Towards a Unified Market for Trading Gilts in India

A Working Group of the Reserve Bank of India (RBI) under the chairmanship of Dr. R. H. Patil has recommended that Indian government securities should be traded in two separate and segregated markets. Banks and primary dealers are to trade on an anonymous electronic screen based order matching trading system - a monopoly exchange based on the Negotiated Dealing System (NDS) owned by the RBI. Households, pension and provident funds and most other investors are proposed to be relegated to a separate segregated market driven by compulsory market making. The Patil Report also recommends that the RBI should indulge in systematic market manipulation in the NDS to reduce the borrowing cost of the government. This paper argues for a reconsideration of most elements of this design. Government securities are a unique asset class to which all Indians should have non discriminatory access. Segregated markets are unacceptable. Nor are monopolies desirable since intense competition is the principal mechanism for fostering innovation and investor protection. Market manipulation is unacceptable in any financial market even if this manipulation is performed by the state itself. Moreover market manipulation to reduce interest rates would reintroduce financial repression through the back door and would reverse the principal success of the financial sector reforms initiated in 1991. The paper proposes an alternative design for the government securities market and also a new regulatory architecture. Unified markets, non discriminatory access to all classes of investors, intense competition and investor protection are the key elements of the proposed design.