The structure of the financial system in the country is required to reflect the development of the real economy. India has developed as a rich-poor country and our financial system is required to have the sophistication of developed markets coupled with base banking to meet the needs of small businesses, farmers, individuals, etc. Pending the development of debt markets, the banking system is being asked to fulfill the job of debt markets and the government’s financial inclusion agenda, which is a tall order. In addition, we have developments in regulations, which would compound the issue further.
India will need huge amounts of funds for its development. As the government grapples with the imperatives of bringing public finances under control and of improving execution efficiency, the role of the private sector in this domain is likely to keep growing. The Twelfth Five Year Plan put in place by the government envisages $1 trillion worth of infrastructure investments over the period 2012-2017. Of this, $500 billion or 50% is expected to come from the private sector—a significant jump from the average private sector participation rate of 25-30% during the Eleventh Five Year Plan period. Of the $500 billion worth of private sector investment towards infrastructure, $350 billion is projected to be funded through debt.
Where does the private sector raise this debt from? Infrastructure projects are long-gestation projects that require long-term funding. This would typically be the domain of the capital markets. Will the domestic private bond market be able to deliver these funds? That seems unlikely. At a mere 5% of GDP, the market for non-government bonds in India remains underdeveloped despite more than a decade of effort. This compares with a corporate bond market size of 16% of GDP for China and 19% for Brazil.
Could this change? Given the experience of the past decade, it would be optimistic to expect a dramatic turnaround in the debt market’s fortunes going forward. The reasons for the stagnation in the bond market are known. Here’s a quick recap of what has held back the development of a debt market.
At the heart of the debt market’s woes lies the government’s large fiscal deficit. The household sector’s savings in financial assets is about 11% of GDP and the corporate sector saves 8% of GDP. The Centre and states combined run a deficit of close to 8% of GDP and finance it largely through bonds and