This morning, India will open its government bond market to retail investors as it seeks to widen the investor base to fund its massive borrowing needs. In February this year, the Reserve Bank of India, in its Statement on Developmental and Regulatory Policies, announced that it will allow retail investors online access to the government securities market, both primary and secondary, along with the facility to open and maintain their government securities account (retail direct gilt account) with the RBI. .
This is a welcome move as it could give more options to retail investors with greater ease, and reduce the cost of investing and trading in government securities. The next step should be to set up an independent Public Debt Management Agency (PDMA). After that the government and RBI need to address the fundamental issue of the integration of bond market regulation and infrastructure with the mainstream financial market regulation and infrastructure.
In 2016, demat account holders of National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) were allowed to trade in government securities on the NDS-OM (Negotiated Dealing System-Order Matching) platform through their depository participants who have the Subsidiary General Ledger (SGL) account. In 2018, the National Stock Exchange provided a facility on its platform to subscribe to government bonds in the primary market.
However, secondary market trading and settlement is possible only through the RBI-managed infrastructure. This arrangement poses a barrier to seamless trading and investment in government securities.
Bond market integration
The bond market infrastructure is primarily the exchange, the clearinghouse and the depository. These three constituents are managed by the RBI. The Harshad Mehta scam of the early 1990s led the RBI to set up an electronic ledger for holding government securities. This ledger, the SGL, is legally mandated to be the only depository for government securities through the Government Securities Act, 2006. The SGL primarily has banks and financial institutions as members, who hold an account in the depository in which they hold government securities.
The legal framework has given the RBI exclusive powers to oversee, govern and regulate participation in the depository. RBI owns the NDS-OM system, which is the exchange for trading in government securities. RBI initiated the creation of an informal clearing corporation, the Clearing Corporation of India Ltd (‘CCIL’), which is owned by banks. This adds up to a parallel exchange — clearinghouse — depository for the purpose of the bond market. This arrangement works as a separate silo from the mainstream financial market infrastructure.
International experience highlights that the bond market infrastructure is broadly a part of the mainstream financial market infrastructure. In most of the countries, government bonds are traded on the platform provided by the stock exchange. The depository infrastructure for government bonds is part of the unified infrastructure for other securities. The settlement of government securities is overseen by the securities market regulator with a few exceptions. India is the only country where all the three elements of bond market infrastructure are owned, controlled and managed by the central bank.
The regulation of the bond market, like its market infrastructure, is separated from India’s securities market. Through amendments in the legal framework (particularly, the RBI Act, 1934 and the Government Securities Act, 2006), the regulatory powers over the bond market have shifted to the RBI. In most of the countries, the unified regulator of the financial market serves as the regulator of the government bond market.
The Indian government securities market lacks the depth and liquidity required to incentivise greater investor participation. The secondary market is characterised by relatively lower volume of trades. The bulk of the trading remains concentrated in a few securities and a few maturity buckets. Further, the lack of seamless integration of the bond market infrastructure with the securities market infrastructure increases costs and inhibits wider retail participation. While a number of incremental steps were announced over the last few years, the friction arising on account of a segmented market infrastructure persists.
The issuance and trading of government securities could be made simpler by allowing the issuance of government securities in demat accounts of retail investors, just like any other security. This could also help the government meet its borrowing programme by widening the investor base.
At present, the RBI faces the challenge of managing the government’s massive borrowing programme at a cheaper cost. Rise in global crude oil prices and commodity prices are translating into higher input costs and could cause a broad-based rise in prices. While the RBI has placed greater priority on reviving growth, as recovery gains momentum and demand picks up, it would have to change its accommodative stance and move towards interest rate hikes.
Rising rates could make it challenging for the RBI to manage the government’s borrowing programme. In this backdrop, allowing greater access to retail investors to widen the investor base is a welcome step.
In the recent past, the RBI has sought to widen the investor base by allowing greater foreign investor participation in government bonds. A ‘fully accessible route’ for investment by foreign investors was opened, under which certain specified securities have been opened for them without any restriction.
As of now, banks hold the bulk of government securities. As the demand for credit picks up, there could be a reduction in banks’ holding of government bonds. As government securities become more market-oriented with a diversified investor base, the management of debt will assume significant challenges. This would then require a specialised agency to manage the government’s borrowing programme.
Direct retail participation is a welcome first step. This needs to be followed by full bond market integration on the one hand and separation of debt management functions from the RBI on the other. To make India a US $10 trillion economy, financial sector reform is a critical step.
Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.
Radhika Pandey is a consultant at NIPFP.
Views are personal.
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