Indian Economy, 5th edition (71 page)

Banks in India accounted for 14.4 per cent of the financing of large firms in 2000-01, which rose further to 17.8 per cent in 2010-11. The
bond market
, on the other hand, has been miniscule in comparison. The thinness of the bond market has been somewhat compensated by foreign borrowing done by Indians, which rose sharply over the last decade. Further, India is characterized by a disproportionate amount of secured borrowing. The small size of unsecured borrowing may, at first sight, not seem to be a matter of concern, but it could be a reflection of the weakness of contract enforcement and lack of adequate information. If contracts were quickly enforced and lenders had information on borrowers, they would be more willing to give unsecured loans. This would give a nimbleness to the financial markets which they presently lack.

There are
many reasons
why bond markets are important for an emerging economy. Prominent among these is the fact that they lead to more efficient entrepreneurship and greater value creation. When an entrepreneur takes a loan or issues bonds, all additional profit over and above the pre-fixed repayment amount accrues to the entrepreneur. So he or she is better incentivized to take sharper decisions. By having a weak bond market, we may be foregoing this efficiency. And further, this efficiency gap may well mean that there is less lending and hence less investment and entrepreneurship in the economy than is feasible. Further, as India tries to garner 500 billion dollars from the private sector in the Twelfth Plan for investment in the infrastructure sector, having an active bond market would be a valuable avenue for raising money.

There can be many reasons why, despite these advantages, the bond market has not developed adequately. One reason has to do with what economists call ‘multiple equilibria’. Consider a situation where the bond market is small. If someone buys bonds and later wish to sell these off, he anticipates difficulty. Since the bond market is not active, he may not easily be able to sell the bonds and thus he will hold simply because he cannot find a buyer. Hence, this may lead to discourage someone from buying the bonds in the first place. If everybody reasons like this, the bond market remains thin. Hence, the need is for a push that nudges the market to another equilibrium, where people readily buy bonds because they know that they can easily sell these off and this becomes a self-fulfilling prophesy and sustains the large bond market.

There is effort currently on to try to boost India’s debt and bond markets and success in this can give another fillip to growth. With the intervention of the
Patil Committee
recommendations, the corporate bond market is slowly evolving. With bank finance drying up for long term infrastructure projects, in view of asset liability problems faced by the banking system, the need for further development of a deep and vibrant corporate bond market can hardly be overemphasised. Recent initiatives for further development of corporate bond markets, taken in the year
2012-13
are as given below –

•
Banks allowed to take limited membership in SEBI-approved stock exchanges for the purpose of undertaking proprietary transactions in the corporate bond markets.

•
To enhance liquidity in the corporate bond markets, the IRDA has permitted insurance companies to participate in the repo market. The IRDA has also permitted insurance companies to become users of
‘credit default swap
’
(CDS).

•
The minimum
haircut
16
(i.e. the difference between prices at which a market maker can buy and sell a security) requirement in corporate debt repo have been reduced from the existing 10 per cent; 12 per cent; 15 per cent to 7.5 per cent; 8.5 per cent; 10 per cent for AAA/AA+/AA-rated corporate bonds.

•
MFs have been permitted to participate in CDS in corporate debt securities, as users.

•
Revised guidelines on CDS for corporate bonds by the RBI provide that in addition to listed corporate bonds, CDS shall also be permitted on
unlisted
but rated corporate bonds even for issues other than infrastructure companies.

•
Users shall be allowed to
unwind
17
their CDS-bought position with the original protection seller at a mutually agreeable or FIMMDA (Fixed Income Money Market and Derivatives Association of India) price. If no agreement is reached, then unwinding has to be done with the original protection seller at FIMMDA price.

•
CDS shall be permitted on securities with original maturity up to
one year
like CPs, certificates of deposit, and non-convertible debentures with original maturity less than one year.

Economic Survey 2012-13
comments: A reasonably well-developed corporate bond market is very much required in any economy to supplement banking credit and the equity market and to facilitate the long-term funding requirement of corporate sector as well as infrastructure development in the country. Though, the development of the corporate bond market has been an important area and has received greater policy attention in recent times, it is yet to take off in a significant manner. Some of the issues that
need to be addressed
in this regard include:

•
Drawing up a roadmap for a structural shift from a
bank-dominated
financial system to a more diverse financial system where top-rated corporates access finance from capital markets;

•
Strengthening of the
legal framework
for regulation of corporate debt by necessary amendments in rules/regulations, and

•
Relaxation of investment
guidelines
for pension, provident, and insurance funds to enable the participation of longterm investors in the corporate bond market.

Introduction of new products and making nascent products such as covered bonds, municipal bonds, credit default swaps, credit enhancements, and securitization receipts more attractive may be considered for public issuance of bonds at reduced cost. Improving the market infrastructure for enabling liquidity, transparency in price discovery, and stimulating growth in trading volumes also need to be suitably addressed.

Inflation-Indexed Bonds

To protect the returns of investors from the vagaries of inflation, the Reserve Bank of India plans to introduce inflation-indexed bonds (IIBs) – it was proposed by the
Union Budget 2013-14
. The government hopes this will help increase
financial savings instead of buying gold
. In the recent years, the rate of return on debt investments has often been below inflation, which effectively means that inflation was eroding savings. Inflation indexed bonds provide returns that are always in excess of inflation, ensuring that price rise does not erode the value of savings. The Bond waslaunched in June, 2013.

Gold Exchnage Traded Funds

Gold Exchange Traded Funds (ETFs) are
open-ended mutual fund schemes
that closely track the price of physical gold. Each unit represents
one gram
of gold having 0.995 purity, and the ETF is listed on stock exchanges. The net asset value of each unit is calculated based on the prices of physical gold prevailing on that day and is designed to provide returns that would closely track the returns from physical gold.

Gold ETFs have seen net outflows in
March 2013
and in the first fortnight of
April 2013
with investors turning net sellers
due to falling prices
of gold in global markets.

e-Gold

e-Gold is another purchase option, involving investments in units traded on the National Stock Exchange (NSEL). Here, the investor is required to have a demat account with an affiliate of NSEL. e-Gold’s brokerage and transaction charges are lower than
gold ETFs
as there are no fund management charges. One can take delivery of gold or sell it in the exchange.

But there is also a
negative point
here from the tax angle – under e-Gold, one has to hold the yellow metal for 36 months to enjoy
long-term capital gain
benefits, and this is taxed at 20 per cent. For ETFs (Exchange Traded Funds) and gold funds, the holding period to be classified as long-term is only one year. After a year, ETF and gold funds will suffer 10 per cent tax without indexation and 20 per cent after indexation. For a small investor, gold ETF would appear to be the best option, as it meets his needs without difficulties in terms of creating a separate demat account, tax implications and wealth tax.

PENSION SECTOR REFORMS

Pension has been the integral part of government jobs in India. Pension serves two important soci-economic objectives –

(i)
It facilitates the flow of long-term savings for development, i.e.,
nation-building
; and

(ii)
Also helps establish a credible and sustainable
social security system
in the country.

The New Pension System (NPS) was introduced for the new recruits who join government service on or after
January 1, 2004
. Although the NPS is perhaps one of the cheapest financial products available in the country, in order to make it affordable for the economically disadvantaged, the government in September 2010 introduced a lower cost version, known as
Swavalamban Scheme
, which enables groups of people to join the NPS at a substantially reduced cost. As per existing scheme under NPS, Swavalamban could be availed either in ‘unorganised sector’ or in
‘NPS Lite’
. NPS Lite is a model specifically designed to bring NPS within easy reach of the economically disadvantaged sections of the society – it is extremely affordable and viable due to its optimised functionalities, available at reduced charges. Under the Swavalamban scheme, the government provides subsidy to each NPS account holder and the scheme has been extended until 2016-17.

A customised version of the core NPS model, known as the
NPS Corporate Sector Model
was also introduced from December 2011 to enable ‘organised-sector’ entities to move their existing and prospective employees to the NPS under its Corporate Model. All the pubic sector banks have been asked to provide a link on their website to enable individual subscribers to open online NPS accounts.

As per the
Economic Survey 2012-13,
the pension reforms in India have generated widespread interest internationally but before universal inclusion of poorer sections of Indian society into the pension network is a reality, the economy needs to solve the following
major challenges
–

(i)
Lower levels of financial literacy, particularly among workers in the unorganised sector;

(ii)
Non-availability of even moderate surplus;

(iii)
Lukewarm response so far from most of the State/UT governments to a co-contributory Swavalamban Scheme; and

(iv)
The lack of awareness, on the supply side, about the NPS and of access points for people to open their accounts individually have been major inhibiting factors.

Financial Stability and Development Council (FSDC)

An apex level Financial Stability and Development Council (FSDC) was set up by the GoI in December 2010, ‘in line with the G–20 initiatives’ with the following
objectives
:

(i)
to strengthen and institutionalise the mechanism for maintaining financial stability,

(ii)
to enhance inter-regulatory coordination, and

(iii)
to promote financial-sector development.

The Council is
chaired
by the Finance Minister and has
heads
of financial-sector regulatory authorities, the Finance Secretary and/or Secretary of the Department of Economic Affairs, Secretary of the Department of Financial Services, and the Chief Economic Adviser as members. Without prejudice to the autonomy of regulators, the Council
monitors
–

(i)
macro-prudential supervision of the economy, including functioning of large financial conglomerates,

(ii)
inter-regulatory coordination and financial-sector development issues, and

(iii)
financial literacy
and
financial inclusion
.

Financial Sector Assessment Programme (FSAP)

The
IMF Board
decided in September 2010, to include 25
systemically
important economies, including India, under the Financial Stability Assessment Programme (FSAP) for members with systemically important financial sectors. The joint IMF-World Bank Financial Stability Assessment Programme (FSAP) was conducted for India in
January 2013
which assessed Indian financial system in relation to the highest international standards. The
assessment
recognises that the Indian financial system remained
largely stable
on account of a sound regulatory and supervisory regime. However, the assessment identifies
some gaps
in
18
–

(i)
International and domestic supervisory information sharing and co-operation;

(ii)
Consolidated supervision of financial conglomerates; and

(iii)
Some limits on the
de jure
independence of the regulators (RBI and IRDA).

Despite having reservations on a few issues, overall the Indian authorities expect the FSAP exercise to play a
significant role
in shaping India’s post-crisis initiatives to strengthen the regulatory and supervisory architecture based on the evolving international consensus as well as careful examination of their relevance in the India-specific context. As a member of the FSB
19
, BCBS
20
and IMF
21
, India is actively participating in post-crisis reforms of the international regulatory and supervisory framework under the aegis of the
G20
. India remains committed to adoption of international standards and best practices, in a phased manner and calibrated to local conditions, wherever necessary, as it is a country characterised by complex and diverse socio-political and economic conditions.