Column : The market for debt

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: Indian investors have been badly battered by the recent turmoil in financial markets. Short-term RBI measures aside, there is a larger need for a fundamental and long-term reform in another segment of the Indian financial market—the market for corporate debt, where investors can buy and sell debt securities issued by firms in a liquid and transparent market setting.

A big anomaly with the Indian financial market is that while it has a relatively well developed stock market, it lacks a well functioning market for corporate debt open to a large class of investors. In fact, from the beginning of this decade, share of debt in total resource mobilisation for the corporate sector has declined from 95.80% in 2000-01 to 71% in 2006-07. The debt market is still overwhelmingly dominated by the government securities. Most of these debts are held by banks and other FIs and not by ordinary investors. The proportion of bank loans to GDP was approximately 39% in 2005-06 and publicly traded debt constitutes a negligible fraction of the total market. The private placement of debt, which accounts for almost of 92% of transactions in value, indicates thinness of the market where issuers are firms with very high credit ratings and buyers form a syndicate of banks and FIs. Consequently, the secondary market for debt is almost nonexistent and illiquid where retail trade falls below 1% of total transactions. Most of these trades are also carried out in the OTC market and not in exchanges.

However, initiating a series of reforms to make this market investor and issuer friendly is easier said than done. While investing in debt securities, a potential investor has three main concerns. First, the purchase price of a bond ought to be commensurate with its quality. Second, transactions in the secondary market must not involve huge search costs of locating a partner and finally, recovery of investment must be made in a shorter time in bankruptcy.