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THE BOND MARKET IN INDIA

INTRODUCTION

Financial markets have become vital tools for sustaining the economies of developing countries.
Due to this, many developing countries have embarked on a number of financial sector
development programmes since the mid 1980's in order to revamp their economies. India is no
exception to this new wave of development. The country has undergone a process of financial
sector restructuring and transformation in order to achieve emerging financial market status.
These reforms have aimed at moving the financial sector from an era characterized by controls to
a market-based regime. The government of India as part of its agenda for the restructuring of the
financial sector, implemented monetary policy reforms leading to the creation of a market for
securities.

In 1986 a weekly auction in Treasury Bills was introduced. Again in 1988 Bank of India Bills
were introduced to take care of excess liquidity in the system especially in the rural areas and
also to provide an avenue of investment for banks. The Central Bank of India has shifted
gradually from a direct system of monetary controls to an indirect system that utilizes market-
based policy instruments. As part of the process, the Bank of India rationalized the minimum
reserve requirements for banks, introduced new financial instruments, and open market
operations for liquidity management. (Bank of India Consultation Paper October 2007).

The restructuring of the financial sector resulted in the creation of the financial market in India.
The market in India is made up of the money market, the bonds market, equity market, foreign
exchange market, mortgage market and the derivatives market. Unfortunately the money market
dominates the financial market in India, bringing with it a number of associated problems. The
major participants in the money markets are the Central Bank, brokers or discount houses,
corporate organizations, commercial and investment banks, other financial institutions and
individual investors. The money market provides a market for the banks where they can lend
when they have excess liquidity and also borrow when they are in short of liquidity.

DEFINITION AND TYPES OF BONDS

Bonds are long-term debt securities, and are often referred to as fixed-income securities. This is
because the debt service of the issuer is fixed. That is, the issuer agrees to pay a fixed amount of
debt periodically and to pay the full amount of principal at maturity. According to R. E Bailey
(2005) a bond is a contract that commits the issuer to make a definite sequence of payments until

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a specific time. He further explained that bonds are special forms of loan, which is commonly an
agreement between a borrower and a lender. Bonds are long term financial securities which
promise its holder some future payments under certain agreed terms. These payments may be in
the form of periodic interest payments(coupons) followed by the payment of the bonds face
value at maturity, a onetime payment of both principal and payment at a future date. Bonds are
usually issued by governments, corporations and municipalities. In India, most bonds are issued
by the government. No agency or municipal bonds have been issued. Some types of bonds are
briefly explained as follows Indiaian examples where applicable:

TREASURY BONDS

This type of bonds is sometimes referred to as government bonds as they are issued by
governments. Upon the purchase of such a bond, government promises to make payments to the
holder on certain terms agreed upon before the issue. Treasury bonds are generally risk-free
bonds. Government of India(GoG) issued bonds can be classified under treasury bonds.

CORPORATE BONDS

Corporate bonds are issued by corporate entities as a means of raising funds for the furtherance
of their operations. Unlike treasury bonds, corporate bonds are exposed to default risk since the
issuers of the bond may be unable to pay, in case the company does not do well in its operations.
The coupon rates of corporate bonds are relatively higher than that of treasury/government bonds
due to the credit risk they come with. An example of corporate bond in India is the HFC dollar
Housing Bond Series and the listing of Standard Chartered Bank's three year Medium Term
Notes which was worth 350billion.

FOREIGN BONDS

These are bonds issued by foreign governments and corporations. Such bonds have some
element of credit risk particularly with respect to those issued by foreign corporations.

EURO BONDS

Euro bonds are bonds which are issued outside the shores of the issuing country and
denominated in a foreign currency. India issued its first Euro bonds in 2007 and raised $700m.

MUNICIPAL BONDS

These bonds are issued by municipal authorities to raise funds for the finance of their activities.
The issue of municipal bonds is subject to approval by the central government after thorough
investigations into the activities of the municipal authority in question and obtained guarantee of
its ability to make payments as and when they fall due. A municipal bond is yet to be issued in
India.
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Throughout the developed world (Europe, Japan, Canada, USA, etc), bonds play significant role
in financial markets. They provides important source of long term borrowing for governments
and corporations. In recent times however, governments of developing countries are beginning to
turn to the issuance of bonds as a means of raising medium and long term funds to finance
various government projects.

According to an IMF working paper of 2009, the financial markets in most sub-Saharan African
(SSA) countries are shallow, and have inadequate access to finance. As a result, mobilization of
domestic resources as an alternative source of financing is becoming increasingly important in
SSA, with SSA governments focusing on domestic markets in order to avoid renewed or
unsustainable external indebtedness. Easy access to concessional financing had reduced the need
to develop domestic bond markets in many SSA countries. Prior to the ongoing financial crisis,
many SSA countries enjoyed relatively simple access to external donor funds, predominantly in
the form of multilateral and bilateral loans and grants secured on concessional terms. Despite a
long history of fiscal deficits and a growing need for developmental and structural investments,
with the one exception of South Africa, bond markets in SSA have remained shallow, illiquid,
and inefficient.

The paper further provided that, as the global financial crisis persists, concerns have emerged
that donors funds may turn out to be scarcer and therefore having sufficiently liquid domestic
bond markets is becoming increasingly important. In the wake of the global financial crisis, the
need for the development of domestic and regional bond markets, as part of the response to the
crisis, becomes more discernible. This is based on the view that there has been over-reliance on
the banking sector for funding, with many banks being subsidiaries of foreign banks with the
attendant contagion effects. The financial sector of many SSA countries is vulnerable to swings
in global market sentiment and foreign investors risk aversion. The development of the domestic
bond market will improve financial intermediation and help to channel more funds into domestic
investment and, therefore, finance development needs.

AN OVERVIEW OF THE BONDS MARKET IN INDIA

HISTORY OF INDIAS BOND MARKET

India has over the years relied on concessionary debt from multilateral sources especially the
International Monetary Fund(IMF) and the World Bank and have had to live with the antecedent
challenges of such concessionary debts which include long gestation periods where
disbursements take up to three(3) years which result in adverse economic costs. Approved
amounts may also be inadequate to undertake earmarked projects to accelerate growth.
Conditionalities attached to the debts not being consistent with national priorities have also
posed problems and high transaction cost appraisal, review missions, monitoring and

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evaluation tying up significant national resources, resulted in government coming to terms with
need to diversify funding sources to mitigate disadvantages of concessional debt.

Reforms undertaken over the last decade have transformed Indias economic condition and
prospects. Indias stable political conditions needed for reforms to succeed and support from
international partners have reinforced the positive steps taken at home. Macroeconomic and
social indicators are also pointing in a positive direction. Vulnerabilities remain but the strategy
is in place and the foundation has been laid for Indias ascent to middle income status by 2015.

The above conditions coupled with the listing of Governments 2, 3, and 5 year bonds have sent
positive signals of an emerging bond market in India. Currently, the issues of Government of
India bonds have been over-subscribed and this signals an interest in fixed income securities.
Indias average domestic debt ratio has increased from 16% of GDP between 1990-2000 and
24% between 2001-2008. The Bank of India recently returned more than GH400m in surplus of its
oversubscribed three-year bond. This is because the governments three year bond, which was to
raise GH200m was hugely oversubscribed as the Bank received GH639m in bids. These bids were
from both local and international investors. According to the Head of Treasury, Mr Adams Nyinaku
GH169m worth of accepted bids were from offshore investors. (Graphic 27/02/12 P.53).

A GSE report of 2007 described the year as the golden year for India's capital market including
the India Stock Exchange. According to GSE reports Market Capitalization shot up by 22.38% to
close 2006 at 112,415.68 billion from a previous value of 91,857.28 billion in 2005. Volume
and value of shares traded were 98.29 million shares and 476 billion respectively as against
81.40 million shares valued at 464 billion recorded in 2005. Trading in listed bonds recorded
values of 1.6 billion compared to 0.1billion in 2005. The report went on to say that in 2007
secondary trading on the floor of the Exchange saw, a tremendous improvement over the recent
past where secondary market trading of government securities, which were done over-the-
counter through a network of primary dealers, saw a tremendous improvement. The volume of
shares traded rose by 193% from 98million in 2006 to 287million in 2007, the value of total
shares traded rose from GH47.60million to GH140.71million. Also as of March 2007, the
GSE had some 32 listed companies, with a market capitalization of approximately GHC 112
trillion (USD 12 bn).

In 2008, the Golden Jubilee Savings Bond, a 5 year Government of India bond was issued in
commemoration of the Golden Jubilee Celebration of India. The bonds were being issued to
encourage long-term savings and investment among Indiaians. The Jubilee Bond was an
obligation of the Government of India (GoG). The subscription period for the Golden Jubilee
Bond had to be extended from March 5, 2008 to June 30, 2008 due to "the significant interest
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shown by Indiaians in the Diaspora and their overwhelming request for the subscription to be
extended".

The main objectives of the issue of the Golden Jubilee Savings Bond were to:

i. Raise GH50 million to embark on infrastructural development in every region in India.

ii. Enable as many Indiaians to commemorate Indias Golden Jubilee Celebration
iii. Create awareness of the importance of saving
iv. Diversify the financial instruments on offer to the market

The Golden Jubilee Bond was a retail savings bond which was purchased from an approved list
of financial institutions all over the Country. It was an Accrual Bond with no interest paid until
redemption. The Bond was also intended to promote savings culture among Indiaians that would
support the significantly higher levels of investment to propel the country into middle-income
status by 2015. The bond was designed to achieve other important objectives such as broadening
the participation of Indiaians in the formal financial system and promoting long term savings and
investment culture in India.

Indias bond market is expected to be deepened by move by government to set up a national

Bond Market Committee. The committee will among other things identify the constraints in the
development of corporate bond market, study and recommend legal, institutional and process
changes needed to accelerate the development of a corporate bond market. The committee will
also monitor the performance of the government bond market and to improve its effectiveness as
an anchor for the corporate bond market as Indias bond market is currently dominated by
government bonds.

India sold its first global bond in 2007 going into the record books as the first country in Sub
Sahara Africa to issue and global bond, raising $700 million to help fund the construction of
roads and power plants. After that, the budget deficit surged to 24 percent of gross domestic
product in 2008 and the global credit crisis sent the currency plunging 49 percent against the
dollar in the year through June 2009, pushing inflation to 20.7 percent that month. In addition to
government bonds, HFC and SCB have issued and listed corporate bonds on the market.

The World Bank Groups International Finance Corporation (IFC) on January 18, 2012 obtained
approval from India and the eight member countries of the West African Monetary Union to
establish local currency bond programs to strengthen domestic capital markets and support
private sector development in the region. The approvals were to enable IFC to issue over $1

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billion equivalent in bonds in Indiaian cedis and CFA francs over the next 10 years, said the
private arm of the World Bank Group.

The bonds will be sold in their respective markets to domestic and foreign institutional investors,
it added as proceeds will fund IFC projects that support private sector development in key areas
such as infrastructure and access to finance for small and medium enterprises. By Ekow
Quandzie(India Business News) it was revealed that foreigners took the chunk of the offer.
Despite these, the secondary bond market however, still remains dormant.

The steady rise in investor confidence in the economy is lending support for increasing liquidity
within the bonds market, giving fresh hope for long-lasting decline in interest rates. Results from
the second issue of the Government of India three-year fixed rate bond has shown that there has
been another over-subscription this time to the tune of 130 percent, for the offer that lasted for
just a day. Against an offer of GH300 million, total subscriptions received were GH690
million. During the week-long offer for the first issue which closed on January 14, 2010, the
offer of GH200 million was oversubscribed by 97.7 percent for which GH310.89 million was
allotted, representing 55.4 percent more than the target. Appendix B gives an overview of some
GoG issued bonds, their subscriptions and yields.

The overwhelming response coupled with the interest expressed by foreign investors in the first
issue, the Treasury Department of the Bank of India (BoG) observed that investor confidence
was being restored in the economy, especially in comparison to a year earlier.

On this second issue, the Treasury Department has said that investor confidence is paving the
way for liquidity in the bonds market. The offer which was issued to yield 14.97 percent
attracted bids, ranging between 12% and 19%, from both local and foreign subscribers. For the
relatively low bids received, officials of the Treasury Department explained that it was an
indication of the much more liquid bonds market now, as compared to previous years.

The IFC Vice President and Treasurer, Jingdong Hua, provided that Deep and liquid local
currency bond markets are indispensable in providing diversified long term funding sources for
private sector companies, including SMEs. The agreements with the government and regulator of
India and the West African CFA countries will enable us to support the development of these
markets. They also allow us to help our private sector clients mitigate foreign-exchange risk, so
that they can grow their businesses and contribute to job creation and growth in Africa.

India is making a fresh bid to develop a corporate bond market and aims to achieve five listings
in the next three years, an adviser to a new government bond development panel told Reuters on
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Thursday, 1st of March 2012. India's bond market is dominated by short-term government
securities and long-term funding is needed to drive investment in the world's second biggest
cocoa grower and Africa's newest oil producer. Currently, only one corporate bond, issued by
HFC Bank, is listed on the India stock exchange.

Regulators say the absence of credit rating agencies and companies' reliance on bank loans have
stalled corporate bond issuance. The National Bond Market Committee will work with state-
owned enterprises and the private sector to encourage them to issue bonds, said Dr. Sam Mensah,
a technical adviser to the panel.

Companies have traditionally relied on bank loans and the tougher requirements for issuing
bonds have been a deterrent, Adu Anane Antwi, director general of the Securities and Exchange
Commission, has said. According to him, it will take time before people will buy into the idea of
coming to the market and added that people would be interested in looking at how businesses are
being operated, resulting in corporate governance, disclosure, transparency issues.

SUCCESS OF THE BONDS MARKET IN INDIA

One remarkable achievement of the financial sector restructuring has been the creation and
growth of the bonds market in India. The bond market in India, though could be said to be in its
early formative years unlike the equity market which started with the setting up of the India
Stock Exchange in 1990 - has shown a tremendous improvement since the first trading of India
Stock Exchange Commemorative Registered Stock of 1990.

Government bonds have been used as debt instruments to provide a foundation for active trading
on India Stock Exchange. Corporate bonds such as that issued by HFC have contributed to a
promote the growth of Indias bond market. The government's aim of developing the bond
market in India cannot be over emphasized. Every attempt was made to sustain the market. In
recent times the government has inundated the market with forty-eight, 2, 3 & 5-year bonds
worth a little over GH1 billion. This acts as boost to the primary market and was described by
the GSE as 'a significant landmark in the history of the Exchange'.

The government's listings enhanced the bond market in India and also showed the government's
commitment to the development of the bond market. As of December 2006, total outstanding
government bonds stood at GHC 2,400 bn (USD 260 million). Another major boost to the market
was the listing of Standard Chartered Bank's three year Medium Term Notes worth 350billion
as well as preference Shares.

The introduction of government of India's golden Jubilee bond in 2008 also signified a major
transformation in the financial markets as well. This 5-year bond was listed in a bid to enhance

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the secondary trading on the market and to ensure liquidity. This has been viewed as a positive
development in the market. (Bank of India Consultation Paper October 2007)

Finally one other major boost to the bond market is the issuing in October 2006 of cedi
dominated Africa Development Bank (AfDB) Bond. This was a two year bond linked to the
Indiaian cedi and it was worth 414.9 billion. The AfDB is reported to have plans of issuing
cedi denominated bonds on the Indiaian market. The purpose of this issue is to provide long-term
local currency financing to support development projects. According to AfDB report this would
be done by the means of direct project lending as well as lines of credits to financial institutions.
Such a transaction simultaneously aims to deepen the bond market in India. (Africa Development
Bank (AfDB) report 2007).

RECOMMENDATIONS:
WAYS FORWARD FOR DEVELOPING AN ACTIVE BONDS MARKET

Broadening the Database

Improve and centralized reporting of all bond transactions reporting to improve transparency and
improve on liquidity of bond markets. Supporting regional initiatives for diversifying bond
markets and providing infrastructure such as bond trading platforms, settlement and custody
systems and trading systems

Taxation policy
Taxation of financial instruments has significant implications for financial market development.
Taxes on capital gains and income from securities affect saving and investment decisions,
demand for financial assets, and investment.

Considering the importance of financial markets in the development of the national economy, it
will be important to adopt tax policies that are compatible with financial market development
while not seriously compromising principles of good taxation. This may provide a level playing
field for both institutional and retail investors on the market.

Already the on-going Pension Reforms has incorporated various tax incentives to retirement
savings plans. For instance, total payroll tax exemptions are capped at 35% for all contributions
into all the pension schemes.

Corporate awareness
There may also be the need to further diversify range of instruments on the bond market by
creating corporate awareness to use bonds as alternatives for long awareness long-term
financing. These would include improved corporate governance, disclosure and accounting

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standards. Finally, there needs to be a strong regulatory framework to drive operations on the
secondary bond market and increase transparency in bond trading to develop a benchmark yield
curve.

Sustaining policy reforms

Macroeconomic reforms focusing on stability which fosters long term capital market activity.
Ensuring that bond issues will be consistent with sustainable debt levels.

CONCLUSION

Though the participation of government in Indias financial market has been substantial and
encouraging, it is regrettable it has t not resulted in substantial strides, particularly in the bond
market. The sound political environment, as well as the favorable macroeconomic achievements
over the last decade has contributed immensely toward the development of confidence in the
economy by both local and foreign investors. It is encouraging that issued bonds have lately been
oversubscribed by domestic and foreign investors, with foreign investors taking a chunk of these
issues but the issue of such bonds solely by government does not seem to be helpful enough for
further extending the frontiers of the bond market.

Regulators say the absence of credit rating agencies and companies' reliance on bank loans have
stalled corporate bond issuance. Currently, only one corporate bond, issued by HFC Bank, is
listed on the India stock exchange. This is mainly associated with the risk inherent in corporate
bonds. To enhance and encourage such bonds, the activities of industry regulators and monitors
must be stepped up to meet international standards. Corporate organizations must also be willing
and able to demonstrate prudent financial and operational practices that would render credibility
to its existence and instill confidence in existing and prospective stakeholders.

Companies have traditionally relied on bank loans, and the tougher requirements for issuing
bonds have been a deterrent. Governments and regulators of financial markets have been very
skeptical and cautious in granting certain approvals for raising funds, especially through the issue
of bond due to the rippling effect that these issues may have on the country involved. Most local
corporate entities have also been adamant in making moves to venture into raising capital
through the issue of bonds for numerous reasons including the reluctance to disclose vital and
sometimes unfavorable information.

The IMF working paper prepared by O. Janet Adelegan and Bozena Radzewicz-Bak in
September, 2009, empirically analyze the determinants of bond market development in a cross
section of 23 sub-Saharan African (SSA) countries between 1990 and 2008. The study found that
the savings constraint is a key impediment to domestic bond markets development as well as
financial market deepening, as it results in a low level of financial intermediation by the banks.
Overall, the results show that a confluence of factors matters for the development of domestic

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bond markets in SSA; these include structure of the economy, investment profile, law and order,
size of the banking sector, the level of economic development, and various macroeconomic
factors. Policy implications include: increased efforts to strengthen the investment environment
and the need for a regional approach to bond market development.

APPENDICES:
A.

VALUE OF GSE LISTED BONDS

Government Corporate SCB Medium-Term
Years Bonds(GHCMillions) Bonds(US$million) Notes(GHCMillion)
1991 0.5 - -
1992 0.5 - -
1993 0.5 - -
1994 0.5 - -
1995 - - -
1996 - 22.5 -
1997 - 4.8 -
1998 - 6.8 -
1999 - 9.5 -
2000 - 11.01 -
2001 100.37 10.2 -
2002 132.69 10.98 -
2003 144.24 8.98 -
2004 51.63 6.28 -
2005 22.5 8.78 -
2006 326.15 2.5 -
2007 1,333.07 6.4 35

Source: Conference on bond markets in emerging market economies, Frankfurt, Germany

Presentation by Dr. Ernest Addison, Director of research, Bank of India.

B
Auction Subscription Issue Yield
GHC200m GHC639m GHC219m 14.99%
GHC300m GHC448m GHC301m 14.25%
GHC400m GHC753.7m GHC401.2m 13.45%
GHC200m GHC395.39 GHC310.89 19%

Source: Bank of India website

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References

1. Bank of India Consultation Paper October 2007

2. Bank of India Website
3. Brigham E.F., Gapenski L. C., Ehrhardt M.C.: Financial Management Theory and
Practice(The Dryden Press)
4. India Business News
5. India Stock Exchange Reports
6. Janet Adelegan O. J and Bozena R. B IMF Working Paper, September, 2009.
7. The Business and Financial Times News Paper
8. The Daily Graphic

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