More retail investors in govt bonds: A dream too far

This policy measure was ignored by most analysts and rightly so, given the technicality in the message. However, behind the message lies a long-drawn policy dream of providing retail investors a choice to invest in government bond markets.

All personal finance textbooks or courses mention that investors have two choices to invest their savings in financial markets — equity and bond markets.  The difference between equity and bond markets is based on the classic return as against risk parameters. The equity markets give the benefit of higher returns, but there is high risk, whereas bond markets give the benefit of low risk but that implies low returns. Thus, an investor should balance the risk and return and allocate the savings in both the products. The thumb rule is that one should invest a larger share in equity markets at a young age and then gradually shift investments towards bond markets as one ages.

The problem in this textbook approach is that the financial choice is available only in the case of equity markets. The bond markets are not available to retail investors and is mainly available to institutional investors. Retail investors substitute investments in bond markets with fixed interest rate products such as term deposits, small savings scheme and so on. The exposure to bonds is mainly via mutual funds (MFs), but share of MFs in bond markets is very low and is currently at 0.77 percent. However, none of these interest rate products give the advantage of ready liquidity which is available with bond markets. This large gap makes a case for pushing for retail participation in bonds.

Apart from filling the gap on the personal finance front, policymakers want to push retail participation in bond markets for another reason. One of the biggest success stories of Indian equity markets is the focus on retail investors, which has made the markets broad based and diversified. Governments are also criticised for using institutions as captive source of financing their bonds (deficits) and retail participation will mitigate the criticism.

Taking a cue, the finance ministry and the RBI have taken several measures to encourage retail participation in bond markets. The government bonds are auctioned in primary markets via competitive bidding with institutional investors. In 2001, non-competitive bidding was introduced wherein a percentage of auctioned amount (5 percent) was reserved for investors such as retail participants who cannot compete with their institutional counterparts.

In 2006, the Government Securities Act was passed, which allowed pledging of the government securities for availing loans and gave legal recognition of ownership to holdings in bond accounts. In 2003, the NSE (National Stock Exchange) and the BSE (formerly Bombay Stock Exchange) launched a retail debt segment, but that has not been successful. In 2012, the RBI extended the institutional market (called NDSOM, Negotiated Dealing System-Order Matching) to retail investors via a web-based platform, which allowed participants to participate directly in secondary and primary markets. (For more details on the other initiatives, please read the speech by former Deputy Governor HR Khan in 2013 and this article by Payal Ghosh and Sahana Rajaram of CCIL).

Despite these measures, the retail participation in bond markets has remained non-existent. The policymakers have also tried investor awareness and literacy campaigns, but have not managed to convince the investors to shift to bond markets. However, one might argue that these campaigns have not been as vigorously done as in the case of equity markets.

The policymakers have not given up on this long cherished dream and keep tweaking policy. In the 2019-20 Budget Speech, the Finance Minister Nirmala Sitharaman announced that the depositories of the RBI and the SEBI (Securities and Exchange Board of India) need to be inter-operable “to bring about seamless transfer of treasury bills and government securities”. To simplify, the government bond markets are under the functioning of the RBI and stock exchanges are under the SEBI, which often leads to turf wars between the two regulators. The depositories are organisations where one keeps an account of shareholding or bondholding. Thus, if one has to incentivise retail investors to invest in government bond markets, one has to allow inter-operability in the depositories managed by the two regulatory bodies.

This announcement by the FM in 2019-20 has made the RBI take the first step in February policy as mentioned above. The central bank has decided to link the registry of government securities to Constituent Subsidiary General Ledger (CSGL, which includes retail investors) accounts. In due course, one should expect that depositories of the RBI and SEBI are also interoperable allowing one to trade in government bonds without worrying over who is governing the depository.

To sum up, it has been nearly 20 years since Indian policymakers started to promote retail ownership in bond markets. Despite multiple efforts, this one policy objective has remained elusive. The market participants usually point out that lack of retail participation is hardly unique to India and most countries mainly have institutional bond markets. This makes it even tougher for the policymakers to encourage retail participation in Indian bond market as one sees inertia both at retail and institutional levels.

Amol Agrawal is faculty at Ahmedabad University. Views are personal.