Views | Credit derivatives make their debut in India

Views | Credit derivatives make their debut in India

It is a small deal that could prove to be a giant step forward for India’s moribund bond market.

CDS allows lenders to buy protection against default by borrowers. The first discussions about introducing these products in India began around a decade ago. Much happened since then, especially the starring role these derivative products played in the near-collapse of the Western financial system at the end of 2008. It is good the Indian central bank has gone ahead to introduce them in India, albeit with a huge delay. China introduced its local currency CDS contracts a year ago.

The Indian guidelines are conservative. The most important safety device is that naked CDS contracts are not allowed. Only a lender with an underlying exposure can buy protection; purely speculative bets are not allowed. The market is also shut to foreign players, with only domestic banks being allowed to use CDS.

The introduction of CDS contracts will hopefully make the sleepy Indian corporate bond markets more attractive to investors. Banks are even allowed to buy credit protection against unlisted bonds from infrastructure companies.

There is a valid reason why only Indian banks are currently been allowed into the local CDS market: they account for more than 90% of bank lending in India. But India will eventually need a deeper corporate bond market, with more players. The government has been assiduously raising the limits for investments by foreign institutional investors in local bonds, partly to fund the current account deficit and partly to deepen the bond markets. The next logical step should be access to credit protection derivatives to foreign investors.

Indian derivative markets have made progress at a glacial pace. The same could be the case for the emerging CDS market. There can be any amount of debate about the pace of change, but there can be little doubt that the CDS deal between ICICI Bank and IDBI Bank on Wednesday is a sign of positive change in the Indian financial system.