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April 6, 2012

Debt markets


The capital market comprises of equities market and debt market. The debt market is the market where fixed income securities of various types and features are issued and traded. Debt markets are therefore, markets for fixed income securities issued by central and state governments, municipal corporations, government bodies and commercial entities like financial institutions, banks, public sector units and also structured finance instruments. Debt instruments are contracts in which one party lends money to another on pre-determined terms with regard to rate of interest to be paid by the borrower to the lender, the periodicity of such interest payment, and the repayment of the principal amount borrowed.

The debt market plays a very critical role for any growing economy which needs to employ a large amount of capital and resources for achieving the desired industrial and financial growth.


Indian debt markets, in the early nineties, were characterized by controls on pricing of assets, segmentation of markets and barriers to entry, low levels of liquidity, limited number of players, near lack of transparency, and high transactions cost. Financial reforms have significantly changed the Indian debt markets for the better. The Indian debt markets are today poised on the threshold of momentous change and transition to an efficient, transparent and vibrant market with significant retail participation. The first half of the twentieth century had witnessed a significant amount of retail interest and participation in the G-Sec market with more than half the holdings of G-Secs issued being held by retail investors.

The Indian debt market in fact is today one of the largest in Asia and includes securities issued by the Government (Central & State Governments), public sector undertakings, other government bodies, financial institutions, banks and corporates. For classification of instruments traded in debt market refer Appendix I.


The development of the debt market in India was led by the need for the government to raise increased amounts from the market, the encouragement given to financial institutions and corporations to raise funds from a competitive market without any specific borrowing allocations, the need for long-term infrastructure financing and the importance of a liquid debt market in promoting these objectives.

In order to develop debt markets in India, as an initial condition for efficient price discovery, it was necessary to move away from administered interest rates. This, along with the reduced reliance by government on high statutory pre-emption of banks resources and automatic monetization of the deficit by the RBI, were two major areas of focus of reforms in the early 1990s. The move to an auction system for issuing government securities, paved the way for market-related interest rates in the government securities market - enabling the emergence of a risk-free yield curve providing a basis for pricing of other debt securities. The Statutory Liquidity Ratio was reduced to its statutorily prescribed minimum level of 24%. The cash reserve ratio, which had reached an effective high of about 16.5%, has been reduced to the current level of 5.5%. Another significant development has been the elimination of the practice of automatic monetization of the central government’s budget deficit through ad hoc T-bills with effect from April 1997 and the introduction of a new scheme of Ways and Means Advances (a limited financing facility available to central and state governments from the RBI to bridge the temporary mismatches in cash flows).

From the 1990s, several other measures were taken by the RBI to create an enabling environment for market development. Prudential norms have been introduced in line with international best practices, banking supervision has been strengthened, transparency and disclosure standards enhanced to meet international standards and risk management practices have been prescribed.

However for further development of the debt market policy measures should be aimed at increasing market liquidity and improving depth and breadth of investor base.

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