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An Overview
History
In most of the countries, the debt market is more popular than the equity market. This is
due to the sophisticated bond instruments that have return-reaping assets as their
underlying. In the US, for instance, the corporate bonds (like mortgage bonds) became
popular in the 1980s. However, in India, equity markets are more popular than the debt
markets due to the dominance of the government securities in the debt markets.
Moreover, the government is borrowing at a pre-announced coupon rate targeting a
captive group of investors, such as banks. This, coupled with the automatic monetization
of fiscal deficit, prevented the emergence of a deep and vibrant government securities
market.
The bond markets exhibit a much lower volatility than equities, and all bonds are priced
based on the same macroeconomic information. The bond market liquidity is normally
much higher than the stock market liquidity in most of the countries. The performance of
the market for debt is directly related to the interest rate movement as it is reflected in the
yields of government bonds, corporate debentures, MIBOR-related commercial papers,
and non-convertible debentures.
Concepts
The debt market is a market where fixed income securities issued by the Central and state
governments, municipal corporations, government bodies, and commercial entities like
financial institutions, banks, public sector units, and public limited companies. Therefore,
it is also called fixed income market. For a developing economy like India, debt markets
are crucial sources of capital funds. The debt market in India is amongst the largest in
Asia. It includes government securities, public sector undertakings, other government
bodies, financial institutions, banks, and companies.
• Default Risk/Credit Risk arises when an issuer of a bond defaults on the interest
or principal obligation.
• Interest Rate Risk can be defined as the risk emerging from an adverse change in
the interest rate prevalent in the market, which would affect the yield on the
existing instruments. For instance, an upswing in the prevailing interest rate may
lead to a situation where the investors' money is locked at lower rates. If they had
waited and invested in the changed interest rate scenario, they would have earned
more.
Other risks associated with trading in debt securities are more generic in nature, such as:
• Counter Party Risk refers to the failure or inability of the opposite party in the
contract to deliver either the promised security or the sale value at the time of
settlement.
• Price Risk refers to the possibility of not being able to receive the expected price
on any order due to an adverse movement in the prices.
The trading platforms for government securities are the ‘Negotiated Dealing System’ and
the Wholesale Debt Market (WDM) segment of NSE and BSE. In the negotiated market,
the trades are normally decided by the seller and the buyer, and reported to the exchange
through the broker, whereas the WDM trading system, known as NEAT (National
Exchange for Automated Trading), is a fully automated screen-based trading system,
which enables members across the country to trade simultaneously with enormous ease
and efficiency.
The instruments traded can be classified into the following segments based on the
characteristics of the identity of the issuer of these securities:
Market Segment
Government Securities
Issuer
Central Government
State Governments
Corporates
Banks
Financial Institutions
Instruments
Debentures, Bonds, Commercial Paper, Floating Rate Bonds, Zero Coupon Bonds, Inter-
Corporate Deposits
• Economic conditions
• General money market conditions, including the state of money supply in the
economy
• Interest rates prevalent in the market and the rates of new issues
• Future Interest Rate Expectations
• Credit quality of the issuer
Note: There is, however, a theoretical underpinning to the determination of the price of
the bond based on the measure of the yield of the security.
The following debt instruments are available in the corporate debt market:
• Non-Convertible Debentures
• Partly-Convertible Debentures/Fully-Convertible Debentures (convertible into
Equity Shares)
• Secured Premium Notes
• Debentures with Warrants
• Deep Discount Bonds
• PSU Bonds/Tax-Free Bonds
Main participants in the retail debt market include mutual funds, provident funds,
pension funds, private trusts, state-level and district-level co-operative banks, housing
finance companies, NBFCs and RNBCs, corporate treasuries, Hindu Undivided Families
(HUFs), and individual investors.
Tenure
Interest rate futures contracts can have short-term (less than one year) and long-term
(more than one year) interest bearing instruments as the underlying asset. In the US,
short-term interest rate futures like 90-day T-Bill and 3-month Euro-Dollar time deposits
are more popular. Long-term interest rate futures include the 10-year Treasury Note
futures contract, and the Treasury Bond futures contract.
Regulatory Authority
The regulators of the Indian debt market are:
RBI: The Reserve Bank of India is the main regulator for the money market. It controls
and regulates the G-Secs market. Apart from its role as a regulator, it has to
simultaneously fulfill several other important objectives, such as managing the borrowing
programme for the Government of India, controlling inflation, ensuring adequate credit at
reasonable costs to various sectors of the economy, managing the foreign exchange
reserves of the country and ensuring a stable currency environment.
The RBI controls the issuance of new banking licences to banks. It controls the manner in
which various scheduled banks raise money from depositors. Further, it controls the
deployment of money through its policies on CRR, SLR, priority sector lending, export
refinancing, guidelines on investment assets, etc.
The RBI also administers the interest rate policy. Earlier, it used to strictly control
interest rates through a directed system of interest rates. Each type of lending activity was
supposed to be carried out at a pre-specified interest rate. Over the years, the RBI has
moved slowly towards a regime of market-determined controls.
SEBI: The regulator for the Indian corporate debt market is the Securities and Exchange
Board of India (SEBI). SEBI controls bond market in cases where entities esp. corporates
raise money from public through public issues.
It regulates the manner in which money is raised and to ensure a fair play for the retail
investor. It forces the issuer to make the retail investor aware of the risks inherent in the
investment and its disclosure norms. SEBI is also a regulator for the mutual funds and
regulates the entry of new mutual funds in the industry. It also regulates the instruments
in which these mutual funds can invest. SEBI also regulates the investments of FIIs.
To begin from the point of truism, one of the essential elements of a successful
enterprise, among other key factors, is the availability of capital. Even at that, it is the
accessibility and the economy of debt capital that has come to play an important role in
the sustainability and growth of a firm.
Not the least bit to be compared with the significance of equity (owners’) participation,
debt capital helps in mitigating the enterprise risk across the entire capital structure. Other
than that, debt capital also frees up the risk capital for the more vital functions and helps
in leveraging the business potential of the firm.
Given this strategic nature of debt capital, it becomes all the more necessary that students
and practitioners of entrepreneurism have an in-depth understanding of how the market
for debt operates in India.
Much later, the NDS (Negotiated Dealing Settlement) and the WDM (Wholesale Debt
Market segment) system were launched by the RBI, BSE and NSE to facilitate the trade
settlement. In short, it was in the last two decades that the technical and regulatory
infrastructure was developed to make the debt capital market as we see it today.
The debt market in India is categorized by many standards. But the most important of
them is based on duration. The market that deals with short term debt, which basically
means debt of less than a one-year maturity period, is called the money market. On the
other hand, debt maturity that exceeds the
one-year timeline is considered to be a part of the bond market.
Both these forms of market are dominated by government debt, which is classified under
T-bills and gilt. This categorization is again based entirely on the duration of the maturity
of the paper issued. That is, gilts normally refer to government borrowings whose
maturity is scheduled after one year.
Concurrently, T-bills are government borrowings whose maturity is scheduled within one
year. The dynamics of the corporate bond market are slightly different from the gilt. The
activity and the size of this market are relatively marginal, given the large shadow of
government borrowings under which it has had to operate.
Additionally, the lack of a wide investor base, the opaqueness and information
asymmetry have been some of the reasons for the tepidity in the growth of the corporate
bond market. The depth and the appetite of this segment have started to expand lately,
though. But from the point of view of this article, we shall dwell further on the money
markets.
Since the securities in this market are less than one year, and the source of these
securities is the government/banks/highly-rated companies, the credit risk involved is
considered to be low (though slightly higher than an FD). Moreover, the tax incidence on
the income from these schemes (depending on the plan) is usually lower than the one that
the interest on savings accounts or FDs invite.
Therefore, from the SME point of view, the leveraging of the debt market can actually
come in two forms. First, as a supplier of debt, and second, as the buyer. The capacity of
the SME to tap the debt market is correlated directly to the growth trajectory of the
corporate debt segment. However, the real and immediate gain potential for SMEs rests
on their ability as the buyer of debt, especially of short term debts.
Now, most of you might have already been doing this unknowingly! That is, your money
—parked in the current, cash or FD accounts—is used by the banks to buy the debt and
the money market securities for you. However, the earning it might be delivering to you
may range from nil to almost nil.
An investor can invest in money market mutual funds for a period of as little as one day.
Avenues are also available for investing for longer horizons according to your risk
appetite.
Debt market refers to the financial market where investors buy and sell debt securities,
mostly in the form of bonds. These markets are important source of funds, especially in a
developing economy like India. India debt market is one of the largest in Asia. Like all
other countries, debt market in India is also considered a useful substitute to banking
channels for finance.
The most distinguishing feature of the debt instruments of Indian debt market
is that the return is fixed. This means, returns are almost risk-free. This fixed return on
the bond is often termed as the 'coupon rate' or the 'interest rate'. Therefore, the buyer (of
bond) is giving the seller a loan at a fixed interest rate, which equals to the coupon rate.
Advantages
The biggest advantage of investing in Indian debt market is its assured returns. The
returns that the market offer is almost risk-free (though there is always certain amount of
risks, however the trend says that return is almost assured). Safer are the government
securities. On the other hand, there are certain amounts of risks in the corporate, FI and
PSU debt instruments. However, investors can take help from the credit rating agencies
which rate those debt instruments. The interest in the instruments may vary depending
upon the ratings.
Another advantage of investing in India debt market is its high liquidity. Banks offer easy
loans to the investors against government securities.
Disadvantages
As there are several advantages of investing in India debt market, there are certain
disadvantages as well. As the returns here are risk free, those are not as high as the
equities market at the same time. So, at one hand you are getting assured returns, but on
the other hand, you are getting less return at the same time.
Retail participation is also very less here, though increased recently. There are also some
issues of liquidity and price discovery as the retail debt market is not yet quite well
developed.
Debt Instruments
There are various types of debt instruments available that one can find in Indian debt
market.
Government Securities
It is the Reserve Bank of India that issues Government Securities or G-Secs on behalf of
the Government of India. These securities have a maturity period of 1 to 30 years. G-Secs
offer fixed interest rate, where interests are payable semi-annually. For shorter term, there
are Treasury Bills or T-Bills, which are issued by the RBI for 91 days, 182 days and 364
days.
Corporate Bonds
These bonds come from PSUs and private corporations and are offered for an extensive
range of tenures up to 15 years. There are also some perpetual bonds. Comparing to G-
Secs, corporate bonds carry higher risks, which depend upon the corporation, the industry
where the corporation is currently operating, the current market conditions, and the rating
of the corporation. However, these bonds also give higher returns than the G-Secs.
Certificate of Deposit
These are negotiable money market instruments. Certificate of Deposits (CDs), which
usually offer higher returns than Bank term deposits, are issued in demat form and also as
a Usance Promissory Notes. There are several institutions that can issue CDs. Banks can
offer CDs which have maturity between 7 days and 1 year. CDs from financial
institutions have maturity between 1 and 3 years. There are some agencies like ICRA,
FITCH, CARE, CRISIL etc. that offer ratings of CDs. CDs are available in the
denominations of Rs. 1 Lac and in multiple of that.
Commercial Papers
There are short term securities with maturity of 7 to 365 days. CPs are issued by
corporate entities at a discount to face value.