Mumbai: Bond dealers and economists are still busy reading the fineprint in the Reserve Bank of India’s 84-page annual monetary policy statement, released last week. Has the central bank changed its stance from hawkish to dovish, laced with caution? The single most important factor that distinguishes RBI governor Yaga Venugopal Reddy’s latest policy statement is not the change or continuity of the monetary stance but the return of RBI to the markets.
Reddy, the main architect of India’s debt and foreign exchange markets, had been so preoccupied with other issues, such as liquidity overhang and a fast-paced credit growth over the past few years that he virtually had no time to look at the markets. Now, they are back on his agenda.
And it is no accident. RBI has been forced to make efforts to deepen and broaden both the debt and foreign exchange markets for two reasons. The development of the debt market will ease the pressure on the banking system to support the huge credit demand while the foreign exchange market must have the necessary infrastructure if India is to open the gate for capital outflows. Without risk management props, nobody would like to take advantage of freer currency movements.
After 30% credit growth for two years in a row, bank credit grew at 28% last year following a series of measures by RBI. Had there been no initiative by the central bank, it would have grown anywhere between 30% and 35%, creating more inflationary pressures. The only way the huge credit demand can be met is by creating a robust corporate bond market.
Some nine years ago, Arthur Levitt Jr, the longest serving chairman of the US Securities and Exchange Commission, said that investors in the corporate bond market did not enjoy the same access to information “as a car buyer or a home buyer or, dare I say, a fruit buyer”. Since then, the US has seen a flourishing corporate bond market but India has not moved an inch. Over 95% of the trading volume in Indian debt market is accounted for by government bonds and most corporate paper is privately placed. In the US, the corporate bond market accounts for over 20% of gross domestic product (GDP). The comparable figure for Japan is 16%, the European Union 10% and India, less than 5%.
Unlike the government bond market, which has been actively supervised by RBI, the government’s debt manager, the corporate bond market has been an orphan falling between the banking regulator and capital market regulator Securities and Exchange Board of India (Sebi). They do not need to be traded as investors normally hold them up to their maturity.
Three years back, Sebi mandated that all secondary market trading of bonds should be screen-based, but investors have been resisting this by entering into bilateral deals. When a buyer and the seller of a bond enter into a private agreement, they do not need to list the instrument on exchanges. A government-appointed high-level panel on corporate bond and securitization is in favour of doing away with the listing procedure and instead making rating compulsory for all corporate bonds. R.H. Patil, former managing director of the National Stock Exchange and now the chairman of the Clearing Corporation of India Ltd, who headed the panel, feels that the Indian corporate bond market is still in the Stone Age.
RBI seems to have listened to Patil. The annual policy says that the reporting platform for corporate bonds has already been established by the bourses and the Fixed Income Money Market and Derivatives Association, India’s premier debt-market body, is in the process of setting up a parallel platform for over-the-counter trade of such bonds. Once the reporting and settlement systems are firmly in place, corporate bondholders will be allowed to use these instruments as collateral to raise short-term funds. This will reduce the volatility in overnight interest rates. At the next stage, RBI should consider introducing credit derivatives in the corporate bond market and allowing foreign institutional investors free play in the market at least for longer-tenure corporate paper.
Two key decisions that will influence the foreign exchange market are allowing enterprises as well as individuals to book forward contracts without underlying exposures and setting up a working group to explore the possibility of introducing currency futures.
Allowing an individual or an enterprise to book forwards contracts without any underlying transaction means RBI is encouraging market players to take a view on the currency. For instance, till last week a firm could book three-month forward dollars only if it was required to pay in dollars for importing plant and machinery three months down the line. But now, even if the firm is not importing plant and machinery, it can book forward dollars if it feels that buying dollar makes economic sense. It can cancel the forward contract and rebook again, depending on its requirement and the value of the dollar in the forward market. Essentially, one can now punt on the currency movement the way one plays on stock movements in the equity market.
The single most important message of the RBI policy is: The dollar is no longer a scarce commodity. RBI has realized this after it failed to check the dollar inflow and the rupee liquidity that gets created following the central bank’s dollar buying from the market. RBI will not buy dollars from the market. It wants others to do its job.
—Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai Bureau Chief of Mint. Please email comments to firstname.lastname@example.org