Government securities market
Introduction
The government securities market is at the core of financial markets in most countries. It deals with tradable debt instruments issued by the Government for meeting its financing requirements. The development of the primary segment of this market enables the managers of public debt to raise resources from the market in a cost effective manner with due recognition to associated risks. The evolution of the government securities market in India has been in line with the developments in other countries. Slow development of the market in the 1970s and the 1980s was shaped by the need to meet the growing financing requirements of the Government. This essentially resulted in financial repression as progressively higher statutory requirements were stipulated, mandating banks to invest in government securities at administered interest rates. The main Govt. securities markets are Primary Market & Secondary Market
Government security
A Government security is a tradable security issued by the Central Government or the State Governments, acknowledging the Government’s debt obligation. Such securities can be short term (usually called Treasury Bills, with original maturities of less than 1 year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both Treasury Bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). Government securities carry practically no risk of default and, hence, are called risk-free instruments. Government of India also issue savings instruments (Savings Bonds, National Saving Certificates (NSCs), etc.) or special securities (Oil bonds, FCI bonds, fertilizer bonds, power bonds, etc.) but they are usually not fully tradable and are not eligible for meeting the SLR requirement.
Significance of the Government Securities Market
The need to develop the government securities market emerges from the three roles it seeks to play, i.e., for the financial markets, for the Government and for the central bank (Reddy, 2002). As alluded to earlier, the government securities market serves as the backbone of fixed income markets through the creation of risk-free benchmarks of a sovereign borrower. Ipso facto, it acts as a channel of integration of various segments of the financial market. The government securities market constitutes a key segment of the financial market, offering virtually credit risk-free highly liquid financial instruments, which market participants are more willing to transact and take positions. The willingness of market participants to transact in government securities, in turn, imparts liquidity to these instruments, which benefits all segments of the financial market. Consequently, government securities are used by dealers as a major hedging tool for interest rate risk and as underlying assets and collateral for related markets, such as repo, futures and options (BIS,1999). Furthermore, large borrowings by the Government also provide an impetus to the development of the bond market.
Primary Market
The issuance of government securities in countries, which are in the early stages of market development, is normally undertaken by way of discretionary non-market placement such as underwriting by a syndicate of financial institutions. In the primary market, a price discovery mechanism was activated by introducing an auction system. Efforts were also made to broaden the investor base and promote voluntary subscriptions in government securities. To provide a wider menu, new instruments were introduced from time to time to suit the investor requirements. Auctions of government securities between 1992-93 and 1998-99 were conducted solely on the basis of yield (coupon). In order to consolidate outstanding loans for ensuring sufficient volumes and liquidity in any one issue, price-based auctions were introduced in May 1999, whereby new loans are raised through re-issuances of existing securities with predetermined coupons. This helps the price discovery of a security already in existence in the market. Yield based auctions are, thus, employed in respect of new issuances, and price-based auctions in respect of reissue of existing securities.
Secondary Market
The secondary market for government securities provides a platform for original investors to trade their holdings before maturity. Traditionally, the trading platform was over-the-counter (OTC) before introduction of trading in stock exchanges in various countries. For instance, in China, trading in treasury bonds was banned till 1980. Subsequently, an OTC trading was initiated. Trading at the Shanghai Stock Exchange commenced in 1992. The development of primary market for government securities with diversified investor base also hinges upon the existence of a well-developed secondary market. This, in turn, requires participants with varied liquidity requirements and differing perceptions regarding the future movement of interest rates. A deep and liquid market is efficient and less volatile. Hence, the Reserve Bank has been taking parallel measures to develop the secondary segment of government securities as well.
Conclusion
The government securities markets have gained importance in most countries in the overall financial system in recent years. Initiatives have been taken to make them more vibrant and active by improving liquidity and depth; enhancing transparency of primary issuances; widening investor base; fine-tuning auction procedures; benchmarking and consolidating across key maturities; developing new instruments; and putting in place appropriate safeguards and sound trading and settlement infrastructure. Furthermore, managers of public debt across countries are paying greater attention to minimizing the cost of borrowings in the medium to long-term, while striking a balance between the costs and the risks in the short run. The government securities market in India has evolved over the years. Several measures have been initiated since the early 1990s to develop a deep and liquid government securities market for reducing the cost of government market borrowings, providing appropriate benchmarks for pricing other financial instruments and conducting monetary policy in a flexible manner. While significant progress has been made in this direction, the evolving economic conditions and the move towards fuller capital account convertibility necessitate further fine-tuning of the operating framework so as to ensure smooth debt management operations.
