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Exclusive| CBDC settlements will ensure finality, reduce risk in the financial system, says JM Financial's Ajay Manglunia

In the long run, the use of CBDC will create an efficient and cheaper currency management system and would eventually enable real-time, cost-effective and seamless integration of cross-border payment systems, Manglunia said.

November 24, 2022 / 03:00 PM IST
Representative image.

Representative image.

The introduction of a central bank digital currency (CBDC) will create an efficient and cheaper currency management system, said  Ajay Manglunia, managing director and head of investment group at JM Financial, in an interview with Moneycontrol. CBDC settlements will ensure finality and reduce risk in the system, he said.

According to him, the domestic bond market is expected to grow at a stable pace with a positive view as inflationary pressure has eased and the rate hike cycle is closer to an end, and credit growth in the Indian banking sector has been good.

In the past few weeks, yields on government securities have moved in a very narrow range of 7.30-7.40%. Currently, the range is 7.2823%. Edited excerpts from the Thursday, 24 November 24, interview:

Why do you think there is a need for public issuance instead of private placement?

When an issuer goes for private placement of debt, the investor class is restricted to a limited base of investors, mostly institutional, thereby subject to various investment regulations/ restrictions and vagaries of institutional capital markets. In public issue of debt, the issuance is targeted towards individual investors in granular ticket sizes, thereby opening up a major and diversified segment of investors.

This is a win-win for both the issuer and retail investors as by way of the public issue route, this untapped category gets unlocked whereby the issuer can mop up incremental funds, while the retail investor gets options beyond FDs (fixed deposits) and mutual funds. This especially makes sense in the current scenario, wherein the rates on these FDs have not kept pace with rising interest rates.

Though the RBI (Reserve Bank of India) has raised the repo rate by 190 basis points since May, it has not been fully transmitted by banks into lending and deposit rates. Even AAA rated-NCDs (non-convertible debentures) today offer much higher interest rates than prevalent FD rates, making them more attractive for retail People invest in such NCDs at smaller ticket sizes via the public issue route. For an Issuer, it offers diversification, a stable source of funding that is not always subject to market conditions and sometimes quantum and rates which are unavailable in the institutional space.

What is your outlook on the bond market? 

The year-end seems to bring a little bit of calm to the markets with reduced inflation fears and growth worries taking centre stage. We believe the rate hike cycle is closer to the end with probably 25-50bps (basis points) remaining. The recessionary environment is likely to ensure that regulators remain cautious in terms of hawkishness going forward.

As we have seen after every rate hike cycle, the dovishness sets in fast and we believe next fiscal year will be the start of it. Credit growth in recent times has been good domestically and we believe India is in a much-balanced position vis-à-vis the world and we will see stable growth in bond markets going ahead. So, in a nutshell, we have a positive view on domestic bond markets in coming years.

What measures do you expect from the RBI over the next few months to deepen and broaden the bond market?

The relevant regulator for the corporate bond market is SEBI (Securities and Exchange Board of India), and it has done a lot over the years to deepen and broaden the bond market in India, and a lot is in the works as well. Some of the measures which can be looked at are:

- Presence of market makers for issuances above a certain threshold. SEBI has already released a discussion paper on the same. The said regulations are likely to ensure presence of liquidity on both bid and ask side with specialised market makers in place. Bharat Bond ETF (exchange-traded fund) as an example has shown how this solves an issue inherent to bond markets and improves investor comfort.

- The regulators across investor segments have established guidelines towards investment management which encourages higher rates (AA+ and above) papers, thereby ensuring concentration of appetite for -rated papers. This can be replaced by rating category-wise limits, empowering investment managers to take calls across the credit spectrum. This ensures appetite for NCDs across rating categories and associated liquidity in it.

- Add a central liquidity provider as a lender/buyer of last resort under a well-established mechanism to ensure liquidity at the time of liquidity events. This goes a long way in establishing trust and liquidity in the markets, knowing that there is a central agency which can provide liquidity in the hour of need. This is akin to a repo facility and is likely to help more investors who currently stick to higher-rated credits due to a dearth of liquidity in lower-rated scripts to take a call.

What should be investors’ approach towards debt markets given the yields on short bonds are higher than those of a longer tenure?

At this point, the yield curve is flattish and not yet inverted unlike debt markets in advanced economies. As inflation concerns are slowly tapering off, we may see a cooling-off period with little upside on rates. This suggests long-only investors may start building positions in a staggered way as we near the top while the rest may be looking at value in particular tenors in the short end given the next to minimal term premia.

How do you think using CBDC to trade government securities in the secondary market will help traders and investors?

The RBI is working on two fronts to test the CBDC: one for the wholesale market, for which a pilot project is already underway, and the other for retail (CBDC-R).

The wholesale use of CBDC right now is more of a test case to see that there are no glitches and check if all the systems are running right in the present simple use case. The underlying bonds are already in the system, what changes is the settlement mechanism where it circumvents the CCIL Clearing Corporation of India Ltd). Once there is enough evidence that the pilot is working as intended, its use case can be expanded. On the retail side, the pilot is expected to be launched soon.

Unlike the existing system of settlement where banks settle trades on a net basis on NDS-OM (a dedicated platform), the CBDC pilot project will enable digital settlement that will happen on T+0 basis against the conventional T+1 . The settlement will be done on a gross billed basis and the balance in CBDC will again be sent to the current account of the bank (for now).

As the settlement is in central bank-backed currency, this ensures finality and reduces risk in the financial system by pre-empting the need for settlement guarantee infrastructure or for collateral to mitigate settlement risk.

In the long run, the use of CBDC will create an efficient and cheaper currency management system and would eventually enable real-time, cost-effective and seamless integration of cross-border payment systems.
Manish M. Suvarna is Senior Correspondent at Moneycontrol. He writes on the Indian money markets.