Is the Debt Market becoming Outdated?

Another question follows – Why?

The Indian debt market may be categorized into three – Government securities (G-Sec) consisting of central and state government securities, the bond market consisting of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures.

Of these, the government securities segment is the most dominant category in the debt market. The most distinguishing feature of these instruments is that the return is fixed i.e. they are as close to being risk free as possible, if not totally risk free. The fixed return on the bond is known as the interest rate or the coupon rate.

Considering the scenario after independence, the immediate concern was to attract capital that would help the economy grow. This was the time when fixed deposits (FDs) in banks were considered safest form of investment that gave guaranteed returns and were risk free at the same time.

But FDs have inherent disadvantages such as the amount always being fixed; and if interest rates dropped, investors tend to lose. At the time, the other option was the underdeveloped equity markets.

Thus the need arrived for instruments that could be traded on the market where the price discovery was far more realistic, favored the investor, and also offered liquidity.

This led to arrival of debt markets.

Cut to 1992 – Glasnost (liberalization) and perestroika (restructuring) swept through the financial markets as well. The country’s economy started changing tracks from a regulated one to a free market; it was then that interest rates became market forces-led rather than completely governed by the Reserve Bank of India (RBI).

India’s equity and debt market started walking in different directions charting their own course. The equity market survived its biggest scam in 1992, the result being the formation of the Securities and Exchange Board of India (SEBI). Badla was banned and the National Stock Exchange (NSE) was created.

Through all this, the debt market moved ahead, blocking fraud and improving systemic integrity, but there was no fresh vision on market design.

Moreover it lacked focus on retail investors, so much so that investors were not even aware about this avenue – where debt instruments could be traded just like equities. The risk is far lower in the case of bonds/debentures as compared to equities. Also, returns are better than those offered by fixed deposits in banks and they have high liquidity.

Another factor that has affected the growth of the debt market is the lack of infrastructure for price discovery and price information dissemination. Retail investors do not understand the mechanics of these markets in regard to instrument-pricing.

Therefore, the areas that need attention are investor education and creating a robust system that will allow this market to develop. The SEBI report on debt market recommends that concept of debt manager is quintessential to the development of the corporate debt market – who should be committed and sufficiently capitalized, who should subscribe, hold, and trade in debt.

Another jump, this time right up to the present, 2008: Inflation is at its peak – 7.8%. In such a scenario is it feasible to invest in G-Sec where the return is only 8%? Instead investors should consider balanced and equity diversified funds for higher returns than the inflation rate. Returns from equities are much higher.

The contrast between these two markets is for every one to see – the debt market does not cross a thousand trades a day, while the NSE has become the fifth largest exchange in the world, within striking reach of a million trades a day. The debt market probably has 20 dealers in one square kilometer of South Bombay whereas the equity market has vibrant presence right from Kashmir to Kanyakumari.

It is high time that the debt market takes lessons from the innovation-led equity market which has survived all odds and achieved a 180-degree turn around.

The author is Senior Editor at Apnaloan.com Services (P) Limited.

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