Financial immaturity in India is perhaps best exemplified in its government bond and corporate bond markets. The equity market has achieved vibrant liquidity based on lakhs of participants in India and abroad. The bond market has policy mistakes limiting participation to a few big financial firms in south Mumbai. And reform of the debt market is one area where there are no political constraints. The Patil, Mistry and Rajan committees have laid out the broad contours of reforms. There are six elements. First, shift regulation of bond markets from RBI to Sebi. Simultaneously, the NDS exchange run by RBI needs to be put out as a third exchange to compete with NSE and BSE. Regulation should unify treatment of stocks and bonds, thus increasing bond market participation. Second, look at capital controls. It is clear theres massive international interest in rupee-denominated bonds on the onshore market. FIIs need to be brought into this game. This will reduce the bias in favour of dollar-denominated ECBs. Third, sort out taxation. India needs to come up to the standards of the top 20 countries in the world on how domestic and foreign investors are treated on the bond market.
Establishing a debt management office (DMO) is the fourth element. The DMO will support treasury requirements of the central and state governments and avoid conflicts of interest with monetary policy as is presently the case. North Block cleared the DMO idea in February but has floundered in its implementation. Fifth, clear bankruptcy rules. When companies issuing bonds go bankrupt, bondholders need to swiftly take over the company, thus expropriating shareholders, possibly sacking the management, and obtaining a fair recovery rate. Finally, the sixth issue is that of stabilising inflation. If an investor is to think of buying a 30-year bond, he faces great uncertainty about what future Indian inflation will be like. Will inflation be more like 3% or will it be more like 13% This has a massive impact on bond valuation. A long-dated bond market will be greatly enabled by monetary policy reform so as to guarantee investors that inflation in the long run will remain low and stable. A bond market going out to five years is compatible with todays RBI; a genuinely long-dated bond market requires RBI reform.