Traditionally, the capital markets in India are more synonymous with the equity markets – both on account of the common investors’ preferences and the oft huge capital gains it offered – no matter what the risks involved are. The investor’s preference for debt market, on the other hand, has been relatively a recent phenomenon – an outcome of the shift in the economic policy, whereby the market forces have been accorded a greater leeway in influencing the resource allocation.
In a developing economy such as India, the role of the public sector and its financial requirements need no emphasis. Growing fiscal deficits and the policy stance of “directed investment” through statutory pre emption (the statutory liquidity ratio – SLR - for banks), ensured a captive but passive market for the Government securities. Besides, participation of the Reserve Bank of India (RBI) as an investor in the Government borrowing programme (monetisation of deficits) led to a regime of financial repression. In an eventual administered interest rate regime, the asset liability mismatches pose no threat to the balance sheets of financial institutions. As a result, the banking system, which is the major holder of the Government securities portfolio, remained a dominant passive investor segment and the market remained dormant.
* The Indian Bond Market has been traditionally dominated by the Government securities market. The reasons for this are
* The high and persistent government deficit and the need to promote an efficient government securities market to finance this deficit at an optimal cost,
* A captive market for the government securities in the form of public sector banks which are required to invest in government securities a certain per cent of deposit liabilities as per statutory requirement 1,
* The predominance of bank lending in corporate financing and
* Regulated interest rate environment that protected the banks’ balance sheets on account of their exposure to the government securities.
While these factors ensured the existence of a big Government securities market, the market was passive with the captive investors buying and holding on to the government securities till they mature. The trading activity was conspicuous by its absence. The scenario changed with the reforms process initiated in the early nineties. The gradual deregulation of interest rates and the Government’s decision to borrow through auction mechanism and at market related rates.
Towards the eighteenth century, the borrowing needs of Indian Princely States were largely met by Indigenous bankers and financiers. The concept of borrowing from the public in India was pioneered by the East India Company to finance its campaigns in South India (the Anglo French wars) in the eighteenth century. The debt owed by the Government to the public, over time, came to be known as public debt. The endeavors of the Company to establish government banks towards the end of the 18th Century owed in no small measure to the need to raise term and short term financial accommodation from banks on more satisfactory terms than they were able to garner on their own.
Public debt, today, is raised to meet the Governments revenue deficits (the difference between the income of the government and money spent to run the government) or to finance public works (capital formation). Borrowing for financing railway construction and public works such irrigation canals was first undertaken in 1867. The First World War saw a rise in India's Public debt as a result of India's contribution to the British exchequer towards the cost of the war. The provinces of British India were allowed to float loans for the first time in December, 1920 when local government borrowing rules were issued under section 30(a) of the Government of India Act, 1919. Only three provinces viz., Bombay, United Provinces and Punjab utilised this sanction before the...