The soul of the debt market

The RBI announced that government securities will trade on exchanges through anonymous order-matching. This is a major milestone for the thought process at RBI, and for India's debt market.

India's equity and debt market have walked in very different directions in the decade of the 1990s. Both markets started out alike. As of 1992 or so, both markets were profitable clubs for a few intermediaries in Bombay, and were ridden with corrupt and fraudulent market practice. The scam of 1992 helped diminish the prestige of the status quo, and gave reformers in government the upper hand. The debt market made progress on blocking fraud and improving systemic integrity, but there was no fresh vision on market design. In the case of the equity market, we saw a complete revolution in market design: badla was banned, and NSE was created.

The contrast between the debt and equity markets is now embarassing. The debt market never crosses a thousand trades a day, while NSE has become the fifth largest exchange in the world (measured by trades per day) and is within striking reach of a million trades a day. The debt market languishes as a club of two dozen dealers in one square kilometre of South Bombay. The equity market has lively activity from Kashmir to Kanniyakumari; less than half of NSE's trades come from Bombay.

At first blush, it is glaringly obvious that RBI's vision for market design has been proved inferior when compared with the innovations which have delivered results on the equity market. Many observers are puzzled at RBI's unwillingness to learn from the success of the equity market, and abandon the non--transparent, clubby nature of the bond market. In this article, I will argue that the truth lies in between. There are some aspects where the equity market is clearly the role model for the debt market, and RBI should not hesitate in abandoning its existing vision for market design. At the same time, there are many aspects where RBI's concerns are well founded, where existing market practice on the equity market is dubious, and should not feature in the future of the debt market.

What the equity market does right.

What the equity market does wrong. At the same time, the equity market has certain important weaknesses. They constitute the reforms agenda for the future of the equity market, and they should not be accepted in a new debt market.

There are cultural differences between RBI and SEBI on the whole question of standards for systemic integrity. The equity market seems to lurch from crisis to crisis at the rate of roughly one crisis every two years. The fixed income market was deeply enmeshed in the scam of 1992, but it has a clean record after that for an eight--year period. SEBI would do well to adopt superior standards for the incidence of systemic crises.

In summary, I think that the truth lies somewhere in-between SEBI's notions of market design and RBI's traditional approach of having two dozen dealers in South Bombay. I think that both SEBI and RBI are overly influenced by the market intermediaries that they deal with : RBI worries about the interests of dealers, while SEBI worries about the interests of stock brokers.

RBI has made an important move in announcing that it would move towards order-matching instead of using bilaterally negotiated trades. There is much that the equity market can offer in terms of new dreams for market design for the debt market. At the same time, the equity market suffers from low aspirations on the question of systemic risk, where RBI can usefully apply higher standards, and ask for a cleaner and more robust market.

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