Reserve Bank of India Deputy Governor T Rabi Sankar said one reason for the limited response to retail participation in Government Securities (g-sec) market is that it is tax-inefficient compared to investing in mutual funds, as the latter provides benefits of indexation.

Similarly, asymmetric accounting norms distort incentives for trading and may also induce inefficiencies in hedging activities, he said at a recent seminar organised by Financial Benchmarks India Private Limited (FBIL).

The Deputy Governor observed that certain regulations have the collateral effect of adversely affecting market liquidity. “There should be coordinated efforts to address the unintended consequences of such taxation, accounting, or regulatory requirements without undermining the basic objective of such policies,” he said.

Sankar noted that the preponderance of the buy-and-hold category of investors in the g-sec and corporate bond market (banks, insurance companies, pension funds, provident funds) aligns trading activity in one direction, leading to volatile overshoots.

“Such infirmities need to be addressed to achieve price efficiency, and consequently, robust benchmark. One way of diversifying the participant base is to open the markets to the larger global investor base,” he said.

Segmentation of markets

The Deputy Governor observed that market segmentation fragments liquidity and leads to price differentials which erode the efficacy of benchmarks.

“Seen in the context of the need for investor diversity, the fragmentation of rupee markets between onshore and offshore warrants prioritised attention. Rupee interest rate and currency markets hold the promise of wider investor base and global liquidity,” he said.

Sankar underscored that for the benefits to accrue to pricing (and therefore benchmarks) it is necessary that price impulses move freely from onshore to offshore and vice versa.

“Among other things, this may require linked and interoperable infrastructure, common market-makers across the segments and eventually a frictionless channel for investors to move from one market to the other. There is a strong case to work towards a long-term solution to this segmentation,” he said.