Issues such as STRIPs fall in the former case. Deep and fundamental problems bedevil the Indian bond market. Minor moves, whether unbanning STRIPs trading or unbanning repos on corporate bonds, are merely tinkering at the margin.
The deeper diagnoses of why India does not have a sensible Bond-Currency-Derivatives Nexus has been done by top experts in the RH Patil, Percy Mistry and Raghuram Rajan reports. The key action points of these reports continue to languish. Minor thing s that will not threaten the status quo are finding their way into announcements. But the essence of what is required is changing the status quo. Speeches by RBI staff in coming weeks will proudly show a great deal of effort on setting up a bond market. What matters is results, not effort. RBI way on the bond market has been tried and failed for 15 years. There is no reason to think that more of the same will now get results.
The deeper problem is the ethos of central planning, of a licence-permit raj. RBI has set itself up as the super-CEO of a set of financial firms. All the product launches of these financial firms are controlled by RBI. Whether we discuss trading in STRIPs or CDS or currency futures or the time at which trading should start and stop: all these decisions are made by the central planner.
This approach has been tried before in India, in the real economy. It failed dismally, and was abandoned. For central planning and a licence-permit raj to work, an omniscient central planner who is maximising the interests of the people is required. Both these conditions are not satisfied in India or anywhere. Growth in India only got started when the central planner started getting out of the way.
To take a specific example, consider currency derivatives. At present, a full array of currency derivatives are traded OTC, which means that the players talk to each other on the telephone and strike up deals. The phone market is a bad way to organise financial trading. It features non-transparency, unfairness to customers, and counterparty credit risk.
The right position for policy makers is to frown on the phone market, and allow exchange-traded derivatives to come about. On exchanges, there is full transparency. Counterparty credit risk is eliminated through the clearing corporation. Thousands of financial firms from all across India are able to participate: their diversity of views yields greater liquidity and market efficiency when compared with the monoculture of banks in South Bombay on the phone market, all of whom think alike.
Prior to the global financial crisis, the international picture was one where governments were neutral about OTC versus exchange. That has changed after the crisis: now governments are encouraging exchanges.
In Indiabefore and after the crisisRBI has steadfastly favoured the phone market. This is partly an analytical failure at RBI (that is, a central planner that was less than omniscient). In addition, RBI is keen to foster the phone market (where it is the regulator) and not keen on exchanges (since Sebi is their regulator). Here, the central planner is placing its own interests first.
All exchange-traded currency derivatives are banned in
India, unless specifically permitted by RBI. Now RBI will permit rupee-dollar and rupee-euro futures, but it continues to ban dollar-euro futures. This third product would close the currency triplet, where the three contractsrupee to dollar, dollar to euro and euro to dollarwould be linked up and strengthen each other. With one of the three legs missing, all three will suffer from inferior price discovery.
In similar fashion, RBI continues to ban options trading on the rupee-dollar on exchanges, while permitting it through the phone market. FIIs and NRIs continue to be banned from the exchange-traded market but permitted on the phone market.
In the Indian discourse, we request RBI to see one issue at a time (for example, please unban trading in rupee-euro futures). However, the entire apparatus of central planning needs to be questioned and dismantled. The phrase RBI has launched rupee-euro futures trading is a throwback to the age of central planning. Economic reforms were not about a government that permitted Tata Motors to launch the Nano in blue and white: they were about a government that got out of licensing.
The author is an economist with interests in macroeconomics, finance and pensions