Opening up the government bond market to retail investors is a good start. The challenge makes it a success

Illustration by Ramandeep Kaur | The imprint

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TThis morning, India will open its government bond market to retail investors as it seeks to broaden the investor base to fund its massive borrowing needs. In February this year, the Reserve Bank of India, in its statement on development and regulatory policies, announced that it would allow retail investors online access to the government securities market, both primary and secondary, as well as the possibility of opening and maintaining their government securities account (retail direct gilt account) with the RBI. .

This is a welcome move, as it could provide more options for retail investors with greater ease and reduce the cost of investing and trading in government securities. The next step should be to set up an independent public debt management agency (PDMA). After that, the government and the RBI need to address the fundamental issue of integrating bond market regulation and infrastructure with traditional financial market regulation and infrastructure.

In 2016, holders of National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL) demat accounts were authorized to trade government securities on the NDS-OM (Negotiated Dealing System-) platform. Order Matching) through their depository participants. which have the account of the General ledger of the subsidiaries (SGL). In 2018, the National Stock Exchange provided on its platform an opportunity to subscribe to government bonds on the primary market.

However, secondary market trading and settlement is only possible through the infrastructure managed by the RBI. This arrangement is an obstacle to transparent trading and investment in government securities.

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Integration of the bond market

The infrastructure of the bond market is mainly the exchange, the clearinghouse and the depositary. These three components are managed by the RBI. The Harshad Mehta scam of the early 1990s led the RBI to set up an electronic ledger for the holding of public securities. This ledger, the SGL, is legally mandated to be the sole custodian of government securities under the 2006 Government Securities Act. The members of the SGL are mainly banks and financial institutions, which hold an account in the depository in which they hold government securities.

The legal framework has given the RBI exclusive powers to supervise, govern and regulate participation in the depositary. RBI owns the NDS-OM system, which is the exchange for trading in government securities. The RBI initiated the creation of an informal clearing company, the Clearing Corporation of India Ltd (‘CCIL’), which is owned by the banks. This is in addition to a parallel exchange – clearing house – custodian for bond market purposes. This arrangement functions as a separate silo from the infrastructure of traditional financial markets.

International experience shows that the bond market infrastructure is largely part of the traditional financial market infrastructure. In most countries, government bonds are traded on the platform provided by the exchange. The depository infrastructure for government bonds is part of the unified infrastructure for other securities. The settlement of government securities is overseen by the securities market regulator with a few exceptions. India is the only country where all three elements of the bond market infrastructure are owned, controlled and managed by the central bank.

Regulation of the bond market, like its market infrastructure, is separate from the Indian securities market. Through changes in the legal framework (in particular, the RBI Act, 1934 and the Government Securities Act, 2006), regulatory powers over the bond market have been transferred to the RBI. In most countries, the unified financial market regulator serves as the regulator of the government bond market.

India’s government securities market lacks the depth and liquidity to incentivize greater investor participation. The secondary market is characterized by a relatively lower volume of transactions. Most of the trading remains focused on a few securities and a few maturity bands. In addition, the lack of seamless integration of bond market infrastructure with securities market infrastructure increases costs and prevents wider participation by individuals. While a number of incremental steps have been announced in recent years, the frictions resulting from segmented market infrastructure persist.

The issuance and trading of government securities could be simplified by allowing the issuance of government securities in the demat accounts of retail investors, like any other security. It could also help the government stick to its borrowing schedule by broadening the investor base.

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RBI’s challenge

Right now, the RBI faces the challenge of managing the government’s massive borrowing program at a lower cost. Rising global crude oil and commodity prices translate into higher input costs and could lead to widespread price increases. As the RBI has placed a higher priority on stimulating growth, as the recovery accelerates and demand accelerates, it is expected to shift its accommodative stance and move towards interest rate hikes. .

Rising rates could make it harder for the RBI to manage the government’s borrowing program. In this context, allowing better access to retail investors to broaden the investor base is a welcome step.

In the recent past, the RBI has sought to broaden the investor base by allowing greater participation of foreign investors in government bonds. A “fully accessible channel” for investment by foreign investors has been opened, under which certain specified securities have been opened for them without any restriction.

Now, banks hold most of the government securities. As the demand for credit intensifies, there may be a reduction in the holdings of government bonds by banks. As government securities become more market-oriented with a diverse investor base, debt management will face significant challenges. This would then require a specialized agency to manage the government’s borrowing program.

Direct retail involvement is a welcome first step. This must be followed by full integration of the bond market on the one hand and a separation of the debt management functions of the RBI on the other. To turn India into a 10 trillion dollar economy, financial sector reform is a critical step.

Ila Patnaik is an economist and professor at the National Institute of Finance and Public Policy.

Radhika Pandey is a consultant at NIPFP.

Opinions are personal.

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