4 India1

International Monetary Fund
Published Date:
August 2003
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India operates under a fiscal regime, with the Constitution of India specifying the fiscal responsibilities for the central and the state governments through the three lists: the Union List, the State List, and the Concurrent List. According to current budgetary practice, there are three sets of liabilities of the government that constitute public debt: internal debt, external debt, and “other liabilities.”

Total outstanding liabilities of the central government as a proportion of GDP reached the peak level of 65.4 percent at the end of March 1992, after which it recorded a significant consolidation over the first half of the 1990s and declined to 56.4 percent by the end of March 1997 (see Table A.1 in the Appendix). In the next period, however, it showed an increasing trend, reaching 65.3 percent of GDP by the end of March 2002 and is projected to be around 67 percent by the end of March 2003.

As in the case of the central government, the debt-GDP ratio of state governments first recorded an improvement, falling from 19.4 percent at the end of March 1991 to 17.8 percent by the end of March 1997; later, the ratio increased significantly, reaching 24.1 percent by the end of March 2001 (see Table A.2 in the Appendix) in the revised estimates. According to the budget estimates of the state governments, the debt-GDP ratio was estimated to be 23.9 percent at the end of March 2002. Concomitantly, the interest payments–GDP ratio of the states increased from 1.5 percent in 1990–91 to a budgeted level of 2.6 percent in 2001–02.

The combined central and state governments liabilities had similar trends and stood at 72.9 percent of GDP at the end of March 2001 (see Table A.2 in the Appendix) and were estimated to be about 76 percent at the end of March 2002, significantly higher than 63.5 percent at the end of March 1997. The sharp increase in the debt-GDP ratio in 2001–02 is mainly attributable to the increase in the total liabilities of the central government. The continuing high level of public debt leads to increasing interest payments, which in turn necessitate higher market borrowings and put pressure on the fiscal deficit.

Until the early 1990s, India used a development strategy based on its predominant role in the public sector. Large statutory preempts and borrowing from the Reserve Bank of India (RBI), the central bank of the country, provided the government the ability to finance the large fiscal deficits. Lower administered yields on government securities coupled with high cash and liquidity reserve requirements resulted in a repressed financial system with very little scope for active debt management.

Reorientation of the debt management strategy began under the overall process of financial sector reforms that were started in the early 1990s. The authorities preferred a gradual approach for this purpose, wherein sequencing the policy initiatives was given the utmost importance.

The first initiative in the reforms process was to allow market-determined rates in the primary issuance market for government securities through auctions (1992). To compensate to some extent for the escalation in the cost of borrowing, and in view of the market preference under the new regime as well as the expectation that interest rates would experience downward trends over the years, the maturity profile of the debt issuance was shortened. The tenor of new loans issued during the next few years after moving toward price discovery mechanism was restricted to 10 years. The move was also prompted by the recommendations of the Committee to Review the Working of the Monetary System. This was followed by a stoppage of automatic monetization of the fiscal deficit and gradual withdrawal of the central bank’s support to finance the government budget at subsidized rates.

The role of net market borrowing in financing gross fiscal deficit gradually increased from 21 percent in 1991–92 to 66.2 percent at present. This has happened even while statutory preempts were being reduced. Reserve requirements were brought down. The statutory liquidity ratio (SLR), which requires banks to invest a certain percentage of their liabilities in government securities, was brought down from a peak of 38.5 percent in 1990 to 25 percent in 1997. (At present, the SLR continues to be at 25 percent, which is the statutory minimum.) The cash reserve ratio (CRR), which requires banks to keep a certain proportion of their liabilities in the form of cash with the RBI, was also brought down from a high of 25 percent in 1992 (including the CRR on incremental liabilities) to 5 percent in June 2002.

Debt management strategy began to focus, on the one hand, on the interest rate and refinancing risks inherent in managing public debt and, on the other hand, on monetary policy objectives so that the debt management policy would be consistent with the objectives of the monetary policy. This strategy, in turn, required the authorities to develop the institutional, infrastructure, legal, and regulatory framework for the government securities market.

Developing a Sound Governance and Institutional Framework


The objective of the debt management policy has changed over the years. It first focused on minimizing the cost of borrowing, but now the objective is minimizing the cost of borrowing over the long run, taking into account the risk involved, and ensuring that debt management policy is consistent with monetary policy.


Under the current Indian budgetary classifications, three sets of liabilities constitute central government debt: internal debt, external debt, and “other liabilities.”

Internal debt and external debt constitute the public debt of India and are secured under the Consolidated Fund of India, as reported under “Consolidated Fund of India—Capital Account” in the Annual Financial Statement of the Union Budget. Article 292 of the Indian Constitution provides for placing a limit on public debt secured under the Consolidated Fund of India but precludes “other liabilities” under the Public Account There is also a similar provision in Article 293 with respect to borrowings by the states, wherein the state legislature has the power to set limits on state borrowings upon the security of the Consolidated Fund of the state. However, a state’s power to borrow is limited to internal debt, and a state is required to obtain prior consent of the government of India as long as the state has outstanding loans made by the government of India.

Internal debt includes market loans; special securities issued to the RBI; compensation and other bonds; treasury bills issued to the RBI, state governments, commercial banks, and other parties; as well as nonnegotiable and non-interest-bearing rupee securities issued to internal financial institutions. The internal debt is classified into market loans, other long- and medium-term borrowing, and short-term borrowing and is shown in the receipt budget of the union government. External debt represents loans received from foreign governments and bodies. The liabilities other than internal and external debts include other interest-bearing obligations of the government, such as post office savings deposits, deposits under small savings schemes, loans raised through post office cash certificates, provident funds, interest-bearing reserve funds of departments such as railways and telecommunications, and certain other deposits.

The “other liabilities” of the government arise in the government’s accounts more in its capacity as a banker than as a borrower. Hence, such borrowings, not secured under the Consolidated Fund of India, are shown as part of the Public Account. Furthermore, some of the items of other liabilities, such as small savings, are more in the nature of autonomous flows, which to a large extent are determined by public preference and the relative attractiveness of these instruments. Nevertheless, it should be emphasized that all liabilities are obligations of the government.

Provisional Actual Budget data for the year 2001–02 show that the gross fiscal deficit of the central government at 6 percent of GDP was financed by domestic market borrowings to the extent of 69.4 percent and through other liabilities to the extent of 26.1 percent. External financing accounted for only 1.6 percent of the gross fiscal deficit. According to budget estimates for 2002–03, the gross fiscal deficit of the central government is targeted at 5.3 percent of GDP and is to be financed by domestic market borrowings to the extent of 70.7 percent and by other liabilities to the extent of 28.7 percent; external financing would contribute only 0.6 percent.

Coordination with monetary and fiscal policies

The RBI acts as the government’s debt manager for marketable internal debt. Because the RBI is also responsible for monetary management, there is a need for coordination between the monetary and debt management policies, especially in view of the large market borrowing program to be completed at market-related rates. At the time the budget is prepared, there are consultations between the government of India and the RBI on the overall magnitude of the market borrowing program of the central government and the aggregate market borrowings of all the states.

The coordination among debt management and fiscal and monetary policies is achieved through

  • the Financial Markets Committee (FMC) within the RBI (the heads of departments responsible for debt management, monetary policy, and foreign exchange reserves management), which meets daily to assess the markets, liquidity, and other financial considerations that might arise;
  • involvement of the debt management functionaries in the monetary policy strategy meeting, which is held at least once a month;
  • the Standing Committee on Cash and Debt Management (with representatives from the RBI responsible for debt management and operations as banker to the government and the ministry of finance (MoF), which meets once a month; and
  • the annual pre-budget exercise of dovetailing the monetary budget with government finances, including the finances of subnational governments.

During the first stages of market development, especially for countries such as India with large net market borrowing (3 to 4 percent of GDP in the recent period), having the central bank responsible for both debt management and monetary management has the advantage of appropriate policy coordination. During this early period, however, as the markets develop, the economy opens up for capital flows and the private sector starts contributing more to the economic activity, and there is a need for independent monetary management and separation of the debt management function from the central bank. Under the Fiscal Responsibility and Budget Management Bill (currently before parliament) and as a first step toward separation of debt management from monetary management, it is proposed that within three years, RBI participation in the primary market for government securities will be eliminated.

The approach of separation of the debt management function from the central bank has in principle been accepted. However, separation of the two functions would be dependent on the fulfillment of three preconditions: reasonable control over the fiscal deficit, development of financial markets, and necessary legislative changes. The actual separation of debt management functions would depend on the extent and speed with which the fiscal deficit can be brought down. The large borrowing requirements of the government and the need to minimize the impact of such borrowing requirements on interest rates has necessitated private placements of securities with the RBI from time to time or participation in the primary issuance market as a noncompetitive bidder with the later sale of such securities to the market as conditions improve. Elimination of RBI participation in the primary market is perceived as the first step in separating the function of debt management from monetary management. A lower fiscal deficit is thus envisaged as a required precondition for ensuring that the government borrowings are not disrupting the financial markets and enabling a smooth transition to the separation of the debt management function. In the development and integration of the financial markets, significant progress has been made with the introduction of new instruments and participants, strengthening of the institutional infrastructure, and greater clarity in the regulatory structure. On the legislative front, two important changes are (a) the proposed amendment in the RBI Act of 1934 to take away the mandatory nature of public debt management by the RBI, vesting the discretion with the central government to undertake the management either by itself or to assign it to some other independent body; and (b) the proposed Fiscal Responsibility and Budget Management Bill, which is expected to rein in the fiscal deficit.

Legal framework

The Constitution of India gives the executive branch the power to borrow upon the security of the Consolidated Fund of India, or that of the respective state, within such limits, if any, as may from time to time be fixed by law by parliament or the respective state legislature.

Although parliament or the state legislature gives the authority to borrow by approving the budget, the RBI as an agent of the government (both union and the states) implements the borrowing program.

The RBI draws the necessary statutory powers for debt management from the RBI Act of 1934. The management of the union government’s public debt is an obligation of the RBI, but the RBI undertakes the management of the public debts of the various state governments by agreement.

The procedural aspects in debt management operations are governed by the Public Debt Act of 1944 and the Public Debt Rules framed hereunder. Considering the technological changes and other developments taking place in the government securities market, the authorities are interested in replacing the 1944 act with an updated proposed Government Securities Act.

Amendments to the RBI Act have been proposed to remove the mandatory nature of public debt management by the RBI and allow the government to entrust the public debt management function to any agent. This would remove a legal hurdle for separation of debt management functions from the RBI.

Organizational structure

All debt management functions for marketable internal debt are currently undertaken in the RBI, albeit in different departments. The middle office functions relating to decisions on the maturity profile and timing of issuance are undertaken in consultation with the MoF.

As regards management of the external debt, several territorial divisions in the Department of Economic Affairs of the MoF, such as the IMF-World Bank Division, the European Central Bank (ECB) Division, ADB Division, EEC Division, and Japan Division, in addition to the RBI, act as the front offices. The External Debt Management Unit of the MoF acts as the middle office, and the Office of the Controller of Aid Accounts and Audit of the MoF acts as the back office.

The RBI is vested with the powers of managing government debt, of both the union and the state governments, under the provisions of the RBI Act of 1934. Management of debt of the union statutorily devolves upon the RBI, but management of the debt of the states has been undertaken by the RBI through mutual agreements between the central bank and the respective states. Thus, the RBI is responsible for managing the market borrowing program of the union and state governments.

Within the RBI, the Internal Debt Management Unit performs the debt management function. The main functions comprise formulation of a core calendar for primary issuance, deciding the desired maturity profile of the debt, designing the instruments and methods of raising resources, deciding the size and timing of issuance, and other critical decisions, taking into account the government’s needs, market conditions, and preferences of various segments while ensuring that the entire strategy is consistent with the overall monetary policy objectives. The Unit also conducts auctions.

The actual receipt of bids and settlement functions are undertaken at various offices of the RBI. Various public debt offices also manage the registry and depository functions and keep securities accounts, including the book entry form of ownership. The central accounts are maintained by the Department of Government and Bank Accounts.

Decisions on the implementation of the borrowing program, based on proposals made by the Unit and market preference, are periodically made by the Standing Committee on Cash and Debt Management, made up of MoF and RBI officials. This represents a formal working relationship between the MoF and the RBI, and it is complemented by regular discussions between the ministry’s Budget and Expenditure Divisions and the RBI.

Another standing committee is the Technical Advisory Committee on Money and Government Securities Market, which advises the RBI on development and regulation of the government securities market. This committee is made up of eminent people from the financial sector, representatives of market associations such as the Primary Dealers Association of India, the Fixed Income Money Markets and Derivatives Association of India, mutual funds, academia, and the government.

The operations of the debt management functions are subject to the statutory audit that takes place at the RBI, which covers all the functions of the RBI. The concerned departments within the RBI are also subjected to internal audit, including management audit and concurrent audit. Separate financial accounts of the debt management operations at the RBI are not prepared, hence there is no scope for subjecting these operations to a formal audit. However, although accounting for the debt management operations is done by the government’s Controller General of Accounts, the accounts are subject to the audit by the Comptroller and Auditor General of Accounts, a constitutional body.

The internal debt management functions are reported in the Annual Report of the RBI, which is a statutory report and is placed before parliament, and the external debt management functions are reported in the Annual Status Report on External Debt presented to parliament by the minister of finance.

Risk Management Framework and Debt Management Strategy

Risk management framework

In view of the large fiscal deficits of the central government—in the range of 5-7 percent of GDP in the 1990s—there is a need to ensure a long-term stable environment for facilitating economic growth with price stability. As regards management of external debt, the Indian government has adopted a cautious and step-by-step approach toward capital account convertibility. It has initially liberalized non-debt-creating financial flows followed by liberalization of long-term debt flows. There is partial liberalization of external commercial borrowing, but only for the medium-term and long-term maturities. There is tight control on short-term external debt and a close watch on the size of the current account deficit. In fact, the government of India does not borrow from external commercial sources, and there is no short-term external debt on the government account. There is a high share of concessional debt, amounting to nearly 80 percent of sovereign external debt at the end of March 2002. The maturity of government debt is also concentrated toward the long end for the debt portfolio.

These policies have paid dividends. Capital account restrictions for residents and modest short-term liabilities helped India to protect itself during the East Asian economic crisis from 1997 to 2000. There has been significant improvement of external debt indicators over the years. The World Bank’s Global Development Finance now classifies India as a low-indebted country. The incidence of external debt burden, as measured by debt-to-GDP ratio, was reduced to 20 percent at the end of December 2001, from the peak level of 38.7 percent at the end of March 1992. Similarly, the burden of debt service as a proportion of gross current receipts on external account declined from a peak of 35.3 percent in 1990–91 to 16.3 percent in 2000–01. With the steady contraction in the stock of short-term debt, the ratio of short-term to total external debt declined from a peak of 10.2 percent at the end of March 1991 to 3.4 percent at the end of March 2001. At the same time, with a substantial increase in foreign exchange reserves, short-term debt as a proportion of foreign exchange assets declined from a high of 382 percent to 8.8 percent.

As regards internal debt, there is a natural incentive to focus on long-term sustainability of interest rates, keeping in view the fiscal scenario and other macroeconomic developments, while planning the maturity pattern of debt and the component of fixed-and floating-rate and external debt. There has been a conscious attempt to avoid issuance of floating-rate and short-term debt and foreign currency–denominated debt.

During the early years of the move to market-determined rates, keeping in sight the investors’ preference, the average maturity of new debt (issued during a year) was between 5.5 and 7.7 years during the period 1992–93 to 1998–99. As inflationary conditions receded and markets developed, keeping in view the redemption pattern of existing debt stock, the need to smooth the maturity pattern of the debt stock, and the need to minimize the refinancing risk, debt management policy has consciously attempted to extend the maturity pattern of the debt. Thus, the average maturity of new debt issued after 1998–99 (issued during a year) was above 10 years, and for the year ending December 2001, the average maturity of loans issued during the year stood at about 14 years. The average maturity of the total debt stock, which was about 6 years in March 1998, stood at about 8.20 years at the end of December 2001.

The trade-off between market timing (which involves carrying cost) and the just-in-time pattern (which involves the risk of uncertain markets) is taken into account while tapping the market. Within the year, to ensure that the markets do not become volatile as a result of the large volume of borrowings made by the government or uncertainties in the foreign exchange markets, the RBI at times subscribes to the primary issuances through private placements of debt with itself. These are later sold in the secondary market when liquidity conditions ease and uncertainty diminishes. To minimize the risk arising from occasional RBI participation in primary auctions, which results in an increase in reserve money, the RBI undertakes active open market operations adjusted to the needs of liquidity in the system using domestic and external operations.

However, the major risk in debt management is the size of the debt itself and the pressures of servicing the debt. Hence, as part of its advisory role and as debt manager, the RBI has been urging the government of India to enforce a ceiling on overall debt. It has also provided the technical inputs in formulating the Fiscal Responsibility and Budget Management Bill to ensure that the country’s vulnerability is minimized. Currently before parliament, the Fiscal Responsibility and Budget Management Bill envisages targeted reduction in the fiscal deficit, especially revenue deficit and total debt as a share of GDP, as well as elimination of RBI participation in the primary issuance of debt.


Given the size of the market borrowing program of the union and the states, the approach to risk management has been one of minimizing the cost of raising debt subject to refinancing risk. Thus, the decisions on composition and maturity of debt reflect a risk-averse preference in the context of the prevailing fiscal deficit and likely fiscal deficits in the future. It comprises three tenets:

  • minimizing refinancing risk,
  • minimizing external debt, and
  • minimizing floating-rate debt.

Simultaneously, the focus has been on ensuring that the interest rates are sustainable over time.

As regards external debt, the focus has been on relatively concessional loans and highest maturity. Recently, the government of India also adopted the policy of prepaying a part of the debt taken from multilateral institutions and other countries. In some cases, maturity and interest rates of these expensive loans have been restructured by the lending institutions or countries.

Avoiding external sovereign debt and floating-rate debt has considerably reduced the country’s vulnerability. According to the revised estimates for 2001–02, internal debt constituted about 61 percent of the total liabilities, and other internal liabilities constituted 24 percent of total outstanding liabilities of the central government (see Table A.2 in the Appendix). External debt (at current exchange rates), which consists mostly of debt to multilateral institutions and other countries, constituted about 15 percent of the total liabilities. The nonmarketable debt, including mainly the small savings mobilizations, is managed by the government. The refinancing risk is very well recognized. The debt management policy focuses on managing the maturity profile of the debt and deciding on the share of 364-day treasury bills in the total borrowing program as well as the share of floating-rate debt.

The process of debt consolidation—involving the reopening and reissuance of existing stock—has helped in more or less containing the number of bonds to the prevailing level at the end of 1999 (fiscal year). The results of the process of consolidation may be gauged from the fact that of the 110 outstanding loans,2 43 loans (39 percent) account for 77 percent of the marketable debt stock. However, in view of the large and growing net borrowings by the government, there has been a need to extend the maturity profile of government debt to minimize the refinancing risk. The loans maturing within the next 5 years account for 31 percent of the total debt stock,3 another 37 percent of the loans mature between the sixth and tenth year. Thus, about 32 percent of the loans mature after 10 years. The weighted average maturity of the debt stock was about 8.20 years as of the end of 2001, compared with about 6 years as of March 31, 1998.

Reopenings through price-based auctions (as opposed to earlier yield-based auctions) began in 1999 and have greatly improved market liquidity and helped the emergence of benchmark securities in the market. In addition, such reopenings also have helped the price discovery process, acting as a proxy for the when-issued market.

Callbacks of numerous existing loans in exchange for a few benchmark stocks have not been considered worthwhile because of administrative, cost, and legal considerations. In the absence of budget surpluses and a call provision for existing stocks, this form of active consolidation would be difficult to achieve.

However, during 2001–02, the government had prepaid a part of expensive external debt from multilateral institutions and restructured some costly external debt from other countries. The government has also allowed selected public sector enterprises to prepay a part of their expensive external debt, which was guaranteed by the government. These policies have helped to reduce sovereign external debt, as well as contingent liabilities of the government, to some extent.

Cash management

In a landmark development in 1994, the government of India entered into an agreement with the RBI to phase out the system of automatic monetization of budget deficits within three years. Accordingly, the system of financing the government through creation of ad hoc treasury bills was abolished effective April 1, 1997. Under a new arrangement, a scheme of ways and means advances (WMAs) was introduced to help the government of India to address the temporary mismatches in its cash flows. According to this scheme, a limit was fixed for WMAs, so that when the government reached 75 percent of the limit, the RBI could enter the market on behalf of the government to raise funds. This arrangement meant that the government has to fund its budget requirements at market-related rates. Keeping in view the trends in the government’s cash flows, the limit for WMAs for the second half of the year is kept lower than that for the first half of the year. The introduction of the WMAs scheme demanded greater skills in active debt management on the part of the RBI. It also brought up the government’s need for efficient cash management. Accordingly, surplus funds, if any, in the government’s account are invested in its own securities available in RBI’s portfolio, thus reducing the net borrowing from the RBI as well as the cost.

The RBI also provides WMAs to the states. The limits are fixed through a formula linked to their revenue receipts and capital expenditure. Once the limits are reached, the accounts go into overdraft, and they are not only limited in size to the WMA bound but also not allowed to continue beyond 12 working days. Beyond this point, payments are stopped on behalf of the respective state government.

Surplus funds of states are invested in special intermediate treasury bills of the central government. Because these instruments can be instantly redis-counted whenever required, the interest rate is fixed at the bank rate minus 1 percent. At the request of the state governments, the RBI also invests their surplus funds in dated securities offered by the government of India from its investment portfolio at prices prevailing in the secondary markets.

Contingent liabilities

Contingent liabilities of the central government arise because of the government’s role in promoting private savings and investment by issuing guarantees. Contingent liabilities of the central government could be both domestic and external contingent liabilities and could also be explicit or implicit in nature. Domestic contingent liabilities of the central government are made up of direct guarantees on domestic debt, recapitalization costs for public sector enterprises, or unfunded pension liabilities. External contingent liabilities are made up of direct guarantees on external debt, exchange rate guarantees on external debt such as Resurgent India Bonds and Indian Millennium Deposits, and counter-guarantees provided to foreign investors participating in infrastructure projects, particularly for electric power. Although from the accounting point of view, contingent liabilities do not form part of the government debt, they could pose severe constraints on the fiscal position of the government in the event of default.

The total outstanding direct credit guarantees issued by the central government on both domestic and external debt remained stable around Rs 1 trillion from the end of March 1994 to the end of March 1999. Domestic guarantees increased modestly during the corresponding period, but there was an absolute decline in the guarantees on external debt. As a proportion of GDP, however, both domestic guarantees and external guarantees registered a decline of 3 percent from 1993 to 1999. Thus, the total guaranteed debt of the central government declined steadily, from 11.8 percent of GDP in 1993–94 to 5.9 percent 1998–99.

In addition, the exchange rate guarantee on external debt has implications for the finances of the central government. For example, for Resurgent India Bonds, according to the agreement, exchange rate loss in excess of 1 percent on the total foreign currency, or the equivalent of US$4.2 billion, would have to be borne by the government of India. The extent of such a loss, since August 1998, when Resurgent India Bonds were first issued, would depend on the exchange rate prevailing at the time of redemption in 2003. A similar exchange rate guarantee was provided on the amount of US$5.5 billion raised through India Millennium Deposits from October to November 2000. Counter-guarantees provided to foreign investors participating in infrastructure projects bring about similar risk for the government exchequer. There is also a growing volume of implicit domestic contingent liabilities in pension funds.

Legal ceilings on government debt and contingent liabilities

Given the legacy of huge public debt and interest burden due to a long history of high fiscal deficits, which has increasingly constrained maneuverability in fiscal management, the central government introduced the Fiscal Responsibility and Budget Management Bill (2000) in parliament. The bill aims at ensuring intergenerational equity in fiscal management and long-term macroeconomic stability. This would be accomplished by achieving sufficient revenue surplus; eliminating fiscal deficit; removing fiscal impediments in the effective conduct of monetary policy and prudential debt management consistent with fiscal sustainability through limits on central government borrowings, debt, and deficits; and establishing greater transparency in fiscal operations. The specific target for debt management in this regard is to ensure that the total liabilities of the central government (including external debt at the current exchange rate) is reduced during the next 10 years and does not exceed 50 percent of GDP. Simultaneously, the central government will not borrow from the RBI in the form of subscription to the primary issues by the RBI.

The bill also attempts to check the contingent liability by restricting guarantees to 0.5 percent of GDP during any financial year. In particular, transparency in budget statements would involve disclosure of contingent liabilities created by way of guarantees, including guarantees to finance exchange risk on any transactions, and all claims and commitments made by the central government that have potential budgetary implications.

Developing the Markets for Government Securities

Need and approach

The development of deep and liquid markets for government securities is of critical importance to the RBI in facilitating price discovery and reducing the cost of government debt. Such markets also enable the effective transmission of monetary policy, facilitate introduction and pricing of hedging products, and serve as a benchmark for other debt instruments. Hence, as the monetary authority, the RBI has a stake in the development of debt markets. Liquid markets imply more transparent and correct valuation of financial assets; they also facilitate better risk management and are therefore extremely useful to the RBI as a regulator of the financial system. As the system integrates with the global markets, it is necessary to ensure low-cost financial intermediation in domestic markets or the intermediation will move offshore. This reinforces the argument for development of domestic debt markets.

Therefore, since the early 1990s, the RBI has been focusing on development of the government securities markets through carefully and cautiously sequenced measures within a clear agenda for primary and secondary market design, development of institutions, enlargement of participants and products, sound trading and settlement practices, dissemination of market information, and prudential guidelines on valuation, accounting, and disclosure.

Primary dealers

In 1996, the structure of primary dealers was adopted for developing both the primary and the secondary markets for government securities in India. The objective of promoting an institutional mechanism for primary dealers is to ensure development of underwriting and market-making capabilities for government securities outside the RBI, so that the latter will gradually shed these functions; the purpose is also to strengthen the infrastructure in the government securities market to make it vibrant, liquid, and broad-based. The intermediate goals include improving the secondary market trading system, which would contribute to price discovery, enhance liquidity and turnover, encourage voluntary holding of government securities among a wider investor base, and make primary dealers an effective conduit for conducting open market operations.

Among their obligations are giving annual bidding commitments to the RBI, to underwrite the primary issuance and offer two-way quotes in select government securities. The annual bidding commitments are determined through negotiations between the RBI and the primary dealers. Serious bidding is ensured through a stipulation of a success ratio (40 percent) linked to the bidding commitments. In return, the dealers are extended a liquidity support by the RBI. This support, which was entirely a standing facility in the initial years (linked to their bidding commitments and secondary market activity with a cap, a certain ratio of their net worth), is being gradually withdrawn. The primary dealers, along with banks, are allowed to participate in the Liquidity Adjustment Facility of the RBI, whereby the RBI operates in the market through repos and reverse repos.

Primary dealers are essentially well-capitalized, nonbanking finance companies, set up as subsidiaries of banks and financial institutions or as corporate entities, and they are predominant players in the government securities market. Currently, 18 primary dealers are authorized by the RBI.

The RBI also envisaged the institutional mechanism of satellite dealers to further the efforts of the primary dealers with a main objective of developing a retail market for government debt. As their name suggests, they were to establish a link with a primary dealer, and thus the RBI did not extend them the same benefits as those extended to primary dealers. This lack of access to the call money market and the impediments in transacting in the repo market (including prohibition of sale of securities purchased under repos and prohibition of short sale) have restricted the operations of the satellite dealers. Thus, the system has never succeeded. Although some of the satellite dealers later became primary dealers, others have been active only as brokers.


Although banks are encouraged to deal directly without involving brokers, they can undertake trades in government securities through the member brokers of the National Stock Exchange, the Bombay Stock Exchange, and the Over-the-Counter Exchange of India. About 35 percent of trades are OTC trades. The remaining trades are negotiated through brokers who are members of the exchanges and are reported on the exchanges. After irregularities in the securities market that involved fraudulent links between the brokers and banks, banks were advised by the RBI not to trade more than 5 percent of their transactions through a single broker.


In the early 1990s, there was experimentation with issuing a variety of instruments, such as zero coupon bonds, stocks for which investors could pay in installments, floating-rate bonds, and capital-indexed bonds, in addition to fixed-rate bonds.

The requirements of the various segments of the market, the need to smooth the redemption pattern across different years, and the need to focus on issuing new securities in key benchmark maturities are all factors that have resulted in issuing relatively longer dated securities in the last few years. To the greatest possible extent, the RBI endeavors to issue securities across the yield curve. Although the extended maturity profile has benefited long-term investors such as insurance companies and pension or provident funds, it has resulted in asset liability mismatches for the banking sector, which continues to be the major final investor in, and holder of, government securities. Recognizing this, the RBI is attempting to develop the separate trading of registered interest and principal of securities (STRIPS) market in government securities. The consultative paper on STRIPS has been placed on the RBI web site for wider consultation.4

Further, to facilitate interest rate risk management, the RBI has reintroduced floating-rate bonds in a modest way (the first issuance of floating-rate bonds was made in 1995). The outstanding floating-rate bonds account for less than 1.5 percent at present. Bonds with callable options have not been experimented with, taking into account the size of the overall debt, new issuance programs, and refinancing risk.

Issuance procedures

Government stock is normally sold through auction. Sometimes it is sold through a tap system with a fixed coupon. The salient features of the issuance procedures have been codified and are placed in the public domain through a government notification called “general notification.” The public is notified of the details of each issuance, generally three to seven days before the flotation or auction.

Issuance of a calendar has to address the trade-off between certainty for the market and flexibility for the issuer in terms of market timing. The uncertain trends in the cash-flow pattern of the government also greatly constrain the publication of the issuance calendar. An indicative calendar for issuance of marketable dated securities by the government of India was introduced in April 2002 for the first half of the fiscal year. It was followed by an announcement of an indicative borrowing calendar for the second half of the year in September 2002. This practice of announcing the calendar twice a year is expected to continue, to enable institutional and retail investors to better plan their investments and provide further transparency and stability in the government securities market. There is already a preannounced issuance calendar for treasury bills auctions.

For the states, the RBI normally prefers a preannounced coupon method, and the yields are fixed about 25 basis points above the rate prevailing in the market for a union government stock of similar maturity.

The auctions of government securities are open for individuals, institutions, pension funds, provident funds, nonresident Indians, overseas corporate bodies, and foreign institutional investors. Individuals and small investors such as provident and pension funds and corporations can also participate in auctions on a noncompetitive basis in certain specific issues of dated government securities and in treasury bill auctions. Noncompetitive bidding has been allowed since January 2002, and up to 5 percent is allocated to noncompetitive bidders at weighted average cutoff rates. Bids are received through banks and primary dealers. A multiple-price auction format has been the predominant method used for the auctions. However, the RBI of late has started using the uniform-price auction method on an experimental basis.

Whenever there is an urgent need for the government to raise resources from the market, and sufficient time is not available to prepare the market for a public issuance, the RBI takes a private placement (at market-related rates based on the secondary market rates) and such acquisitions are off loaded in the secondary market during appropriate market conditions. The tap method is also used when the demand is uncertain and the RBI and the government do not want to take on the uncertainty of auctioning the security. This approach is widely used in the case of state government loans.

Technological development and settlement mechanism

The RBI developed a negotiated dealing system (NDS), which became operational in February 2002. The NDS facilitates electronic bidding in auctions and offers a straight-through settlement, because it connects with the public debt offices and banks’ accounts with the RBI. Banks, primary dealers, and other financial institutions, including mutual funds, can negotiate deals in government securities through this electronic mode on a real-time basis and report all trades to the system for settlement. The details of all trades are transparently available to the market on the NDS. In October 2002, the RBI also began disseminating data on trades in government securities reported on the NDS on a real-time basis through its web site.

The delivery-versus-payment system (DvP), introduced in 1995 for the settlement of transactions in government securities, has greatly mitigated the settlement risk and facilitated growth in the volume of transactions in the secondary market for government securities. Completion of the ongoing projects and launching of the associated functions and products relating to the Clearing Corporation of India Ltd. (CCIL), the NDS, electronic funds transfer, and the Real-time gross settlement (RTGS) system, as well as the proposed Government Securities Act (in lieu of the existing Public Debt Act of 1944), would further augment the efficiency and safety of the government securities market.

A clearing corporation, the CCIL, was introduced simultaneously with the NDS in February 2002. The CCIL acts as a central counter-party in the settlement of outright and repo transactions in government securities. The settlements through the CCIL are guaranteed by the corporation through a settlement guarantee fund within the corporation, which is funded by the members. The establishment of the CCIL is seen as a major step in the development of the government securities market, and the repo market is expected to witness significant growth.

Work on the RTGS system has already begun, and it is expected to bring about further improvement in the payment and settlement system.

Retail market

The RBI has been encouraging wider retail participation in government securities. As part of these efforts, the RBI has been promoting the gilt mutual funds to develop a retail market for government securities. Gilt funds are mutual funds with 100 percent of their investments in government securities; the fund in turn sells its units to investors. The RBI offers a limited liquidity support to the mutual funds in the form of repos to promote an indirect retail market for government securities.

The RBI allows retail participation at the auctions on a noncompetitive basis up to a maximum of 5 percent of the notified amount. Banks and primary dealers operate the scheme.

To bring about efficient and easy retail transactions in government securities, an order-driven, screen-based system is proposed to be implemented through the stock exchanges with adequate safeguards for settlement.

Coordination between public debt management and private sector debt

Together with active debt management of marketable government debt, the RBI has been focusing on the need to rationalize the continuing administered interest rates and tax regime on small savings and contractual savings, such as provident and pension funds, not only to minimize the effective cost of overall debt but also to align the interest rates on these liabilities with market-determined rates. Public financial institutions, or long-term development banking institutions, are the largest issuers of debt in the nongovernmental sector, and guidelines have been issued to them for ensuring that the interest rates on debt they issue do not go beyond certain spreads over government securities of similar tenor. Corporate debt is not governed by the RBI and while communicating to the government of India (MoF) the acceptable level of total market borrowing, the RBI takes into account the needs of the corporate sector that have to be met from both credit market and capital (debt) markets.

Laws and regulations

The existing Public Debt Act of 1944 is expected to be replaced by a new government securities bill. The proposed legislation seeks to streamline and simplify procedures in the handling of public debt of the central and state governments and will reflect the changes in the operating and technological environment.

Under the amendments in March 2000 to the Securities (Contracts) Regulation Act, powers have been clearly delegated to the RBI for regulating the dealings in the government securities market.5

Short selling of securities is not permitted under the current regulatory framework.

Tax treatment

Government securities are not subject to withholding tax. Gains are treated as both income and capital gains, depending on the nature of the transaction, and investors are allowed to pay tax on both a cash and an accrual basis. Such a treatment, however, could cause distortions in the market when the STRIPS market on government securities comes into existence. The Central Board of Direct Taxes has amended the guidelines on tax treatment of zero-coupon bonds or deep discount bonds by requiring that for tax purposes, the mark-to-market gains in the relevant year will be reckoned. The tax incentive on nonmarketable debt, such as small savings, has tended to distort the market for government securities and a committee under the Deputy Governor of RBI recently recommended rationalization of tax treatment on such instruments.

Adherence to CPSS-IOSCO standards

A detailed examination of CPSS-IOSCO standards is being undertaken separately. Nevertheless, the broad adherence to the standards can be described:

  • Presettlement risk: Currently, all trades between direct market participants are confirmed directly between the participants on the same day and are settled either on the same day or on the next day, thereby minimizing presettlement risk. For trades undertaken through members of the exchanges, confirmation is done on T+0, but settlement can be done up to T+5.
  • Settlement risk: All trades undertaken by banks, financial institutions, primary dealers, and mutual funds having “scripless” accounts with the RBI in its Public Debt Office are settled under a gross trade-by-trade DvP system with queuing up to the end of the day, when funds settlement is eventually known. At this time, if there is shortage of securities or funds, trades are considered “failed.” Such failure constituted only around 0.01 percent of the total number of trades in 2001 and about 0.3 percent of the total value of trades in 2001. Both the presettlement and settlement risks were minimized with the setting up of the CCIL and its ability to provide guaranteed settlement by various risk management systems, including the constitution of the settlement guarantee fund.
  • Legal risk: Several of the legal safeguards recommended for securing safe settlement systems—including rights of central counter-parties to the settlement guarantee fund in the event of, for example, insolvency of members—are yet to be put in place. However, pending detailed legislative changes, the legality of various aspects of the settlement process has been achieved through the framing of mutual agreements under contract law and through the use of concepts such as novation for ensuring legality of netting.
Table A.1.Outstanding Liabilities of the Central Government(In Rs 10 million)
YearInternal liabilities(3+4)Internal debtOther internal liabilitiesExternal debtaTotal outstanding liabilities(2+5)External debt adjustedbTotal outstanding liabilities adjustedb (2+7)
2001–02 (RE)1,274,369909,052365,31767,8991,342,268222,7801,497,149
2002–03 (BE)1,444,2481,021,739422,50968,5201,512,768n.a.n.a.
(As percent of GDP)
2001–02 (RE)55.639.715.
2002–03 (BE)56.940.316.62.759.6n.a.n.a.

At historical exchange rate.

Converted at year-end exchange rates.

Source: Indian authorities.

At historical exchange rate.

Converted at year-end exchange rates.

Source: Indian authorities.
Table A.2.Combined Outstanding Liabilities of the Central and State Governments(In Rs 10 million)
Central governmentCombined central and state governments
YearDomesticExternalbTotalState govt. debt DomesticDomesticExternalbTotal
2001–02 (RE)1,274,369222,7801,497,149n.a.n.a.222,780n.a.
2002–03 (BE)1,444,248n.a.n.a.n.a.n.a.n.a.n.a.
(As percent of GDP)
2001–02 (RE)55.69.765.3n.a.n.a.9.7n.a.
2002–03 (BE)56.9n.a.n.a.n.a.n.a.n.a.n.a.

At historical exchange rate.

Converted at year-end exchange rates.

At historical exchange rate.

Converted at year-end exchange rates.


The case study was prepared by Usha Thorat and Charan Singh from the Reserve Bank of India and Tarun Das from the Ministry of Finance.


These results are as of the end of 2001.


These figures also occurred as of the end of 2001.


The Securities and Exchanges Board of India is the capital market regulator. A High-Level Committee on Capital Market coordinates both the regulators.

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