Indian debt markets – father to premature baby named CDS!?

This sure isn’t just going to be boulevard of broken dreams. SEBI/RBI is finally going to introduce credit derivatives in the Indian debt markets (well a circular / draft has been issued to that effect). It is one among several definite steps undertaken by RBI as India moves towards CAC (Capital Account Convertibility). RBI had recently introduced an analogous concept in the lines of MTNs (Medium Term Notes) in the US.

However, one question still needs to be addressed. Are the Indian debt markets broad enough to sustain and develop CDS instruments? The market and liquidity for corporate bonds in India is still very thin. Given the fact that latest fetish for the corporate houses are ECBs (External Commercial Borrowings). This is done by leveraging the low yields in the developed western countries where the yields are low as compared to the Indian scenario of 8%. Than there are the more innovative instruments called FFCBs (Foreign Currency Convertible Bonds). Given the appreciating rupee, FFCBs are also becoming more cost effective and a darling of India Inc.

RBI still needs to stimulate the corporate debt market before CDS can be successful in India. Till than CDS will be like premature baby in the Indian capital markets.

How can this be done?
- Encourage borrowings from domestic markets – this will also mope up the intemperance liquidity from the system – reduce strain on RBI (Buying $ leads to increase in money supply – RBI than issues MSS to mope up excess rupee in the system – now given the limit on MSS at 100,000 crores and 3000 crores for reverse repo RBI will be forced to use unproductive measures like the CRR)
- FFCBs and ECBs should be used only for foreign exposures and global M&A activities (thwart excess $ getting into Indian markets – prevent rupee appreciation and maintain it at a more manageable levels)

There are two pronged benefits of these. First, it is a positive step towards developing the debt markets. And the second, it also addresses the current tribulations of excess dollars flowing into the Indian economy and fueling rupee appreciation and inflation (which currently is under control – not likely to sustain if the inflow of dollar continues).

After all the hooplas of the equity markets, this sure is going to be the next big thing to watch out for. Till than its wait and watch for the Indian investors in the bond markets. As the old saying goes: ‘sometimes it takes time for all the good things to come –‘

Note – CDS instruments do exist on Indian bonds issued by corporates like Reliance, TATA etc. however, they are issued on dollar denominated bonds issued in the global markets.