How Can India’s Bond Markets be Truly Vibrant 

The importance of developing domestic bond markets is to diversify risks in the financial system. The basic philosophy of developing a diversified financial system with banks and non-banks operating in equity markets and debt markets is that it enhances risk pooling and risk-sharing opportunities for investors and borrowers. In the absence of a debt market, the banking system would be larger than it otherwise should be. Prevalence of a vibrant domestic debt market can move a crisis outside the banking system, making it easier for the government to manage.  

Debt markets facilitate efficient financial intermediation as they use the market mechanism for allocating and pricing of credit. In particular, debt markets are expected to facilitate availability of long-term funds for specific uses, such as for infrastructure. Also, debt instruments are mostly rated by independent rating agencies, and investor awareness and monitoring are greater, which mitigates the moral hazard arising out of deposit insurance as in the case of banks. Further, the variety of instruments possible in the domestic debt market may result in gains to savers and borrowers, thus providing a mechanism for efficient allocation of resources in the economy. 

Limited Market Depth 

In recent years, the Indian economy has witnessed significant structural volume led buoyancy in the equity and debt markets. The Indian bond markets can be divided broadly into two segments, the government securities market and the corporate bond markets. The government securities market is generally vibrant in India with buoyant trades reported across several maturity buckets and the presence of a well-developed yield curve. However, the corporate bond market is on the opposite side of the spectrum and poses myriad challenges to policymakers and market participants alike. 

Also Read | How Corporate Bonds Can Attract More Retail Attention

The corporate bond markets clocked cumulative bond issuances in FY22-24 reported at Rs 22 lakh crore as compared to the banking system offtake of Rs 25 lakh crore in the same period. The latter clocked a compound annual growth rate (CAGR) of 9% over the last five years. However, the buoyancy in issuances is not reflected in trading volumes and more so as we traverse down the credit curve.  

Corporate bond markets in India are known to be AA and above markets with rare trades reported in the lower end of the credit spectrum. This poses manifold risk on the banking system and issuers alike. Also, over the past decade, the supply of public issuances of corporate bonds in India has significantly reduced from 12% of overall corporate bond issuances in 2014 to a mere 2% in 2024.   

This decline highlights a pronounced shift towards private placements, driven by factors such as regulatory ease, lower costs and faster execution times. The overall Indian bond market remains largely illiquid, as evident from the fact that the average daily turnover of corporate bond is at Rs 6,000 crore only (as per NSE and BSE trade data).  

A significant portion of corporate bond transactions in India occurs over the counter. These transactions lack the transparency of exchange-traded markets, leading to information asymmetry and reduced investor confidence. Corporate bonds in India are predominantly issued through private placements with large ticket sizes, thus excluding retail investors. This constrains market depth and diversification.  

Bringing in Retail Investors 

In order to make the corporate bond markets more vibrant, policymakers can consider different options. First, in India, corporates prefer bank borrowings on account of relationship and fewer hassles like shorter gestation and flexibility in repayments. In this route, corporates have to manage a consortium of banks compared to the bond route, which involves addressing several investors. Thus there is high inertia for corporates in India to access bond markets. In this regard, earmarking 10% incremental term loan as bond is highly desirable. This also provides banks with a risk mitigation mechanism as bonds are liquid and traded in the markets as compared to loans, which are generally ‘held-to-maturity’.  

These bonds should be issued through the public route, listed on stock exchanges and issued in minimum lot size of Rs 10,000. This will attract small investors into the market. The Securities and Exchange Board of India’s (Sebi) recent step to reduce lot size to Rs10,000 is a right beginning in this direction.  

The Indian equity markets have gradually become vibrant on account of larger retail participation. On the contrary, retail activity in Indian debt markets is limited to few high net-worth individuals. Retail investments in government security mutual funds, popularly known as gilt funds, is less than 15%. The inertia of retail investors to fixed income instruments stems from limited knowledge of fixed income products, the mathematics involved in pricing and lack of trading opportunities. Increasing market depth through the presence of large number of retail investors will result in efficient price discovery mechanism and increase the absorption ability of debt issues. 

Some primary measures could be introducing a system of market making for corporate bonds, compulsory listing of bonds on stock exchanges, publishing bond price indices, making tax-free capital gains and interest received from bonds for a five-year period, consolidating multiple issues though reissuance and exemption of stamp duty for re-issuance and having a repository of centralised information for bonds to be set up by the regulator. 

Secondary measures can include second phase migration to an online order driven matching system, a non-competitive bidding process for retail investors and PF trusts to widen investor base, progressive setting up of DVP1, DVP2 and DVP3 systems and reducing shut periods and introduction of unified conventions between corporate bonds and government securities. Introduction of interest rate derivatives, bond insurance in India, educating investors through television and print media will also help. Depending on investor buoyancy, hedging tools like interest rate futures can be introduced in the markets.  

These measures will go a long way in bringing retail participation to the corporate bond market and enhance both demand and supply legs. This is essential for an economy that aims to catapult into developed status in the medium term.  

The writer is chief analytical officer, Infomerics Ratings. Views expressed are personal