The case of today’s missing bond market


The sleuths are at it again. They are trying to enravel what caused the sudden demise of the corporate bond market and the magic potion to revive it. You hear comments such as ‘We thought we cracked the code this time around. And all of a sudden, it disappeared.’ “It’s all because of ILF&S’. ‘Mutual funds have deserted the bond market. What happened?’ And many more.. But I can just say ‘Elementary, my dear Watson. How do you expect a building to weather all storms if the foundation is weak?’ Yes…unless the risk free curve is robust, liquid and credible with all points of the term structure available for expressing a view, we cannot talk of putting building blocks on it.

When I said this at a meeting, I was told this was blasphemy and we have one of the most liquid and vibrant government securities market. My response was ‘We have the most vibrant and liquid ten-year benchmark and a non-existent market at other points of the curve.’ Sample this: the most liquid ten-year benchmark which was the darling of all market participants till January suddenly becomes a ‘pariah’ with no one wanting to touch it today and it trades 30 bps above the new ten-year benchmark. The new benchmark outstanding is a fraction of the old benchmark bond. I shudder to think where yields could be today if the OMOs did not take place.

Were we like this all these years? Not at all. Even when the term structure was only up to 10 years in the late 1990s, almost all points of the curve traded. You could execute curve views, like sell the 5-year and buy the barbell of 3/ 7 years. You could buy more value in the same tenor by buying a more illiquid security, secure with the feeling that there would be an exit when needed, at a price. A decade ago, the way you expressed a rate cut/ hike view was through the OIS market and volumes in that market dwarfed bond market volumes. Today, the only way to do that is to ‘buy/ sell the benchmark 10 year’. We had a much more liquid cross-currency swap market extending to 10 years with the associated MIFOR swap market to facilitate hedging of non-rupee borrowings.

The quality of bond market today is far inferior, though the actual traded volumes today may be far higher. We had market and economic research detailing trade ideas in bond and swap markets and an active sales and broker network to enable execution. How did we lose our way?

What is today’s cast of characters in the bond market? It is only issuers and investors with economists making a guest appearance around policy/ data release dates. Investors play the important role. They need to price the credit, market and liquidity risk of an issue, buy it and then manage the risk with available tools. They have a much larger vested interest in market development.

Banks are the only all-weather investors and logically should have the most stake in market development. The regulator has taken efforts to make the most tools available but left it banks to carry it further. However, banks have refused to carry this burden. Treasury income is not material in the overall bank earnings and it forms part of ‘noncore income’. This means that the income does not matter and as any bank CEO will tell you ‘The market does not pay for this income, while it will punish you for the loss.’ Now, as for mutual funds, in a benign cycle, they will buy feverishly as inflows gush in and in a tightening cycle, they will head for the exit as investors find other greener pastures.

Look no further than our TV channels to see what makes the equity markets tick. There are trade ideas every minute for investors. Every investment bank has an equity broking business that has research and sales people providing data, analysis and trade ideas to investors. While bond markets don’t need such activity levels, there is a case for a whole of lot of diverse participants (non-institutional intermediaries) who provide trade ideas, liquidity and risk warehousing. It is futile hoping to create a market with only buy and hold investors. A lot of market development in most markets have happened through such intermediaries. The biggest trigger for volume explosion in the domestic government securities market was the introduction of primary dealers. Let’s get a new support cast to scale up the bond markets. Welcome players who create volumes and have diverse investment time horizons. Speculation, leverage and short-term trading are essential components of every vibrant secondary market.