320.4 4902 49505.3 9501 61534.8 22683 148166.1
2009-10 7408 53323.5 12522 151919.9 18300 195954.5 38230 401198
2010-11 4465 39581 8006 155951.2 31589 409741.9 44060 605274.2
2011-12 6424 49842 11973 193435 33136 350506 593783
51533
2012-13 8639 51622.4 21141 242105.1 36603 444904.1 738631.6
2013-14 66383
10187 103027.1 20809 275701.3 39891 592071 70887 970799.8
2014-15 17710 204505.5 58073 886787.5 0.83 75791 1091293.8
2015-16 16900 207652.3 53223 814755.6 0 1022407.9
2016-17 70123
24372 292153.9 64123 1178508.5 88495 1470662.5

2.18.6 Indian DebtMarket: Factors of Growth and Role

The Indian debt market experienced reforms in the early
nineties and since then the role of this market
redefined. The market has three distinct segments government securities market, public sector undertaking
bond market., and private corporate debt market. Among these
markets, the government securities nars
 Money and Capital Market 89

signitcant portion of the debt market. Other segmentsalso have great potentialto deveiop andthe
oupicsa
qUNernmenthasrecently tried to apply various reform measures in these segments.
Orerthe vearsIndian debt market has grown significantly mainly due to the following reasons:
liquidityin the debt market attracts the new investors. This actually led to broadening of
Fist, increased
themarket.
Serond. the
movement from administered rate of interest to the regime of deregulated market rate of
interest
improved the flexibility of the market, which is one of the factors of growth in the Indian debt
market.
Third, the presence of a strong regulatory system with the presence of RBI and SEBI provided conf
investors to invest in the debt market.
dencetothe
Fourth, the improved settlement system induced the investors to be attached with this market. Previously.
the.settlement system was poor and the investors had to face serious problems in this context.
Fifh. the introduction of new and effective instruments in this market improved the efficacy of the
Indian debt market. The introduction of these instruments enhanced the scope and
opportunities of this
market.
Sixth. the existence of the exchange-traded corporate debt market raised the transparency and eflective
nes of the Indian debt market.
definitely raised the
Finally, the participation of foreign institutional investors in the Indian debt market
volume for transactions. This is a healthy sign for the growth of the market.
impor
Thus, especially after new economicreforms in 1991, the Indian debt market became one of the
after experienc
tant facets of the financial market. Naturally, the role of the debt market has been redefined
economy.
ing reforms. Now we will assess the role of Indian debt market in transforming the
efficient and
Allocation and mnobilization of resources The mobilization of resources has to be
ensures efficient al!loca
effective enough for the growth of the financial system. The Indian debt market
tion and mobilization of the resources.
The
Channelization of funds Indian debt market is involved with proper channelization of funds.
accumulated funds are allocated to the productive sectors of the economy.
the working of financial
Provision of assured rate of returns In spite of the frequent changes in volume
investors. This is conducive to rise in the
sector, the debt market provides assured returns to the
of the capital market.
to the monetary authority about the future mon
. Proper signal Indian debt market provides a signal
policy. The monetary authority can judge the status of the market and accordingly implement the
etary
policy
governments The shift of focus from automatic accommodation of the fiscal deficit
Keliance of This
and central governments on Indian debt market.
leads to the increased dependence of both state
Indicates the increasing importance of the debt market.
and infrastructural growth The economic development of a nation depends on the
Industrial
industrial growth and infrastructure development. The debt marketprovides huge funds tor
Volume of in lndia acts
development and also for the growth of infrastructure. Thus, the debt market
he industrial
S One of the propellers of growth of India. management. It
The debt market in India plays a vital role n the lqudity
Liquidity management
lacilitates both short- and long-term liquidity management. part of Indian financial market.
The market has
Thus, the debt market in India is an extremely important
(See Fig 2.17).
enormous potential to develop in the near future