Bond market boost

The Reserve Bank of India’s concerted efforts to bring about structural changes in the government bond market is laudable; but a lot more needs to be done. In the recent monetary policy, the central bank drew up a schedule to reduce government securities held by banks in the ‘held-to-maturity’ category — in which banks do not have to reset the value of the securities to reflect their market value — from 24 to 22 per cent of their short-term liabilities. The RBI also increased the limits for short-selling these securities. These measures will help improve volumes, an objective the central bank has been seriously pursuing over the last few months. Recently, the central bank had mandated that banks reduce government securities held in the HTM category from 24.5 to 24 per cent. It is probably a result of this that trading volumes in government bonds increased by 37 per cent in September compared to the previous months. Other moves by the RBI such as increasing the limit of foreign portfolio investment in these securities and introducing interest rate futures to hedge volatility in interest rates have also helped.

The central bank is right to focus attention on the government bond holdings of banks. Banks are the largest holders and generate about 65 per cent of the turnover in these securities. While banks typically hold G-secs to meet the statutory requirement, slack credit growth had led many banks to park more than the mandatory quantity of funds in these securities. Reduction in the HTM limit will make banks reduce their government bond holdings, freeing funds for lending. Also, if banks start churning their G-sec portfolio more actively, it will result in increased trading volumes. A vibrant market for government securities is necessary not just because it is a tool through which the central bank controls liquidity, but also because it helps communicate future interest rate and inflation expectations of the market to the RBI and provides a benchmark for corporate credit.

But this transmission is not taking place effectively. Trading is concentrated in just a few securities. Work needs to be done on consolidating securities in which hardly any trading takes place, closing the more illiquid ones and allowing investors to switch. It is still a wholesale market with mainly banks, mutual funds and insurance companies participating in the trading. Retail participation needs to be encouraged by providing tax breaks for investing in these instruments. If investment in equity is still being encouraged with the introduction of schemes such as the Rajiv Gandhi Equity Saving Scheme, why not extend similar concessions for government bonds? Resuscitating the trading of these securities on stock exchanges, by making banks trade on these platforms, can help towards this end. The retail response to bond issues by IRFC, NHB and HUDCO shows that there is demand for such fixed-income instruments.

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