NAGINDAS KHANDWALA COLLEGE OF SCIENCE,

COMMERCE, ARTS AND MANAGEMENT STUDIES.

PROJECT REPORT ON
Futures of Debt Market in India

SUBMITTED BY
Harsh M. Shah

T.Y.BCOM (FINANCIAL MARKETS)

SEMESTER V

PROJECT GUIDE
Prof. HANUMANTHA RAO

UNIVERSITY OF MUMBAI
ACADEMIC YEAR
*2015-16*

ACKNOWLEDGEMENT

I HARSH SHAH take this opportunity to express my profound gratitude and deep
regards to my guide PROF. HANUMANTHA RAO for his exemplary guidance,
monitoring and constant encouragement throughout the course of this thesis. The
blessing, help and guidance given by him time to time shall carry me a long way in
the journey of life on which I am about to embark.
I would also like to thank teaching staff of my college, my colleagues, and librarian
and other people for providing their help as and when required to complete this
project.
Last but not the least, I would like to thank my parents who helped me a lot in
gathering different information, collecting data and guiding me from time to time
in making this project despite of their busy schedules, they gave me different ideas
in making this project unique.
I am making this project not only for marks but to also increase my knowledge.

INDEX

PARTICULARS

SR. NO.
1

EXECUTIVE SUMMARY

OBJECTIVE OF THE PROJECT

Page No.
-

4
3

INTRODUCTION TO INDIAN DEBT MARKET

7

PARTICIPANTS IN DEBT MARKET

10

MARKET SEGMENTS
13

FIXED INCOME INSTRUMENTS

15

GOVERNMENT SECURITIES MARKET

23

CORPORATE DEBT MARKET

34

SECURITIZED DEBT INSTRUMENTS

43

10

PSUs BOND MARKET

47

11

DEBENTURES
49

12

POLICY DEVELOPMENTS
50

13

FUTUR SCENARIO OF DEBT MARKET IN INDIA

54

14

COCLUSION
56

15

BIBLIOGRAPHY

EXECUTIVE SUMMARY:
The Indian Debt market while composed of bonds, both government and corporate, is dominated
by the government bonds. The central government bonds are the predominant and most liquid
component of the bond market. In the offering is the new Interest Rate Derivatives Segment.
The bond markets exhibit a much lower volatility than equities, and all bonds are prices based on
the same macroeconomic information. Bond market liquidity is normally much higher than 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 and
corporate debentures.
The government borrowing program under the market stabilization scheme (MSS) is a tool to
manage liquidity in the system with the long term view. Another temporary tool used to manage
liquidity in the system is the Liquidity adjustment facility (LAF).
The investment strategy that can be kept in the mind is that, if the interest rate in the economy is
moving downward, one tries to maximize the yield by investment in long term maturity
instruments which were issued earlier and carry the interest rate for the yield or coupon greater
than current available interest rate. In case of the rising interest rate scenario in the economy, it is
advisable to minimize the duration or maturity profile of instrument or portfolio that is hold. This
would minimize the potential losses by keeping lower yielding long maturity instrument in the
portfolio.
Finally, let us have a light glimpse of the subtleties and pitfalls of the debt instrument. Practically
the bond prices move or fluctuate less than equity prices and when desired superior performance
has to be on the lookout for the even smaller differentials in the prices and returns. The investor
should ponder the level of risk of the debt market as to prosper effectively on portfolio strategy
making.
The debt market instrument is not entirely risk-free. Specifically two main types of risks are
involved i.e. default risk and the interest rate risk. The former arises when the company defaults
the interest or principal obligation. The later occurs when the bond doesnt represent the true
return to the investor over his holding period unless the interest rates remain unchanged
throughout the holding period. The holding period return is exposed to the interest rate risk.

OBJECTIVE OF THE PROJECT

To collect information on the Indian debt market and present this information in a
simplified form for the better understanding of the investors.
Debt market is highly ignored segment of the financial system which has bright future
prospect.
Still there is lot to explore in the debt market segment in order to take benefit of fix return
with low risk.
Lack of Knowledge has led to slow growth of this market.

RESEARCH METHODOLOGY:
During this project, the data was collected through various sources. Its not possible to find data
through discussion and questionnaires survey of debt market in India, so rather than using
primary sources, data was collected through secondary sources like:

Various books related to debt market in India.

Various websites.
Newspapers.

Table and diagram is collected from the different kinds of websites. All the data collected is true
and relevant in all respect.

Introduction to Indian Debt Market

The debt market in India comprises mainly of two categories, firstly the government securities or
the G-Sec markets consisting of central government and state governments securities. The
government to finance its fiscal deficit floats the fixed income instruments and borrows by
issuing G-Sec that are sovereign securities and are issued by the Reserve Bank of India (RBI) on
behalf of Government of India.
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 second category comprises of the non G-Sec markets i.e the corporate securities consisting
of FI (financial institutions) bonds, PSU (public sector units) bonds and corporate bonds/
debentures. The G-secs are the most dominant category of debt markets and form a major part of
the market in terms of outstanding issues, market capitalization and trading value. It sets a
benchmark for the rest of the market. The market for debt derivatives have not yet developed
appreciably though a market for OTC derivatives in interest rate products exists.
Trends During 2008-09, the government and corporate sector collectively mobilized Rs.
6,125,147 million (US $ 120,219 million) from primary debt market, a rise of 64.54% as
compared to the preceding year. About 71.29% of the resources were raised by the government
(Central and State Governments), while the balance amount was mobilized by the corporate
sector through public and private placement issues. The turnover in secondary debt market
during 2008- 09 aggregated Rs. 62,713,470 million (US $ 1,230,883 million), 11.01% higher
than that in the previous year. The share of NSE in total turnover in debt securities witnessed
stood at 5.36 % during 2008-09.
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.

Trends
During 2008-09, the government and corporate sector collectively mobilized Rs. 6,125,147
million (US $ 120,219 million) from primary debt market, a rise of 64.54% as compared to the
preceding year (Table 6-1). About 71.29% of the resources were raised by the government
(Central and State Governments), while the balance amount was mobilized by the corporate
sector through public and private placement issues. The turnover in secondary debt market
during 2008- 09 aggregated Rs. 62,713,470 million (US $ 1,230,883 million), 11.01% higher
than that in the previous year. The share of NSE in total turnover in debt securities witnessed
stood at 5.36 % during 2008-09.

Debt Market Expected Growth (in US$)

DIFFERENCE BETWEEN DEBT AND EQUITY

DEBT:-

Debt means obligation.

The company who borrows money from the investors to raise the capital is obliged to the
coupons and finite intervals and payback the principal amount at end of tenure.
Debt holders are like money lenders.
Raising capital using dept is a burden as they have to pay interest monthly.
Coupon or monthly interest is earned by the investors.
Investment in debt is less risky compared to equity.
Returns are periodic and almost fixed.

EQUITY:-

Equity means ownership.

Everyone who owns the equity is part owner of that company. He/she can influence the
decision.
Equity holders are the owner of the company.
Raising capital using equity is that the company who issues shares need not to pay any
money to the shareholder.
Investors only earn when company issues dividend.
Investment in equity is risky compared to debt.
Returns are only when selling of shares happens or dividends are issued. Returns are not
fixed.

PARTICIPANTS IN THE DEBT MARKETS

Debt markets are pre-dominantly wholesale markets, with institutional investors being major
participants. Banks, financial institutions, mutual funds, provident funds, insurance companies
and corporate are the main investors in debt markets. Many of these participants are also issuers
of debt instruments. The small number of large players has resulted in the debt markets being
fairly concentrated and evolving into a wholesale negotiated dealings market. Most debt issues
are privately placed or auctioned to the participants. Secondary market dealings are mostly done
on telephone, through negotiations. In some segments, such as the government securities market,
market makers in the form of primary dealers have emerged, which enable a broader holding of
treasury securities. Debt funds of the mutual fund industry, comprising of liquid funds, bond
funds and gilt funds, represent a recent mode of intermediation of retail investments into the debt
markets. The participants in the debt market are described below:

a) Central government : raises money through bond and T-bill issues to fund budgetary deficits
and other short and long term funding requirements.

b) Reserve Bank of India (RBI) : As investment banker to the government, raises funds for the
government through dated securities and T-bill issues, and also participates in the market through
open-market operations in the course of conduct of monetary policy. RBI also conducts daily
repo and reverse repo to moderate money supply in the economy. RBI also regulates the bank
rates and repo rates, and uses these rates as tools to its monetary policy. Changes in these
benchmark rates directly impact debt markets and all participants in the market as other interest
rates realign themselves with these changes.

c) Primary Dealers (PDs) : Who are market intermediaries appointed by RBI, underwrite and
make market in government securities by providing two-way quotes, and have access to the call
and repo markets for funds. Their performance is assessed by RBI on the basis of their bidding
commitments and the success ratio achieved at primary auctions. In the secondary market, their
outright turnover has to three times their holdings in dated securities and five times their
holdings in treasury bills. Satellite dealers constituted the second tire of market makers till
December 2002.

10

d) State government, municipal and local bodies issues securities in the debt markets to fund
their developmental projects as well as to finance their budgetary deficits.
e) Public Sector Undertakings (PSUs) and their finance corporations are large issuers of debt
securities. They raise funds to meet the long term and working capital needs. These corporations
are also investors in bonds issued in the debt markets.

f) Corporate issue short and long term paper to meet their financial requirements. They are also
investors in debt securities issued in the market.

g) Development Financial Institutions (DFIs) regularly issue bonds for funding their financing
requirements and working capital needs. They also invest in bonds issued by other entities in the
debt markets. Most FIs hold government securities in their investment and trading portfolios.

h) Banks are the largest investors in the debt markets, particularly the government securities
market due to SLR requirements. They are also the main participants in the call money and
overnight markets. Banks arrange CP issues of corporate and are active in the inter-bank term
markets and repo markets for their short term funding requirements. Banks also issue CDs and
bonds in the debt markets. They also issue bonds to raise funds for their Tier-II capital
requirements.

i) The investment norms for insurance companies make them large participants in government
securities market.

j) Mutual funds have emerged as important players in the debt market, owing to the growing
number of debt funds that have mobilised significant amounts from the investors. Most mutual
funds also have specialised debt funds such as gilt funds and liquid funds. Mutual funds are not
permitted to borrow funds, except for meeting very short-term liquidity requirements. Therefore,
they participate in the debt markets pre-dominantly as investors, and trade on their portfolios
quite regularly.

k) Foreign Institutional Investors (FIIs) are permitted to invest in treasury and corporate
bonds, with certain limits.

11

l) Provident and pension funds are large investors in the debt markets. The prudential
regulations governing the deployment of the funds mobilised by them mandate investments predominantly in treasury and PSU bonds. They are, however, not very active traders in their
portfolio, as they are not permitted to sell holdings, unless they have a funding requirement that
cannot be met through regular accruals and contributions.

m) Charitable institutions, trusts and societies are also large investors in the debt markets.
They are, however, governed by their rules and bye-laws with respect to the kind of bonds they
can buy and the manner in which they can trade on the debt portfolios.

n) Since January 2002, retail investors have been permitted submit non-competitive bids at
primary auction through any bank or PD. They submit bids for amounts of Rs. 10,000 and
multiples thereof, subject to the condition that a single bid does not exceed Rs. 1 Crore. The noncompetitive bids upto a maximum of 5% of the notified amount are accepted at the weighted
average cut off price/yield.

12

MARKET SEGMENTS
There are three main segments in the debt markets in India, viz.,
Government Securities
Public Sector Units(PSU) bonds
Corporate securities.
The market for Government Securities comprises the Centre, State and State-sponsored
securities. In the recent past, local bodies such as municipalities have also begun to tap the debt
markets for funds. Some of the PSU bonds are tax free, while most bonds including government
securities are not tax-free. Corporate bond markets comprise of commercial paper and bonds.
These bonds typically are structured to suit the requirements of investors and the issuing
corporate, and include a variety of tailor- made features with respect to interest payments and
redemption.
The market for government securities is the oldest and most dominant in terms of market
capitalization, outstanding securities, trading volume and number of participants. It not only
provides resources to the government for meeting its short term and long term needs, but also
sets benchmark for pricing corporate paper of varying maturities and is used by RBI as an
instrument of monetary policy. The instruments in this segment are fixed coupon bonds,
commonly referred as dated securities, treasury bills, floating rate bonds, zero coupon bonds and
inflation index bonds. Both Central and State government securities comprise this segment of the
debt market.
The issues by government sponsored institutions like, Development Financial Institutions, as
well as the infrastructure-related bodies and the PSUs, who make regular forays into the market
to raise medium-term funds, constitute the second segment of debt markets. The gradual
withdrawal of budgetary support to PSUs by the government since 1991 has compelled them to
look at the bond market for mobilizing the resources. The preferred mode of issue has been
private placement, barring an occasional public issue. Banks, financial institutions and other
corporates have been the major subscribers to these issues.
The tax-free bonds, which constitute over 50% of the outstanding PSU bonds, are quite popular
with institutional players. The market for corporate debt securities has been in vogue since early
1980s. Until 1992, interest rate on corporate bond issuance was regulated and was uniform
across credit categories. In the initial years, corporate bonds were issued with sweetners in the
form of convertibility clause or equity warrants. Most corporate bonds were plain coupon paying
bonds, though a few variations in the form of zero coupon securities, deep discount bonds and
secured promissory notes were issued.
After the de-regulation of interest rates on corporate bonds in 1992, we have seen a variety of
structures and instruments in the corporate bond markets, including securitized products,
corporate bond strips, and a variety of floating rate instruments with floors and caps. In the
recent years, there has been an increase in issuance of corporate bonds with embedded put and
call options. The major part of the corporate debt is privately placed with tenors of 1-12 years.
13

SECURITY TYPE

MARKET
CAPITALIZATION (Rs. In
Crore)

Share in total (%)

Government Securities

1,392,219

65.57

PSU Bonds

96,268.47

4.53

State loans

315660.71

14.87

Treasury Bills

111562.13

5.25

Financial Institutions

32092.92

1.51

Corporate bonds

75675.73

3.56

Others

99867.09

4.70

Total

2123346.28

100.00

* Others include securitized debt and bonds of local bodies

14

FIXED INCOME INSTRUMENTS

Debt Instrument: Fundamental Features
Debt instruments are a way for markets and participants to easily transfer the ownership of debt
obligations from one party to another. Debt obligation transferability increases liquidity and
gives creditors a means of trading debt obligations on the market. Without debt instruments
acting as a means to facilitate trading, debt is an obligation from one party to another. When a
debt instrument is used as a medium to facilitate debt trading, debt obligations can be moved
from one party to another quickly and efficiently.

Instrument Features
a) Maturity
b) Coupon
c) Principal

In the bond markets, the terms maturity and term-to-maturity, are used quite frequently. Maturity
of a bond refers to the date on which the bond matures, or the date on which the borrower has
agreed to repay the principal amount to the lender. The borrowing is extinguished with
redemption, and the bond ceases to exist after that date. Term to maturity, on the other hand,
refers to the number of years remaining for the bond to mature. Term to maturity of a bond
changes every day, from the date of issue of the bond until its maturity.

Coupon Rate is the interest rate that the issuer pays to the holder. Usually this rate is fixed
throughout the life of the bond. It can also vary with a money market index, such as LIBOR, or it
can be even more exotic. The name "coupon" arose because in the past, paper bond certificates
were issued which had coupons attached to them, one for each interest payment. On the due
dates the bondholder would hand in the coupon to a bank in exchange for the interest payment.
Interest can be paid at different frequencies: generally semi-annual, i.e. every 6 months, or
annual.

Principal refers to nominal, principal, par or face amount is the amount on which the issuer pays
interest, and which, most commonly, has to be repaid at the end of the term. Some structured
15

bonds can have a redemption amount which is different from the face amount and can be linked
to performance of particular assets.

Yield
The yield is the rate of return received from investing in the bond. It usually refers either to

the current yield, or running yield, which is simply the annual interest payment divided
by the current market price of the bond (often the clean price), or to
the yield to maturity or redemption yield, which is a more useful measure of the return of
the bond, taking into account the current market price, and the amount and timing of all
remaining coupon payments and of the repayment due on maturity. It is equivalent to
the internal rate of return of a bond.

Credit quality
The quality of the issue refers to the probability that the bondholders will receive the amounts
promised at the due dates. This will depend on a wide range of factors. High-yield bonds are
bonds that are rated below investment grade by the credit rating agencies. As these bonds are
more risky than investment grade bonds, investors expect to earn a higher yield. These bonds are
also called junk bonds.

Market price
The market price of a tradeable bond will be influenced amongst other things by the amounts,
currency and timing of the interest payments and capital repayment due, the quality of the bond,
and the available redemption yield of other comparable bonds which can be traded in the
markets.
The price can be quoted as clean or dirty. ("Dirty" includes the present value of all future cash
flows including accrued interest. "Dirty" is most often used in Europe. "Clean" does not include
accrued interest. "Clean" is most often used in the U.S.)
The issue price at which investors buy the bonds when they are first issued will typically be
approximately equal to the nominal amount. The net proceeds that the issuer receives are thus the
issue price, less issuance fees. The market price of the bond will vary over its life: it may trade at
a premium (above par, usually because market interest rates have fallen since issue), or at a
discount (price below par, if market rates have risen or there is a high probability of default on
the bond).

16

TYPES OF BONDS

Fixed rate bonds have a coupon that remains constant throughout the life of the bond. A
variation are stepped-coupon bonds, whose coupon increases during the life of the bond.

Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference
rate of interest, such as LIBOR or Euribor. For example the coupon may be defined as three
month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every
one or three months.

Zero-coupon bonds (zeros) pay no regular interest. They are issued at a substantial
discount to par value, so that the interest is effectively rolled up to maturity (and usually
taxed as such). The bondholder receives the full principal amount on the redemption date. An
example of zero coupon bonds is Series E savings bonds issued by the U.S.
government. Zero-coupon bonds may be created from fixed rate bonds by a financial
institution separating ("stripping off") the coupons from the principal. In other words, the
separated coupons and the final principal payment of the bond may be traded separately. See
IO (Interest Only) and PO (Principal Only).

High-yield bonds (junk bonds) are bonds that are rated below investment grade by
the credit rating agencies. As these bonds are more risky than investment grade bonds,
investors expect to earn a higher yield.

Convertible bonds let a bondholder exchange a bond to a number of shares of the

issuer's common stock. These are known as hybrid securities, because they
combineequity and debt features.

17

Exchangeable bonds allows for exchange to shares of a corporation other than the issuer.

Inflation-indexed bonds (linkers) (US) or Index-linked bond (UK), in which the

principal amount and the interest payments are indexed to inflation. The interest rate is
normally lower than for fixed rate bonds with a comparable maturity (this position briefly
reversed itself for short-term UK bonds in December 2008). However, as the principal
amount grows, the payments increase with inflation. The United Kingdom was the first
sovereign issuer to issue inflation linked gilts in the 1980s. Treasury Inflation-Protected
Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S.
government.
Other indexed bonds, for example equity-linked notes and bonds indexed on a business
indicator (income, added value) or on a country's GDP.

Asset-backed securities are bonds whose interest and principal payments are backed by
underlying cash flows from other assets. Examples of asset-backed securities are mortgagebacked securities (MBS's), collateralized mortgage obligations (CMOs) and collateralized
debt obligations (CDOs).

18

Bond valuation
At the time of issue of the bond, the interest rate and other conditions of the bond will have been
influenced by a variety of factors, such as current market interest rates, the length of the term and
the creditworthiness of the issuer.
These factors are likely to change over time, so the market price of a bond will vary after it is
issued. The market price is expressed as a percentage of nominal value. Bonds are not
necessarily issued at par (100% of face value, corresponding to a price of 100), but bond prices
will move towards par as they approach maturity (if the market expects the maturity payment to
be made in full and on time) as this is the price the issuer will pay to redeem the bond. This is
referred to as "Pull to Par". At other times, prices can be above par (bond is priced at greater than
100), which is called trading at a premium, or below par (bond is priced at less than 100), which
is called trading at a discount. Most government bonds are denominated in units of $1000 in
the United States, or in units of 100 in the United Kingdom. Hence, a deep discount US bond,
selling at a price of 75.26, indicates a selling price of $752.60 per bond sold. (Often, in the US,
bond prices are quoted in points and thirty-seconds of a point, rather than in decimal form.)
Some short-term bonds, such as the U.S. Treasury bill, are always issued at a discount, and pay
par amount at maturity rather than paying coupons. This is called a discount bond.
The market price of a bond is the present value of all expected future interest and principal
payments of the bond discounted at the bond's yield to maturity, or rate of return. That
relationship is the definition of the redemption yield on the bond, which is likely to be close to
the current market interest rate for other bonds with similar characteristics. (Otherwise there
would be arbitrage opportunities.) The yield and price of a bond are inversely related so that
when market interest rates rise, bond prices fall and vice versa.
The market price of a bond may be quoted including the accrued interest since the last coupon
date. (Some bond markets include accrued interest in the trading price and others add it on
separately when settlement is made.) The price including accrued interest is known as the "full"
or "dirty price". (See also Accrual bond.) The price excluding accrued interest is known as the
"flat" or "clean price".
The interest rate divided by the current price of the bond is called the current yield (this is
the nominal yield multiplied by the par value and divided by the price). There are other yield
measures that exist such as the yield to first call, yield to worst, yield to first par call, yield to put,
cash flow yield and yield to maturity.

19

The relationship between yield and term to maturity (or alternatively between yield and the
weighted mean term allowing for both interest and capital repayment) for otherwise identical
bonds is called a yield curve. The yield curve is a graph plotting this relationship.
Bond markets, unlike stock or share markets, sometimes do not have a centralized exchange or
trading system. Rather, in most developed bond markets such as the U.S., Japan and western
Europe, bonds trade in decentralized, dealer-based over-the-counter markets. In such a
market, market liquidity is provided by dealers and other market participants committing risk
capital to trading activity. In the bond market, when an investor buys or sells a bond,
the counterparty to the trade is almost always a bank or securities firm acting as a dealer. In some
cases, when a dealer buys a bond from an investor, the dealer carries the bond "in inventory", i.e.
holds it for his own account. The dealer is then subject to risks of price fluctuation. In other
cases, the dealer immediately resells the bond to another investor.
Bond markets can also differ from stock markets in that, in some markets, investors sometimes
do not pay brokerage commissions to dealers with whom they buy or sell bonds. Rather, the
dealers earn revenue by means of the spread, or difference, between the price at which the dealer
buys a bond from one investorthe "bid" priceand the price at which he or she sells the same
bond to another investorthe "ask" or "offer" price. The bid/offer spread represents the
total transaction cost associated with transferring a bond from one investor to another.

Investing in bonds
Bonds are bought and traded mostly by institutions like central banks, sovereign wealth
funds, pension funds, insurance companies, hedge funds, and banks. Insurance companies and
pension funds have liabilities which essentially include fixed amounts payable on predetermined
dates. They buy the bonds to match their liabilities, and may be compelled by law to do this.
Most individuals who want to own bonds do so throughbond funds. Still, in the U.S., nearly 10%
of all bonds outstanding are held directly by households.
The volatility of bonds (especially short and medium dated bonds) is lower than that of equities
(stocks). Thus bonds are generally viewed as safer investments than stocks, but this perception is
only partially correct. Bonds do suffer from less day-to-day volatility than stocks, and bonds'
interest payments are sometimes higher than the general level of dividend payments. Bonds are
often liquid it is often fairly easy for an institution to sell a large quantity of bonds without
affecting the price much, which may be more difficult for equities and the comparative
certainty of a fixed interest payment twice a year and a fixed lump sum at maturity is attractive.
Bondholders also enjoy a measure of legal protection: under the law of most countries, if a
company goes bankrupt, its bondholders will often receive some money back (the recovery
amount), whereas the company's equity stock often ends up valueless. However, bonds can also
be risky but less risky than stocks:
20

Fixed rate bonds are subject to interest rate risk, meaning that their market prices will
decrease in value when the generally prevailing interest rates rise. Since the payments are
fixed, a decrease in the market price of the bond means an increase in its yield. When the
market interest rate rises, the market price of bonds will fall, reflecting investors' ability to
get a higher interest rate on their money elsewhere perhaps by purchasing a newly issued
bond that already features the newly higher interest rate. This does not affect the interest
payments to the bondholder, so long-term investors who want a specific amount at the
maturity date do not need to worry about price swings in their bonds and do not suffer from
interest rate risk.

Bonds are also subject to various other risks such as call and prepayment risk, credit
risk, reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation
risk, sovereign risk and yield curve risk. Again, some of these will only affect certain classes of
investors.
Price changes in a bond will immediately affect mutual funds that hold these bonds. If the value
of the bonds in their trading portfolio falls, the value of the portfolio also falls. This can be
damaging for professional investors such as banks, insurance companies, pension funds and asset
managers (irrespective of whether the value is immediately "marked to market" or not). If there
is any chance a holder of individual bonds may need to sell his bonds and "cash out", interest rate
risk could become a real problem (conversely, bonds' market prices would increase if the
prevailing interest rate were to drop, as it did from 2001 through 2003. One way to quantify the
interest rate risk on a bond is in terms of its duration. Efforts to control this risk are
called immunization or hedging.

Bond prices can become volatile depending on the credit rating of the issuer for
instance if the credit rating agencies like Standard & Poor's and Moody's upgrade or
downgrade the credit rating of the issuer. An unanticipated downgrade will cause the market
price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest
payments (provided the issuer does not actually default), but puts at risk the market price,
which affects mutual funds holding these bonds, and holders of individual bonds who may
have to sell them.
A company's bondholders may lose much or all their money if the company
goes bankrupt. Under the laws of many countries (including the United States and Canada),
bondholders are in line to receive the proceeds of the sale of the assets of a liquidated
company ahead of some other creditors. Bank lenders, deposit holders (in the case of a
deposit taking institution such as a bank) and trade creditors may take precedence.

21

There is no guarantee of how much money will remain to repay bondholders. As an example,
after an accounting scandal and a Chapter 11 bankruptcy at the giant telecommunications
company Worldcom, in 2004 its bondholders ended up being paid 35.7 cents on the dollar. In a
bankruptcy involving reorganization or recapitalization, as opposed to liquidation, bondholders
may end up having the value of their bonds reduced, often through an exchange for a smaller
number of newly issued bonds.

Some bonds are callable, meaning that even though the company has agreed to make
payments plus interest towards the debt for a certain period of time, the company can choose
to pay off the bond early. This creates reinvestment risk, meaning the investor is forced to
find a new place for his money, and the investor might not be able to find as good a deal,
especially because this usually happens when interest rates are falling.

22

GOVERNMENT SECURITIES MARKET:

Government Security
A government security is a tradable instrument issued by the central government or the state
governments. It acknowledges the governments debt obligation. Such securities are short-term
(usually called treasury bills, with original maturities of less than one year) or long-term (usually
called government bonds or dated securities with original maturity of one year or more).

Market Design of Government Securities

o Types of Securities

Treasury Bills:
Treasury bills (T-bills) are money market instruments, i.e., short-term debt instruments
issued by the Government of India, and are issued in three tenors91 days, 182 days, and 364
days. The T-bills are zero coupon securities and pay no interest. They are issued at a discount and
are redeemed at face value on maturity.
Cash Management Bills:
Cash management bills (CMBs)3 have the generic characteristics of T-bills but are
issued for a maturity period less than 91 days. Like the T-bills, they are also issued at a discount,
and are redeemed at face value on maturity. The tenure, notified amount, and date of issue of the
CMBs depend on the temporary cash requirement of the government. The announcement of their
auction is made by the RBI through a Press Release that would be issued one day prior to the
date of auction. The settlement of the auction is on a T+1 basis.
Dated Government Securities:
Dated government securities are long-term securities that carry a fixed or floating
coupon (interest rate), which is paid on the face value, payable at fixed time periods (usually
half-yearly). The tenor of dated securities can be up to 30 years.
State Development Loans:
23

State governments also raise loans from the market. State Development Loans (SDLs)
are dated securities issued through an auction similar to the auctions conducted for the dated
securities issued by the central government. Interest is serviced at half-yearly intervals, and the
principal is repaid on the maturity date. Like the dated securities issued by the central
government, the SDLs issued by the state governments qualify for SLR. They are also eligible as
collaterals for borrowing through market repo as well as borrowing by eligible entities from the
RBI under the Liquidity Adjustment Facility (LAF).

o Types of Dated Government Securities

Fixed Rate Bonds:

These are bonds on which the coupon rate is fixed for the entire life of the bond. Most
government bonds are issued as fixed rate bonds.

Floating Rate Bonds:

Floating rate bonds are securities that do not have a fi xed coupon rate. The coupon is re-set at
pre-announced intervals (say, every 6 months, or 1 year) by adding a spread over a base rate. In
the case of most fl oating rate bonds issued by the Government of India so far, the base rate is the
weighted average cut-off yield of the last three 364-day Treasury Bill auctions preceding the
coupon re-set date, and the spread is decided through the auction. Floating rate bonds were fi rst
issued in India in September 1995.

Zero Coupon Bonds:

Zero coupon bonds are bonds with no coupon payments. Like T-Bills, they are issued at a
discount to the face value. The Government of India issued such securities in the 90s; it has not
issued zero coupon bonds after that.

Capital Indexed Bonds:

These are bonds, the principal of which is linked to an accepted index of inflation with a view to
protecting the holder from inflation. Capital indexed bonds, with the principal hedged against
inflation, were first issued in December 1997. These bonds matured in 2002. The government is
currently working on a fresh issuance of Inflation Indexed Bonds wherein the payment of both
the coupon as well as the principal on the bonds would be linked to an Inflation Index
24

(Wholesale Price Index). In the proposed structure, the principal will be indexed and the coupon
will be calculated on the indexed principal. In order to provide the holders protection against
actual inflation, the final WPI will be used for indexation.

Bonds with Call/Put Options:

Bonds can also be issued with features of optionality, wherein the issuer can have the option to
buy back (call option) or the investor can have the option to sell the bond (put option) to the
issuer during the currency of the bond.
The optionality on the bond could be exercised after the completion of five years from the date
of issue on any coupon date falling thereafter. The government has the right to buy-back the bond
(call option) at par value (equal to the face value), while the investor has the right to sell the bond
(put option) to the government at par value at the time of any of the half-yearly coupon dates
starting from July 18, 2007.

Special Securities:
In addition to T-Bills and dated securities issued by the Government of India under the market
borrowing program, the government also issues special securities, from time to time, to entities
such as oil marketing companies, fertilizer companies, the Food Corporation of India, and so on
as compensation to these companies in lieu of cash subsidies. These securities are usually longdated securities carrying a coupon with a spread of about 2025 basis points over the yield of the
dated securities of comparable maturity. These securities are, however, not eligible SLR
securities, but are eligible as collateral for market repo transactions. The beneficiary oil
marketing companies may divest these securities in the secondary market to banks, insurance
companies, primary dealers, etc., for raising cash.

Separate Trading of Registered Interest and Principal of Securities (STRIPS):

Steps are being taken to introduce new types of instruments such as the STRIPS (Separate
Trading of Registered Interest and Principal of Securities). Accordingly, guidelines for the
stripping and the reconstitution of government securities have been issued. The STRIPS are
instruments in which each cash flow of the fixed coupon security is converted into a separate
tradable zero coupon bond and traded.4 These cash flows are traded separately as independent
securities in the secondary market. The STRIPS in government securities will ensure the
availability of sovereign zero coupon bonds, which will facilitate the development of a marketdetermined zero coupon yield curve (ZCYC). The STRIPS will also provide institutional
investors with an additional instrument for their asset-liability management. Further, as the
STRIPS have zero reinvestment risk (being zero coupon bonds), they can be attractive to
retail/non-institutional investors. The process of stripping/reconstituting government securities is
carried out at the RBI, the Public Debt Office (PDO) in the PDO-NDS (Negotiated Dealing
25

System) at the option of the holder at any time from the date of issuance of a government
security till its maturity. All dated government securities, other than floating rate bonds, having
coupon payment dates on January 2 and July 2 (irrespective of the year of maturity) are eligible
for stripping/ reconstitution. The eligible government securities are held in the Subsidiary
General Ledger (SGL)/ Constituent Subsidiary General Ledger (CSGL) accounts maintained at
the PDO, RBI, Mumbai. Physical securities are not eligible for stripping/reconstitution. The
minimum amount of securities that needs to be submitted for stripping/reconstitution will be ` 1
crore (face value) and multiples thereof.

o Issuers of Securities

In India, the central government issues T-bills and bonds or dated securities, while the state
governments issue only bonds or dated securities, which are called State Development Loans
(SDLs). Government securities carry practically no risk of default, and, hence, are called riskfree gilt-edged instruments. The Government of India also issues savings instruments such as
Savings Bonds, National Saving Certificates (NSCs) and special securities (oil bonds, Food
Corporation of India bonds, fertilizer bonds, power bonds, and so on).

o Issuance of Government Securities

Government securities are issued through auctions conducted by the RBI. The auctions are
conducted on an electronic platform called the NDSAuction platform. Commercial banks,
scheduled urban co-operative banks, primary dealers, insurance companies, and provident funds,
who maintain a funds account (current account) and securities account (SGL account) with the
RBI are members of this electronic platform. All the members of the PDO-NDS can place their
bids in the auction through this electronic platform. All non-NDS members, including nonscheduled urban co-operative banks, can participate in the primary auction through scheduled
commercial banks or primary dealers. For this purpose, the urban co-operative banks need to
open a securities account with a bank / primary dealer; such an account is called a Gilt Account.
A Gilt Account is a dematerialized account maintained by a scheduled commercial bank or
primary dealer for its constituent (e.g., a non-scheduled urban co-operative bank).
The RBI, in consultation with the Government of India, issues an indicative half-yearly auction
calendar, which contains information about the amount of borrowing, the tenor of security, and
the likely period during which auctions will be held. A Notification and a Press Communique
giving the exact details of the securities, including the name, amount, type of issue, and the
procedure of auction are issued by the Government of India about a week prior to the actual date
of auction. The RBI places the notification and a Press Release on its website (www.rbi.org.in),
and also issues an advertisement in leading English and Hindi newspapers.
26

Information about auctions is also available at select branches of public and private sector banks
and the primary dealers.

o Different types of auctions used for issue of securities

Prior to the introduction of auctions as the method of issuance, the interest rates were
administratively fixed by the government. With the introduction of auctions, the rate of interest
(coupon rate) gets fixed through a market-based price discovery process.
An auction may be either yield-based or price-based.

Yield-Based Auction:
A yield-based auction is generally conducted when a new government security is issued.
Investors bid in yield terms up to two decimal places (for example, 8.19 percent, 8.20 percent,
and so on). The bids are arranged in ascending order, and the cut-off yield is arrived at the yield
corresponding to the notified amount of the auction. The cut-off yield is taken as the coupon rate
for the security. Successful bidders are those who have bid at or below the cut-off yield. Bids that
are higher than the cut-off yield are rejected.

Price-Based Auction:
A price-based auction is conducted when the Government of India re-issues securities issued
earlier. The bidders quote in terms of price per ` 100 of the face value of the security (e.g., `
102.00, ` 101.00, ` 100.00, ` 99.00, etc. per ` 100). The bids are arranged in descending order,
and the successful bidders are those who have bid at or above the cut-off price. Bids that are
below the cut-off price are rejected.

Multiple Price-Based:
In a Uniform Price auction, all the successful bidders are required to pay for the allotted quantity
of securities at the same rate, i.e., at the auction cut-off rate, irrespective of the rate quoted by
them. On the other hand, in a Multiple Price auction, the successful bidders are required to pay
for the allotted quantity of securities at the respective price/yield at which they have bid.

o Holding of Government Securities

27

The Public Debt Office (PDO) of the Reserve Bank of India, Mumbai acts as the registry and
central depository for the government securities. Government securities may be held by investors
either as physical stock or in dematerialized form. From May 20, 2002, it is mandatory for all
the RBI regulated entities to hold and transact in government securities only in
dematerialized (SGL) form. Accordingly, the UCBs are required to hold all government
securities in demat form.

Physical form:
Government securities may be held in the form of stock certificates. A stock certificate is
registered in the books of the PDO. The ownership of stock certificates cannot be transferred by
way of endorsement and delivery. They are transferred by executing a transfer form as the
ownership and transfer details are recorded in the books of the PDO. The transfer of a stock
certificate is final and valid only when the same is registered in the books of the PDO.

Demat Form:
Holding government securities in the dematerialized or scripless form is the safest and the most
convenient alternative, as it eliminates the problems relating to custody, such as the loss of
securities. Besides, transfers and servicing are electronic and hassle free. The holders can
maintain their securities in dematerialized form in one of two ways:

1) SGL Account:
The RBI offers a Subsidiary General Ledger (SGL) account facility to select entities, who can
maintain their securities in SGL accounts maintained with the PDO of the RBI.
2) Gilt Account:
As the eligibility to open and maintain an SGL account with the RBI is restricted, an investor has
the option of opening a Gilt Account with a bank or a primary dealer that is eligible to open a
Constituents Subsidiary General Ledger Account (CSGL) with the RBI. Under this arrangement,
the bank or the primary dealer, as a custodian of the Gilt Account holders, would maintain the
holdings of its constituents in a CSGL account (which is also known as an SGL II account) with
the RBI. The servicing of the securities held in the Gilt Accounts is done electronically,
facilitating hassle free trading and maintenance of the securities. The receipt of maturity
proceeds and periodic interest is also faster, as the proceeds are credited to the current account of
the custodian bank/PD with the RBI, and the custodian (CSGL account holder) immediately
passes on the credit to the Gilt Account Holders (GAH).

28

Investors also have the option of holding government securities in a dematerialized account with
a depository (NSDL, CDSL, etc.). This facilitates the trading of government securities on the
stock exchanges.

o Listing of G-Secs on Stock Exchanges

All government securities and T-bills are deemed to be listed automatically as and when they are
issued.

o Trading in Government Securities

There is an active secondary market in government securities. The securities can be bought/sold
in the secondary market

over the counter (OTC),

through the Negotiated Dealing System (NDS),
Through the Negotiated Dealing System-Order Matching (NDS-OM).

(i) Over the Counter

In this market, a participant who wants to buy or sell a government security may contact a bank/
primary dealer/financial institution either directly or through a broker registered with SEBI, and
negotiate for a certain amount of a particular security at a certain price. Such negotiations are
usually done over the telephone, and a deal may be struck if both the parties agree on the amount
and rate. In the case of a buyer, such as an urban co-operative bank wishing to buy a security, the
banks dealer (who is authorized by the bank to undertake transactions in government securities)
may get in touch with other market participants over the telephone and obtain quotes.
All trades undertaken in the OTC market are reported on the secondary market module of the
Negotiated Dealing System (NDS).

(ii) Negotiated Dealing System

The Negotiated Dealing System (NDS) for electronic dealing and reporting of transactions in
government securities was introduced in February 2002. It allows the members to electronically
submit bids or applications for the primary issuance of government securities when auctions are
conducted. The NDS also provides an interface to the Securities Settlement System (SSS) of the
PDO of the RBI, Mumbai, thereby facilitating the settlement of transactions in government

29

securities (both outright and repos) conducted in the secondary market. Membership to the NDS
is restricted to members holding SGL and/or current accounts with the RBI, Mumbai.

(iii) Negotiated Dealing System-Order Matching

In August 2005, the RBI introduced an anonymous screen-based order matching module on the
NDS, called the Negotiated Dealing System-Order Matching (NDS-OM). This is an order-driven
electronic system where the participants can trade anonymously by placing their orders on the
system or accepting the orders already placed by other participants. The NDS-OM is operated by
the Clearing Corporation of India Ltd. (CCIL) on behalf of the RBI. Direct access to the NDSOM system is currently available only to select financial institutions such as commercial banks,
primary dealers, insurance companies, and mutual funds. Other participants can access this
system through their custodians, i.e., those with whom they maintain Gilt Accounts. The
custodians place the orders on behalf of their customers, like the urban co-operative banks. The
advantages of the NDSOM are price transparency and better price discovery.
Gilt Account holders have been given indirect access to the NDS through custodian institutions.
A member (who has direct access) can report on the NDS the transaction of a Gilt Account
holder in government securities. Similarly, Gilt Account holders have also been given indirect
access to the NDS-OM through the custodians. However, two Gilt Account holders of the same
custodian are currently not permitted to undertake repo transactions between themselves.

Stock Exchanges
Facilities are also available for trading in government securities on the stock exchanges (NSE,
BSE), which cater to the needs of retail investors. The NSEs Wholesale Debt Market (WDM)
segment offers a fully automated screen-based trading platform through the National Exchange
for Automated Trading (NEAT) system. The WDM segment, as the name suggests, permits only
high value transactions in debt securities.
The trades on the WDM segment can be executed in the continuous or negotiated market. In the
continuous market, orders entered by the trading members are matched by the trading system.
For each order entering the trading system, the system scans for a probable match in the order
books. On finding a match, a trade takes place. In case the order does not find a suitable counter
order in the order books, it is added to the order books and is called a passive order. This could
later match with any future order entering the order book and result into a trade. This future
order, which results in the matching of an existing order, is called the active order. In the
negotiated market, deals are negotiated outside the exchange between the two counterparties, and
are reported on the trading system for approval.

Brokerage Rates
30

The NSE has specified the maximum rates of brokerage chargeable by trading members in
relation to trades done in securities available on the WDM segment of the Exchange.

o Reporting of Government Securities

Transactions undertaken between market participants in the OTC/telephone market are expected
to be reported on the NDS platform within 15 minutes after the deal is put through over the
telephone. All OTC trades are required to be mandatorily reported on the secondary market
module of the NDS for settlement.
Reporting on the NDS is a four-stage process wherein the seller of the security has to initiate the
reporting followed by confirmation by the buyer. This is followed by the issue of confirmation
by the sellers back office on the system, and the reporting is complete with the last stage, where
the buyers back office confirms the deal. The system architecture incorporates the makerchecker model to preempt individual mistakes as well as misdemeanor.
Reporting on behalf of the entities maintaining gilt accounts with custodians is done by the
respective custodians in the same manner as they would do for their own trades, i.e., for
proprietary trades.
The securities leg of these trades settle in the CSGL account of the custodian. Once the reporting
is complete, the NDS system accepts the trade. Information on all such successfully reported
trades flow to the clearing house i.e., the CCIL. In the case of the NDS-OM, the participants
place orders (price and quantity) on the system. Participants can modify/cancel their orders. The
order could be a bid for purchase or an offer for the sale of securities. The system, in turn, will
match the orders based on price and time priority; i.e., it matches the bids and the offers of the
same prices with time priority. The NDS-OM system has a separate screen for the central
government, state government, and the T-bill trading. In addition, there is a screen for odd lot
trading for facilitating the trading by small participants in smaller lots of less than ` 5 crore (i.e.,
the standard market lot). The NDS-OM platform is an anonymous platform where the
participants will not know the counterparty to the trade. Once an order is matched, the deal ticket
gets generated automatically, and the trade details flow to the CCIL. Due to the anonymity
offered by the system, the pricing is not influenced by the participants size and standing.

o Major players in the Government Securities market

31

The major players in the government securities market include commercial banks and primary
dealers, in addition to institutional investors such as insurance companies. Primary dealers play
an important role as market makers in the government securities market. Other participants
include co-operative banks, regional rural banks, mutual funds, and provident and pension
funds. Foreign Institutional Investors (FIIs) are allowed to participate in the government
securities market within the quantitative limits prescribed from time to time. Corporates also
buy/sell the government securities to manage their overall portfolio risk.

Settlement of Government Securities

o Primary Market
Once the allotment process in the primary auction is finalized, the successful participants are
advised of the consideration amounts that they need to pay to the government on the settlement
day. The settlement cycle for dated security auctions is T+1, whereas that for T-bill auctions is
T+2. On the settlement date, the fund accounts of the participants are debited by their respective
consideration amounts, and their securities accounts (SGL accounts) are credited with the
amount of securities that they were allotted.
o Secondary Market
The transactions relating to government securities are settled through the members securities/
current accounts maintained with the RBI, with the delivery of securities and the payment of
funds done on a net basis. The Clearing Corporation of India Ltd. (CCIL) guarantees the
settlement of trades on the settlement date by becoming a central counterparty to every trade
through the process of novation, i.e., it becomes the seller to the buyer and the buyer to the seller.
All outright secondary market transactions in government securities are settled on a T+1 basis.
However, in the case of repo transactions in government securities, the market participants will
have the choice of settling the first leg on either a T+0 basis or a T+1 basis, as per their
requirement. Shut period means the period for which the securities cannot be delivered. During
the period under shut, no settlements/delivery of the security that is under shut will be allowed.
The main purpose of having a shut period is to facilitate the servicing of the securities, i.e., fi
nalizing the payment of the coupon and the redemption proceeds, and to avoid any change in
ownership of securities during this process. Currently, the shut period for the securities held in
SGL accounts is one day.
Delivery versus Payment (DvP) is the mode of settlement of securities, wherein the transfer of
securities and funds happens simultaneously. This ensures that unless the funds are paid, the
securities are not delivered, and vice versa. The DvP settlement eliminates settlement risk in
transactions. There are three types of DvP settlements, namely, DvP I, DvP II, and DvP III, which
are explained below.
32

i. DvP I: The securities and funds legs of the transactions are settled on a gross basis, i.e., the
settlements occur transaction by transaction without netting the payables and receivables of the
participant.
ii. DvP II: In this method, the securities are settled on a gross basis whereas the funds are settled
on a net basis, i.e., the funds payable and receivable of all transactions of a party are netted to
arrive at the fi nal payable or receivable position, which is then settled.
iii. DvP III: In this method, both the securities and the funds legs are settled on a net basis, and
only the final net position of all the transactions undertaken by a participant is settled.
The liquidity requirement in a gross mode is higher than that of a net mode since the payables
and receivables are set off against each other in the net mode.

Clearing Corporation of India Limited (CCIL)

The CCIL is the clearing agency for government securities. It acts as a Central Counterparty
(CCP) for all transactions in government securities by interposing itself between two
counterparties. In effect, during settlement, the CCP becomes the seller to the buyer and the
buyer to the seller of the actual transaction. All outright trades undertaken in the OTC market and
on the NDS-OM platform are cleared through the CCIL. Once the CCIL receives the trade
information, it works out the participant wise net obligations on both the securities and the funds
legs. The payable/receivable position of the constituents (gilt account holders) is reflected against
their respective custodians. The CCIL forwards the settlement fi le containing the net position of
the participants to the RBI, where the settlement takes place by the simultaneous transfer of
funds and securities under the Delivery versus Payment system. The CCIL also guarantees the
settlement of all trades in government securities. This means that during the settlement process,
if any participant fails to provide funds/securities, the CCIL will make the same available from
its own means. For this purpose, the CCIL collects margins from all participants, and maintains a
Settlement Guarantee Fund.

CORPORATE DEBT MARKET

33

Introduction
While it is true that the Indian corporate debt market has transformed itself into a much more
vibrant trading field for debt instruments from the elementary market that it was about a decade
ago, there is still a long way to go. This column systematically lays down the issues and
challenges facing the corporate debt market in India.
At the current time, when India is endeavouring to sustain its high growth rate, it is imperative
that financing constraints in any form be removed and alternative financing channels be
developed in a systematic manner for supplementing traditional bank credit. While the equity
market in India has been quite active, the size of the corporate debt market is very small in
comparison to not only developed markets, but also some of the emerging market economies in
Asia such as Malaysia, Thailand and China. A liquid corporate debt market can play a critical
role by supplementing the banking system to meet the requirements of the corporate sector for
long-term capital investment and asset creation.

Current status
According to the Securities and Exchange Board of India (SEBI) database, outstanding corporate
bonds amounted to around Rs. 9 trillion ($147 bn approx.) in 2011 making it nearly 10.5% of
Gross Domestic Product (GDP) (SEBI 2012), whereas the proportion of bank loans to GDP in
India is approximately 37%. In contrast, as seen in Figure 1 below, outstanding corporate bonds
are close to 90% of GDP in US where the corporate debt market is most developed and bond
market financing has long replaced bank financing as a funding source for the corporates; around
34% in Japan and close to 60% in South Korea (Bank for International Settlements (BIS 2012).
In terms of size, as of 2011, the Indian corporate debt market was close to 7% of that of China
and 15% of that of South Korea (BIS 2012).

Cross-country comparison of corporate debt:GDP ratios

34

A comparison of corporate funding split with other economies shows a higher reliance of India
on loans from banks and other financial institutions (Figure 2). Traditionally, bank finance
coupled with equity markets and external borrowings has been the preferred funding source for
Indian corporates (Figure 3). The long-term debt market consists largely of government
securities (G-Secs). In 2011, in terms of size, Indian corporate debt market stood at Rs. 9 trillion
($147 bn approx.) which was only 31% of G-Secs, the outstanding issuances of which stood at a
staggering Rs. 28,427 billion ($464 bn approx.) (SEBI 2012).

The figures and statistics potentially demonstrate a huge funding gap that can be bridged by
developing a well-functioning corporate bond market. Among other things, as India aims to
regain its erstwhile high growth rates of the early 2000s, there is bound to be a lot of pressure on
infrastructure financing which is currently done primarily through budgetary support or bank
credit and this is where a well-developed corporate debt market can play a significant role.
According to the 12th Five-Year Plan, during 2012-2017, $1 trillion is supposed to be spent on
infrastructure projects in India and for this the infrastructure companies could tap the corporate
bond market to raise long-term capital instead of depending on the banking sector that is already
overstretched and burdened with non-performing assets. However the corporate bond market
itself faces several challenges.
Main issues
Some of the constraints facing the Indian corporate debt market are structural while some
emanate from regulatory roadblocks. In our research, we have systematically categorised these
issues into supply-side, demand-side, secondary-market and risk hedging related, and have made
an attempt to explore each of these in detail (Sengupta and Anand 2014).

35

Development of the domestic corporate debt market in India is thwarted by a number of factors,
the prominent ones being low primary issuance of corporate bonds leading to illiquidity in the
secondary market, narrow investor base, high costs of issuance, lack of debt market accessibility
to small and medium enterprises, dearth of a well-functioning derivatives market that could have
absorbed risks emanating from interest rate fluctuations and default possibilities, excessive
regulatory restrictions on the investment mandate of financial institutions, large fiscal deficit,
high interest rates and the dominance of issuances through private placements and AAA2 rated
bonds which in turn also prevent retail participation and aggravate the dependence on bank
financing.

Total corporate bond issuance in India is highly fragmented because bulk of the debt raised
(more than 90% of the issuances) is through private placements3. Corporates typically
circumvent the private placement investor cap by making multiple bond issuances for multiple
groups of 49 investors4. In 2005, a High Powered Expert Committee (HPEC) on Corporate
Bonds and Securitization was formed under Dr. R. H. Patil. The Patil Committee Report (Patil
2005) highlighted ease of issuance, cost efficiency and institutional demand as key reasons for
the dominance of private placements. The disclosure requirements for debt securities are
provided by the SEBI Issue and Listing of Debt Securities Regulations 2008. While the private
placement disclosure and documentation requirements are viewed by the market to be
comprehensive, disclosure requirements for public issuance of debt are viewed by the market as
being extremely onerous and difficult to comply with.

Private vs. public placements in Indian corporate debt market

36

Apart from the supply-side constraints, there are also several demand-side issues. For instance,
the investment norms of insurance companies, banks and pension funds in India are heavily
skewed towards investment in government and public sector bonds.

Under the eligible Statutory Liquidity Ratio (SLR) investments, banks are required to hold 24%
of their liabilities in gold, cash and government securities. Insurance Regulatory and
Development Authority (IRDA) Investment Amendment Regulations, 2001, which covers life
insurance, pension and general annuities, unit linked life insurance, general insurance and reinsurance businesses, mandates that life businesses require that at least 65% of assets be held in
various types of public sector bonds; non-government investments, if allowed, may not exceed
15% in unapproved assets and approved assets do not include corporate bonds rated below AA.
As a result, a major part of investments for life and pension businesses is being held in G-Secs
and other approved securities, which are relatively safe instruments (Figure 5). In practice,
insurance companies hold less than 7% in unapproved assets.

Furthermore, the market preference for very safe AA and above rated assets has resulted in a thin
market for lower rated bonds (Figure 6). This has resulted in the exclusion of small and medium
enterprises, which are generally rated below investment grade of BBB, from the debt market.
The secondary market activity is also marginal with most of the volumes dominated by the top 510 names. Thus, the corporate debt market in India faces a chicken-and-egg dilemma with a
shallow secondary market failing to beget a healthy demand among the investors, thereby
resulting in lower volumes and vice versa. Although the trading volumes have increased in the
recent times, they are significantly smaller than those in G-Secs and equities (Figure 7). The
secondary market activity is hampered by issues such as absence of market makers and liquidity,
lack of pricing and benchmarks, and small institutional investor base.

Break-up of investment of life-insurance companies

37

Corporate bond issuance by ratings

Break-up of secondary market turnover

38

Finally, the Indian corporate debt market is also constrained by lack of adequate risk
management products, be it credit default swaps (CDS) or interest rate futures (IRF)5.

o Market Design for Corporate Bond Market

Issuers of Corporate Bonds
Public sector units including public financial institutions and bonds issued by the private
corporate sector.
General Conditions for Issuance of Corporate Bonds
No issuer can make any public issue of debt securities if (as on the date of fi ling of the draft
offer document and the final offer document) the issuer, or the person in control of the issuer, or
its promoter, has been restrained or prohibited or debarred by SEBI from accessing the securities
market or dealing in securities, and such direction or order is in force.
No issuer can make a public issue of debt securities unless the following conditions are satisfied
(on the date of fi ling the draft offer document and the final offer document):
(a) The issuer has to apply to one or more recognized stock exchanges for the listing of such
securities. If the application is made to more than one recognized stock exchange, the issuer
should choose one of them as the designated stock exchange (having nationwide trading
terminals). However, for any subsequent public issue, the issuer may choose a different stock
39

exchange as the designated stock exchange, subject to the requirements of the SEBI (Issue and
Listing of Debt Securities) Regulations, 2008.
(b) The issuer has to obtain in-principle approval for the listing of its debt securities on the
recognized stock exchanges where the application for listing has been made.
(c) Credit rating has to be obtained from at least one credit rating agency registered with SEBI,
and has to be disclosed in the offer document.
(d) It has entered into an arrangement with a depository registered with SEBI for the
dematerialization of the debt securities that are proposed to be issued to the public, in accordance
with the Depositories Act, 1996 and other relevant regulations.
(e) The issuer is required to appoint one or more merchant bankers registered with the Board, at
least one of whom has to be a lead merchant banker.
(f) The issuer is required to appoint one or more debenture trustees in accordance with the
provisions of Section 117B of the Companies Act, 1956 (1 of 1956) and the Securities and
Exchange Board of India (Debenture Trustees) Regulations, 1993.
(g) The issuer is not allowed to issue debt securities for providing loans to or the acquisition of
shares of any person who is part of the same group or who is under the same management.

Price Discovery through Book Building

The issuer may determine the price of the debt securities in consultation with the lead merchant
banker, and the issue may be at a fixed price or the price may be determined through the book
building process in accordance with the procedures specified by SEBI.

Minimum Subscription
The issuer can decide the amount of minimum subscriptions that it seeks to raise by the issue of
debt securities, and disclose the same in the offer document. In the event of nonreceipt of the
minimum subscription amount, all the application money received in the public issue has to be
refunded to the applicants.

40

Debenture Redemption Reserve

For the redemption of the debt securities issued by a company, the issuer has to create a
debenture redemption reserve in accordance with the provisions of the Companies Act, 1956 and
the circulars issued by the central government in this regard. Where the issuer has defaulted in
the payment of interest on debt securities, or the redemption thereof, or in the creation of security
as per the terms of the issue of debt securities, any distribution of dividend would require the
approval of the debenture trustees.

Listing of Debt Securities

Mandatory Listing
An issuer wanting to make an offer of debt securities to the public has to apply for listing to one
or more recognized stock exchanges according to the terms of the Companies Act, 1956 (1 of
1956). The issuer has to comply with the conditions of listing of debt securities as specified in
the Listing Agreement with the stock exchange where such debt securities are sought to be listed.

Conditions for listing of debt securities issued on private placement basis

An issuer may list its debt securities issued on a private placement basis on a recognized stock
exchange subject to the following conditions:
(a) The issuer has issued such debt securities in compliance with the provisions of the Companies
Act, 1956, the rules prescribed in it, and other applicable laws;
(b) Credit rating has been obtained in respect of such debt securities from at least one credit
rating agency registered with SEBI;
(c) The debt securities proposed to be listed are in a dematerialized form;
(d) The prescribed disclosures have been made. For continuous listing, various conditions have
to be followed.

Trading of Debt Securities

(1) The debt securities issued to the public or on a private placement basis that are listed in
recognized stock exchanges are traded, cleared, and settled in recognized stock exchanges,
subject to the conditions specified by the SEBI.
(2) In the case of trades of debt securities that have been made over the counter, such trades are
required to be reported on a recognized stock exchange having a nationwide trading terminal or
another such platform as may be specified by the SEBI.

41

Clearing and Settlement

The corporate bonds are cleared and settled by the clearing corporations of stock exchanges, i.e.,
the ICCL and the NSCCL.
All trades in corporate bonds available in demat form that are reported on any of the specified
platforms (including the FIMMDA, the NSE-WDM, and the NSE Website) are eligible for
settlement through the NSCCL. In order to facilitate the settlement of corporate bond trades
through the NSCCL, both buy as well as sell participants are required to explicitly express their
intention to settle the corporate bond trades through the NSCCL.
The trades will be settled at the participant level on a DvP I basis, i.e., on a gross basis for
securities and funds. The settlements shall be carried out through the bank/DP accounts specified
by the participants.
On the settlement date, during the pay-in, the participants are required to transfer the securities to
the depository account specified by the NSCCL, and to transfer the funds to the bank account
specified by the NSCCL within the stipulated cut-off time.
On successful completion of pay-in of securities and funds, the securities/funds shall be
transferred by the NSCCL to the depository/bank account of the counterparty.

Regulatory Framework
The SEBI (Issue and Listing of Debt Securities) Regulations, 2008 (private placement) for over
one year. The SEBI is responsible for the primary and the secondary debt market, while the RBI
is responsible for the market for repo/reverse repo transactions in corporate debt. Issuance of
Non-Convertible Debentures (Reserve Bank) Directions, 2010 (for issuance of NCDs of original
or initial maturity up to one year). According to the Repo in Corporate Debt Securities (Reserve
Bank) Directions 2010, dated January 8, 2010, issued by the RBI.

42

SECURITIZED DEBT INSTRUMENTS

MEANING OF SECURITIZED DEBT
The Securities Contracts (Regulation) Act, 1956 was amended in 2007 to include under the
definition of securities any certificate or instrument (by whatever name it is called) issued to an
investor by any issuer who is a special purpose distinct entity possessing any debt or receivable,
including mortgage debt assigned to such entity, and acknowledging the beneficial interest of the
investor in such debt or receivable, including mortgage debt, as the case maybe.
Securitization involves the pooling of financial assets and the issuance of securities that are repaid from the cash flows generated by these assets.
Common assets for securitization include credit cards, mortgages, auto and consumer loans,
student loans, corporate debt, export receivable, and offshore remittances.

REGULATORY FRAMEWORK
The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest
Act, 2002.
The SEBI (Public Offer and Listing of Securitized Debt Instruments) Regulations, 2008 for
listing on stock exchanges.
The Securitization Companies and Reconstruction Companies (Reserve Bank) Guidelines and
Directions, 2003.

ELIGIBILITY CRITERIA FOR TRUSTEES

According to the SEBI (Public Offer and Listing of Securitized Debt Instruments) Regulations,
2008, no person can make a public offer of securitized debt instruments or seek listing for such
securitized debt instruments unless
(a) It is constituted as a special purpose distinct entity;
(b) All its trustees are registered with the SEBI under the SEBI (Public Offer and Listing of
Securitized Debt Instruments) Regulations, 2008; and
(c) It complies with all the applicable provisions of these regulations and the Act.

43

The requirement of obtaining registration is not applicable for the following persons, who
may act as trustees of special purpose distinct entities:
(a) Any person registered as a debenture trustee with SEBI;
(b) Any person registered as a securitization company or a reconstruction company with the RBI
under the Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 (54 of 2002);
(c) The National Housing Bank established by the National Housing Bank Act, 1987 (53 of
1987);
(d) the National Bank for Agriculture and Rural Development established by the National Bank
for Agriculture and Rural Development Act, 1981 (61 of 1981).
However, these persons and special purpose distinct entities of which they are trustees are
required to comply with all the other provisions of the SEBI (Public Offer and Listing of
Securitized Debt Instruments) Regulations, 2008. However, these Regulations are not applicable
for the National Housing Bank and the National Bank for Agriculture and Rural Development, to
the extent of inconsistency with the provisions of their respective Acts.

LAUNCHING OF SCHEMES
(1) A special purpose distinct entity may raise funds by making an offer of securitized debt
instruments by formulating schemes in accordance with the SEBI (Public Offer and Listing of
Securitized Debt Instruments) Regulations, 2008.
(2) Where there are multiple schemes, the special purpose distinct entity is required to maintain
separate and distinct accounts for each such scheme, and should not combine the asset pools or
the realizations of a scheme with those of other schemes.
(3) A special purpose distinct entity and the trustees should ensure that the realizations of debts
and receivables are held and correctly applied towards the redemption of securitized debt
instruments issued under the respective schemes, or towards the payment of the returns on such
instruments, or towards other permissible expenditures of the scheme.
(4) The terms of issue of the securitized debt instruments may provide for the exercise of a cleanup call option by the special purpose distinct entity, subject to adequate disclosures.
(5) No expenses should be charged to the scheme in excess of the allowable expenses as may be
specified in the scheme, and any such expenditure, if incurred, should be borne by the trustees.

44

MANDATORY LISTING
A special purpose distinct entity desirous of making an offer of securitized debt instruments to
the public shall make an application for listing to one or more recognized stock exchanges in
terms of Sub-section (2) of Section 17A of the Securities Contracts (Regulation) Act, 1956 (42 of
1956).

MINIMUM PUBLIC OFFERING FOR LISTING

For the public offers of securitized debt instruments, the special purpose distinct entity or trustee
should satisfy the recognized stock exchange(s) (to which a listing application is made) that each
scheme of securitized debt instruments was offered to the public for subscription through
advertisements in newspapers for a period of not less than two days, and that the applications
received in pursuance of the offer were allotted in accordance with these regulations and the
disclosures made in the offer document.
In the case of a private placement of securitized debt instruments, the special purpose distinct
entity should ensure that it has obtained credit rating from a registered credit rating agency for its
securitized debt instruments.
In the case of a private placement of securitized debt instruments, the special purpose distinct
entity should fi le the listing particulars with the recognized stock exchange(s), along with the
application containing such information as may be necessary for any investor in the secondary
market to make an informed investment decision related to its securitized debt instruments.
All the credit ratings obtained, including the unaccepted ratings, if any, should be disclosed in the
listing particulars fi led with the recognized stock exchange(s).

CONTINUOUS LISTING CONDITIONS

The special purpose distinct entity or its trustee should provide information, including financial
information relating to the schemes, to the stock exchanges and investors, and comply with such
other continuing obligations as may be stipulated in the listing agreement.

TRADING OF SECURITIZED DEBT INSTRUMENTS

The securitized debt instruments issued to the public or on a private placement basis that are
listed in recognized stock exchanges shall be traded, and such trades shall be cleared and settled
in the recognized stock exchanges, subject to the conditions specified by the SEBI.

45

BOND INDEX
A widely tracked benchmark for the performance of bonds is the ICICI Securities (Isec) Bond
Index (i-BEX), which measures the performance of the bond markets by tracking the returns on
government securities. There are other indices also, such as the NSEs Government Securities
(G-Sec) Index and the NSEs T-Bills Index. These have emerged as the benchmark of choice
across all classes of market participantsbanks, financial institutions, primary dealers, provident
funds, insurance companies, mutual funds, and foreign institutional investors. It has two variants,
namely, a Principal Return Index (PRI) and a Total Return Index (TRI). The PRI tracks the price
movements of bonds or capital gains/losses from the base date. It is the movement of prices
quoted in the market, and could be seen as the mirror image of yield movements. In 20102011,
the PRI of the i-BEX and the NSE G-Sec Index declined by 1.41 percent and 2.00 percent,
respectively.

The TRI, on other hand, tracks the total returns available in the bond market. It captures both
interest accruals as well as capital gains/losses. In a declining interest rate scenario, the index
gains due to interest accrual and capital gains, while losing on reinvestment income. During
rising interest rate periods, the interest accrual and reinvestment income is offset by capital
losses. Therefore, the TRI typically has a positive slope, except during periods when the drop in
market prices is higher than the interest accrual. In 20102011, the TRI registered a rise of 6.34
percent and 3.93 percent for the i-BEX and the NSE G-Sec Index, respectively. While
constructing the NSE G-Sec Index, prices from the NSE ZCYC are used so that the movements
reflect the returns to an investor due to changes in the interest rates. The index provides a
benchmark for portfolio management by various investment managers and gilt funds

PSUS Bonds Market:

46

PSU bonds are medium and long term obligations issued by public sector undertakings.
PSU bonds issue is a phenomenon of the late 1980s when the Central Government stopped /
reduced funding to PSUs through the general budget. PSUs float bonds in the primary market to
raise funds. PSUs borrow funds from the market for their regular working capital or capital
expenditure requirement by issuing bonds. The market for PSU bonds has grown substantially
over the past decade. All PSU bonds have a built in redemption and some of them are embedded
with put or call options. Many of these are issued by infrastructure related companies such as
railways and power companies, and their sizes vary widely from Rs 10-1000 crore. PSU bonds
have maturities ranging between five and ten years. They are issued in denominations of Rs
1,000 each

The majority of PSU bonds are privately placed with banks or large investors. In privately placed
issues, rating is not mandatory while public issues are mandatorily rated by one or more of the
four rating agencies in India. Historically, default rates of PSU bonds are negligible and PSUs
are perceived as quasi-sovereign bodies. Usually, bonds issued by state owned PSUs carry
interest payment and principal payment guarantee by the respective state government. Such
guarantees are issued mainly to facilitate the fund raising programs for various long gestation
infrastructure projects.

PSUs are permitted to issue two types of bonds: tax free and taxable bonds. Tax free bonds are
bonds for which the amount of interest is exempted from the investors income. PSUs issue tax
free bonds or bonds with certain exemptions under the Income Tax Act with prior approval from
the government through the Central Board of Direct Taxes (CBDT) for raising funds for such
projects. PSUs which have raised funds through the issue of tax free bonds are central PSUs such
as MTNL and NTPC, and state PSUs such as State Electricity Boards (SEBs) and State Financial
Corporations (SFCs). The bonds issued by the State Financial Corporations are SLR eligible for
cooperative banks and non-banking finance companies (NBFCs). Interest on these bonds is
calculated on Actual / 365 days basis. Tax deduction at source is applicable. In the pre-reform
period, that is, before 1991, the maximum interest rate on taxable bonds was stipulated at 14 per
cent and maximum interest rate on tax free bonds was fixed at 10 per cent. The ceiling of banks
investment in PSU bonds was 1.5 per cent of incremental deposits. With effect from August
1991, the ceiling on interest rate on PSU bonds was removed and subsequently some of the PSUs
floated bonds at an interest rate of 17-18 percent. Later, ceiling on tax free bonds was raised to
10.5 percent. The ceiling of banks investments in PSU bonds was also removed which enabled
banks to invest freely in them.
Provident Funds were initially allowed to invest 15 per cent of their incremental deposit in PSU
bonds. Later, this limit was increased to 30 percent.

47

The revised guidelines for the issue of PSU bonds were issued in October 1993. The guidelines
indicate that the minimum maturity of tax free bonds should be seven years whereas PSUs will
have the freedom to fix the maturities of taxable bonds. The public issues shall be subject to
guidelines issued by SEBI.

PSUs are allowed to issue floating rate bonds, deep discount bonds, and variety of other bonds.
All new issues have to be listed on a stock exchange.

Investors in PSU bonds include banks, insurance companies, non-banking finance companies,
provident funds, mutual funds, financial institutions and individuals
Survey reveals a declining trend in the amount raised through the issue of tax free bonds. Since
1991-92, taxable bonds have become popular as the ceiling on interest rate of taxable bonds was
removed. PSU bonds which traditionally were floated in the public issue market were privately
placed in the 1990s. The PSUs preferred the private placement route for the issue of bonds. They
did not tap the primary market for four consecutive years that is, from 1998-99 to 2001-02. The
PSUs continued to tap the private placement market for their capital requirements.

DEBENTURES
In corporate finance, a debenture is a medium- to long-term debt instrument used by large
companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally
48

referred to a document that either creates a debt or acknowledges it, but in some countries the
term is now used interchangeably with bond, loan stock or note. A debenture is thus like a
certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified
amount with interest and although the money raised by the debentures becomes a part of the
company's capital structure, it does not become share capital. Senior debentures get paid before
subordinate debentures, and there are varying rates of risk and payoff for these categories.

Debentures are generally freely transferable by the debenture holder. Debenture holders have no
rights to vote in the company's general meetings of shareholders, but they may have separate
meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to
them is a charge against profit in the company's financial statements.

Attributes

A movable property.
Issued by the company in the form of a certificate of indebtedness.
It generally specifies the date of redemption, repayment of principal and interest on
specified dates.
May or may not create a charge on the assets of the company.
Corporations in the US often issue bonds of around $1,000, while government bonds are
more likely to be $5,000.

In the United States, debenture refers specifically to an unsecured corporate bond, i.e. a bond that
does not have a certain line of income or piece of property or equipment to guarantee repayment
of principal upon the bond's maturity. Where security is provided for loan stocks or bonds in the
US, they are termed 'mortgage bonds'.

However, in the United Kingdom a debenture is usually secured.

POLICY DEVELOPMENTS

49

I. RBI modifies guidelines for securitization companies/reconstruction companies

(SCs/RCs)
On April 21, 2010, the RBI modified the guidelines issued to SCs/RCs on various aspects, in
order to bring about more transparency and market discipline.

II. India Infrastructural Finance Company Limited permitted to undertake ready forward
contracts in corporate debt securities
Vide an RBI circular dated April 16, 2010, the India Infrastructural Finance Company Limited
(IIFCL) was permitted to undertake ready forward contracts in corporate debt securities. The
entities that are eligible to enter into ready forward contracts in corporate debt securities are
mentioned in the Repo in Corporate Debt Securities (Reserve Bank) Directions, 2010. These
regulations were released in January 2010, and were made effective in March 2010. According to
these regulations, the following entities are allowed to enter into ready forward contracts in
corporate debt securities:
a) Scheduled commercial banks, excluding RRBs and LABs;
b) Primary dealers authorized by the RBI;
c) NBFCs registered with the RBI (other than government companies as defined in Section 617
of the Companies Act, 1956);
d) All India Financial InstitutionsExim Bank, NABARD, NHB, SIDBI, and other regulated
entities such as any mutual fund registered with SEBI, any housing finance company registered
with the National Housing Bank, and any insurance company registered with the Insurance
Regulatory and Development Authority.

III. RBI places the draft report of the Internal Group on introduction of credit default
swaps (CDS) for corporate bonds
On August 4, 2010, the RBI came out with a draft report on the introduction of credit default
swaps (CDS) for corporate bonds for public comments.

IV. Clarification for NBFCs participating in ready forward contracts in corporate debt
securities
On August 11, 2010, the RBI notified that the Non-Banking Financial Companies (NBFCs)
registered with RBI (other than government companies as defined in Section 617 of the
Companies Act, 1956) are eligible to participate in repo transactions in corporate debt securities.
The revised guidelines by the RBIs IDMD department on uniform accounting for repo/reverse
repo transactions were issued on March 23, 2010. It was clarified that the NBFCs should have an
asset size of ` 100 crore and above (i.e., NBFCs-ND-SI), and the risk weights for credit risk for
50

assets that are the collateral for such transactions as well as the risk weights for the counterparty
credit risk shall be as applicable to the issuer/ counterparty in the NBFC (non-deposit accepting
or holding) Prudential Norms Directions, 2007, as amended from time to time.

V. Changes in settlement period for repo trades in corporate debt securities and changes in
minimum haircut applicable on market value of corporate debt securities
The Second Quarter Review of the Monetary Policy 20102011announced that the repo trades in
corporate debt securities were permitted to be settled on a T+0 basis in addition to the existing
T+1 and T+2 bases under the DvP I (gross basis) framework. The minimum haircut applicable on
the market value of the corporate debt securities prevailing on the rate of trade of the first leg,
which was earlier stipulated as 25 percent, was revised.

VI. Allocation of government debt long term and corporate debt (old investment limits) to
FIIs (Circular date: March 08, 2011)
Based on the assessment of the allocation and the utilization of the limits to FIIs for investments
in debt, SEBI decided to allocate the unutilized limits in government debt long term and
corporate debt (old category) in the following manner:a) Allocation through bidding process: The bidding for these limits was done on
the NSE from 3:30 pm to 5:30 pm, on March 15, 2011, in terms of the SEBI
Circular IMD/FII&C/37/2009 dated February 06, 2009, subject to the
modifications stated below:
b) Government debt long term: In partial amendment to Clause 3(h) of the SEBI
Circular IMD/FII&C/37/2009, no single entity shall be allocated more than ` 750
crore of the investment limit. Where a single entity bids on behalf of multiple
entities, in terms of Para 7 of the SEBI Circular CIR/IMD/FIIC/18/2010 dated
November 26, 2010, such bids would be limited to ` 750 crore for every such
single entity. In partial amendment to Clause 3(c) and 3(d) of the SEBI Circular
IMD/ FII&C/37/2009, the minimum amount that can be bid for will be ` 100 crore
and the minimum tick size will be ` 50 crore.
c) Corporate Debt (Old limits): No single entity shall be allocated more than ` 300
crore of the investment limit. Where a single entity bids on behalf of multiple
entities, in terms of Para 7 of the SEBI Circular CIR/IMD/FIIC/18/2010 dated
November 26, 2010, such bids would be limited to ` 300 crore for every such
single entity. The minimum amount that can be bid for will be ` 100 crore, and the
minimum tick size will be ` 50 crore.
d) Allocation through first come first serve (FCFS) process: Following the terms
of the SEBI Circular dated January 31, 2008, the government debt long term and
the corporate debt (old limits) were allocated on an FCFS basis subject to the
following conditions: The remaining amount in the government debt long term
and the corporate debt (old limits) other than the bidding process shall be
51

allocated among the FIIs/sub-accounts on an FCFS basis. The debt requests in this
regard shall be forwarded to the dedicated email id fii_debtrequests@sebi.gov.in.
The window for the FCFS process shall open at 08:30 am IST on March 15, 2011.
The maximum limit per request under this process shall be ` 50 crore. A nonutilization charge would be levied from average successful bid premiums (in the
respective bidding processes) for the non-utilized part from the allocation on an
FCFS basis. VII. Listing Agreement for securitized debt instruments (Circular
date: March 16, 2011) In order to develop the primary market for securitized debt
instruments in India, SEBI notified the Securities and Exchange Board of India
(Public offer and Listing of Securitized Debt Instruments) Regulations, 2008. The
Regulations provide a framework for the issuance and listing of securitized debt
instruments by a special purpose distinct entity (SPDE). The listing of securitized
debt instruments would help improve the secondary market liquidity for such
instruments. With a view to enhancing the information available in the public
domain on the performance of asset pools on which securitized debt instruments
are issued, it has been decided to put in place a Listing Agreement for securitized
debt instruments. The Listing Agreement provides for the disclosure of pool-level,
tranche-level, and select loan-level information. For the listed securitized debt
instruments, it is clarified that the SPDEs that make frequent issues of securitized
debt instruments are permitted to file umbrella offer documents along the lines of
a shelf prospectus. In order to ensure a uniform market convention for the
secondary market trades of securitized debt instruments, Actual/Actual day count
convention shall be mandatory for all listed securitized debt instruments.

VIII. FII Investment in corporate bonds infra long-term category I (Circular date:
November 26, 2010)
Vide the SEBI circular CIR/IMD/FIIC/18/2010 dated November 26, 2010, SEBI announced the
mechanism of the allocation of the newly announced limit of long-term corporate debt
(infrastructure).
a) Increase in overall limits : The existing limit of US $ 5 billion for investment by foreign
institutional investors (FIIs) in corporate bonds issued by companies in the infrastructure sector
with a residual maturity of over five years was increased by an additional limit of US $ 20
billion, taking the total limit to US $ 25 billion. With this, the total limit available to the Flls for
investment in corporate bonds would be US $ 40 billion. These investments are now allowed in
unlisted instruments.
b) Investments in unlisted bonds : The FIIs shall now be eligible to invest in unlisted bonds
issued by companies in the infrastructure sector that are generally organized in the form of
special purpose vehicles.
c) Lock-in period for investments subject to inter-FII trading : Investments in such bonds
shall have a minimum lock-in period of three years. However, during the lock-in period, the FIIs
52

will be allowed to trade among themselves. However, during the lock-in period, the investments
cannot be sold to domestic investors.
d) No change in identification of companies eligible as infrastructure : The identification
of corporate bonds issued by companies in the infrastructure sector shall be in terms of the SEBI
Circular IMD/FII&C/18/2010 dated November 26, 2010.
e) Manner of allocation : In partial amendment to the SEBI Circular IMD/FII&C/18/2010
dated November 26, 2010, it was decided to do away with the allocation methodology for
investment in the corporate debt long-term infra category. The FIIs/ sub-accounts can now avail
of these limits without obtaining SEBIs approval until the overall FII investments reaches 90
percent i.e., US $ 22.5 billion, after which the process mentioned in the Circular dated November
26, 2010 shall be initiated for the allocation of remaining limits.
f) Special window at exchanges : For the benefit of the FIIs during the lock-in period
(mentioned in Para c above), a special trading window for the FIIs shall be provided by the
exchanges on the same lines as is available for equities in companies where the overall FII
investment has touched the maximum limit.

IX. Infrastructure Finance Companies (IFCs) as eligible issuers for FIIs investment limit in
debt instrument for infrastructure
The SEBI has decided that the Non-Banking Financial Companies (NBFCs) categorized as
Infrastructure Finance Companies (IFCs) by the RBI shall also now be considered eligible
issuers for the purposes of FII investment under the corporate debt long-term infra category

FUTURE SCENARIO OF DEBT MARKET IN INDIA

53

The Retail Debt Market is set to grow tremendously in India with the broadening of the market
participation and the availability of a wide range of debt securities for retail trading through the
Exchanges.

The following are the trends, which will impact the Retail Debt Market in India in the near
future:

Expansion of the Retail Trading platform to enable trading in a wide range of government
and non-government debt securities

Introduction of new instruments like STRIPS, G-Secs. with call and put options,
securitised paper etc.

Development of the secondary market in Corporate Debt

Introduction of Interest Rate Derivatives based on a wide range of underlying in the

Indian Debt and Money Markets.

Development of the Secondary Repo Markets.

The BSE vision for the Indian Debt Market foresees the markets growing in leaps and bounds in
the near future, soon attaining global standards of safety, efficiency and transparency. This will
truly help the Indian capital markets to attain a place of pride among the leading capital markets
of the world.

Morgan Stanley expects the size of the Indian USD/G3bond market to nearly triple in size and
reach $160 billion by 2018 driven by non-financials.
A recent report titled 'The Next India - Fixed Income: From Volatility to Moderation', coauthored by Viktor head of Asia fixed income research at Morgan Stanley, suggests that a pickup in economic growth and rising private capital needs will be important drivers for the Indian
credit markets, along with an increased reliance on the debt capital markets in the future.
In 2007, the Indian USD/G3-denominated bond market was small and illiquid, composed mostly
of state-owned banks. Financials together accounted for more than 75% of the market by
notional. "Since the global downturn in 2008, much has changed. India's credit market has

54

increased 2.4x in size, from $25 billion to $61 billion currently, with most of the growth taking
place post-2010 and in non-financial corporate," the report says.
In the Asian region, Morgan Stanley expects India (15% of the USD/G3 bond market) to be the
second largest issuer behind China (44%), which would dominate the USD/G3 bond market due
to the size of its economy, the capital requirements, and tighter onshore lending conditions.
"On average, the Indian USD/G3 bond market should see annual gross issuance in excess of $30
billion by 2018. Again, non-financial corporate should dominate the issuance, accounting for
more than 50% of the overall annual issuance by 2018," the report says.
Morgan Stanley suggests that existing investors would be an answer, but they also expect global
credit investors, Asian life insurers and Asian mutual funds to play a big role in future demand,
not only for Indian credit but also for Asian credit in general.
"Indian credit has increasingly been held by non-Asian investors and funds over the past few
years. Both these investor classes should continue to provide support as the sector increases in
size. We believe the next decade for India's FX and fixed income markets will be marked by
policy-driven reform and increasing liberalization of its debt markets," the report says.
"On the one hand, the government has already embarked on second stage of economic
liberalization through raising FDI (foreign direct investment) limits in a push for more
privatization. On the other, a gradual opening up of the Indian debt markets will also expand the
avenues available for funding private sector investment, which we see as a key driver for India's
economic growth over the next decade."

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CONCLUSION
Development of long-term debt markets is critical for the mobilisation of the huge magnitude of
funding required to finance potential businesses as well as infrastructure expansion. Despite a
plethora of measures adopted by the authorities over the last few years, India has been distinctly
lagging behind other developed as well as emerging economies in developing its corporate debt
market. The domestic corporate debt market suffers from deficiencies in products, participants
and institutional framework.

For India to have a well-developed, vibrant, and internationally comparable corporate debt
market that is able to meet the growing financing requirements of the countrys dynamic private
sector, there needs to be effective co-ordination and co-operation between the market participants
that include investors and corporates issuing bonds as well as the regulators. Issues such as
crowding of debt markets by government securities cannot be addressed by market participants
and regulators alone. Better management of public debt and cash could result in a reduction in
the debt requirements of the government, which in turn would provide more market space and
create greater demand for corporate debt securities.

Clearly, the market development for corporate bonds in India is likely to be a gradual process as
experienced in other countries. It is important to understand whether the regulators have
sufficient willingness to shift away from a loan-driven bank-dependent economy and also
whether the corporations themselves have strong incentives to help develop a deep bond market.
Only a conjunction of the two can pave the way for the systematic development of a wellfunctioning corporate debt market.

A vibrant debt market provides an alternative to conventional bank finances and also mitigates
the vulnerability of foreign currency sources of funds. From the perspective of financial stability,
there is a need to strengthen the debt market. Limited Investor base, limited number of issuers
and preference for bank finance over bond finance are some of the other obstacles faced in
development of a deep and liquid debt market.

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BIBLOGRAPHY
WEBSITES

www.nseindia.com
www.Iepf.gov.in
www.bse.com
www.nseindia.com
www.moneycontrol.com

MAGAZINES:

Forbes India Magazines.

Insight magazine.

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