Author: Sucharita Mukherjee, IFMR Trust, September 2013
Abstract: This note highlights the need for active and deep debt capital markets, both fixed income and derivative markets in India. A review of the current state of Indian debt capital markets reveals a number of limitations such as its small size relative to GDP, its narrow focus on AAA-rated bonds, the predominance of short term issuances, and limited risk transfer owing to limited trading activity. A root cause analysis of these limitations reveals a regulation-induced buy and hold culture within banks, deep distortions introduced by taxation, limited product diversity in the debt markets, inhibited access to debt markets for NBFCs induced by regulation, and a low appetite for higher risk debt instruments due to historical reasons such as a weak bankruptcy resolution regime.
In the view of these limitations, and their underlying root causes, this note recommends a number of ideas for change. In the near-term, it suggests the removal of loan-bond arbitrage on the books of banks, bank level stress test reporting and segment level RAROC reporting, modification of SLR requirements reducing requirements to hold government bonds and removing hold to maturity protection for SLR eligible government bonds, reinstating and clarifying the tax pass through status of securitisation vehicles, developing standardising bond documentation to make the process of bond issuance easier and cheaper, product development such as corporate bond indices to attract debt investments from retail savings, changing regulation to allow issuance of bonds at all points in the capital structure, and increasing the supply of AAA structured paper in the market. In the longer term, it recommends a uniform stamp duty structure, strengthening of the bankruptcy resolution process, introduction of credit default swaps on standardised syndicated loans to enable risk hedging, and the creation of benchmark issues through consolidation and reissuance enabling the development of credit curves.