While making investment decisions, with a view to optimise total gains, it is common among seasoned investors to prioritise analyses pertaining to the corporations or firms they're planning to bank upon. Indeed, this practice is vital and should be encouraged, but true financial wisdom lies in not hyper focusing on this aspect alone. While it is important to track these particulars, it is equally crucial to keep a tab on policy changes and regulations that inform the said changes to a reasonable extent. The importance of doing so is further underlined when the products in question are market-linked. In India, major policy changes affiliated with macro-economic stability are facilitated by the Reserve Bank of India (RBI).
As a bond investor, how important is it to comprehend the rules and regulations proposed by the RBI? To what extent do they impact the bond market?
Regulatory Answers To Issues Plaguing The Indian Bond Market
Unlike how many understand this subject, the purpose of market regulations is not to hamper growth or individual returns, but to maintain market stability. Thus, the RBI’s core intention pertains to intervening positively for the greater good of the investors and the wider economy at large.
Keeping this in mind, it is worthwhile to explore the challenges that are prevalent in the Indian bond market and to know how policy changes by the RBI affect them.
Dealing with Liquidity
In the context of every category of products that are market-linked, liquidity management never ceases to be a core concern. In accordance with the demands of the situation, the RBI steps in with a status-quoist mindset to prevent a liquidity crisis. For instance, it conducts Open Market Operations (OMO) with a view to keep bond yields in check, thereby also ensuring that bond prices are not reasonably affected. To be precise, OMO refers to the process of the RBI actively buying government bonds and securities from banks and investors to prevent a demand-supply mismatch. As a result, in simple words, an increase in buying interest with respect to bond products allows investors to realise their investments at a premium.
In the process, investors and organisations are further incentivized to favourably engage in the bond market and the yields are kept in check, thereby lowering the sovereign's cost of borrowing funds through the bond market.
Managing Interest Rates
The state of debt supply, policy changes in the international arena, fluctuations in the indexes of influential asset classes and changes in prices of oil - both individually and in confluence with other changes - impact bond interest rates, thereby increasing the cost of borrowing funds for the government and for corporations. To ameliorate this situation, the RBI intervenes through a number of policy changes, including adjusting the repo rate - the interest rate at which banks borrow funds from RBI.
For instance, in a rising interest rate environment, a decreased repo rate allows the interest rates to get lowered, thereby keeping bond yields from rising above and bond prices from falling below the ideal range.
Besides this, the RBI also allows banks to avoid Market-To-Market Provisioning (MTM), wherein banks are obligated to record gains and losses pertaining to changes in bond prices even before realising the same, through the influx of Held-To-Maturity (HTM) bonds. The latter allows the bank to take into account the original purchase prices of the concerned bonds, as opposed to the current market prices, thereby limiting the uncertainty associated with dealing in bonds.
Enabling Market Access
While the bond market has grown tremendously over the last 3 decades, the larger share of investors remain insulated from access to these markets for several reasons. In the recent past, the RBI has attempted to enhance the situation by introducing the Retail Direct Scheme, to encourage direct investment in bond markets. While it is known that investors deal in bonds indirectly through mutual fund managers, insurance-based investments and the like, the said move was aimed at publicizing the possibility of directly investing in bonds.
Conclusion
Having said all of the above, it is also important to admit that, despite genuine attempts, regulatory gaps persist.
For instance, the access to corporate bonds are open to investment overwhelmingly only for select firms and organizations. Thus, the said market remains untapped for want of easy access. However, since these are essentially not government firms, opening up access to the same would require a much more robust infrastructure to scrutinize the credit worthiness of the private corporations in question. Thus, while the move is attached to the possibility of growth, it is also prone to several risks and challenges - precisely why the regulatory gap prevails.
All said and done, however, it must be acknowledged that the RBI’s decisions pertaining to the bond market harbor the potential to impact bond prices and yields. And for this precise reason, among others, the ideal investor must comprehend the vitality of RBI’s role and the wisdom in following what it does.
Disclaimer: The contents of this article should not be construed as tax or financial advice. Readers should seek advice from their tax or financial advisor before making any investment decision.