Budget's Market-Maker Proposal for Corporate Bonds: A Liquidity Solution?
The recent budget announcement to introduce market makers in India's corporate bond market has sparked significant discussion. This initiative aims to inject much-needed liquidity and facilitate easier retail access. Market makers, entities that provide buy and sell quotes, play a crucial role in stabilizing markets by holding securities and offering them to buyers, thereby assuming price risk in exchange for regulatory benefits.
Lessons from the Government Securities Market
In the government securities (G-Sec) market, primary dealers perform this function, subscribing to primary issuances and providing secondary market quotes. This system has granted G-Secs a degree of liquidity. However, liquidity is unevenly distributed. With approximately 120 long-term securities totaling around ₹120 trillion in outstanding liabilities, trading is heavily concentrated. Data from the first nine months of 2025-26 reveals that nearly 60% of trading occurred in 10-year bonds, with another 18-20% in 5- and 15-year securities. The remaining bonds saw minimal activity.
Benchmark securities dominate trading volumes, particularly the 5, 10, and 15-year bonds, with the 10-year bond serving as a key reference for yields and global comparisons. Notably, benchmark status shifts annually; for instance, the 2035 bond was replaced by the 2036 bond in 2025-26, leading to reduced trading in the older security. This pattern highlights that even in the G-Sec market, liquidity remains a challenge for non-benchmark bonds, especially as they approach maturity.
Complexities in the Corporate Bond Market
The corporate bond market presents additional hurdles. Unlike G-Secs, which have a single issuer (the Government of India), corporate bonds involve multiple issuers across various companies. AAA-rated bonds, considered safer with lower coupon rates, exhibit yield variations between private firms and public sector entities. This diversity complicates market-making efforts.
Key questions arise: Which securities should market makers focus on? Should selection be based on companies, ratings, tenures, or yields? The Securities and Exchange Board of India (Sebi) has proposed re-issuance of securities to increase floating quantities, but this may not align with issuers' asset-liability management needs. Even with harmonized maturities, market makers must carefully choose which companies to support, adding another layer of complexity.
Challenges with Counter-Parties and Retail Participation
A broader issue involves the nature of debt subscribers. Major players like insurance companies, pension funds, and provident funds are typically 'buy and hold' investors, prioritizing long-term asset-liability matching over trading. Mutual funds may trade occasionally, but portfolio stability concerns can limit activity. Thus, identifying active counter-parties for market makers is critical.
Retail investor participation has been a topic of discussion, but liquidity constraints pose a barrier. Unlike equities, where counter-parties are readily available, corporate bonds lack this ease of trading. Additionally, bond pricing is complex, with yields and prices moving inversely, requiring specialized knowledge. Retail investors may struggle to track portfolio changes, such as a 10-year bond becoming a 9-year instrument over time.
Potential Pathways Forward
One viable approach is to encourage retail investors toward debt mutual funds, where professional managers handle corporate bond investments. This strategy was more popular before tax asymmetries emerged, with debt returns taxed at income-tax slab rates and equity gains at capital-gains rates. Revisiting these tax rules could revitalize interest.
Aligning tax treatment for interest earnings from bank deposits with other investments might also boost financial savings. Such reforms could be considered in future budgets, potentially enhancing market dynamics and investor engagement.
In summary, while the budget's market-maker proposal holds promise for corporate bond liquidity, its success depends on addressing structural impediments, learning from G-Sec market limitations, and implementing supportive tax and regulatory reforms.
