RBI Breaking The Barriers

In this week's FinMail we are going to explore the huge debt market and look at why retail participation is low. We understand RBI's new step to solve this.

The Story:

Last Friday, 5th Feb 2020, RBI announced its bi-monthly monetary policy and along with that, it announced that it will soon open an easy access door for retail investors to enable their entry into the debt market. In a move that will prove a major structural reform for Indian Financial Markets, RBI announced that it will soon launch a platform, Retail Direct that will allow retail investors to directly open an investment account with the RBI, which will give them direct access to invest in G-Secs or Government Bonds. With this, India will be amongst a few handfuls of countries in the world and the first Asian country that will allow direct retail investor participation in the debt market. RBI announced that it will issue guidelines on the same later on.

Why is this a major reform and why this move is a win-win situation for both investors and the government? We'll discuss it but let's try to measure the depth of the debt market.

How big is the Money Market?

BSE data showed that the daily average Equity Market's volume stood at ₹5,203.16 Crores and on NSE the same stood at ₹72,472 Crores for the month of January 2021.

Seems huge?

Wait till we present you with some money market numbers. The market turnover for the 5th of February is whopping ₹4,39,700.53 Crores!

As Pratik Gandhi in Scam 1992 said, "Share Market Itna Gehra Kuva hai ki pure Desh ki Pyaas bujha sakta hai." But later on, he realizes that the Debt Market is even bigger than Equity Market.

But as much huge as the debt market is, the proportion of retail participation is significantly low. The reason behind this is that the current investment process is too complicated for the investor to understand and even for the dealers (banks or brokers) to facilitate. Another reason is that there is less awareness about bonds and debentures as a Distinct/Direct Investment Option. The only investment options in the debt portion that most of the investors know are Fixed Deposits or Debt Mutual Funds. As a result, only those who know about it and those who know the process sorrounding it currently invests in G-Secs or other bonds.

But how complex the current process is? Let's understand it with an analogy.

The Analogy:

Let's assume that you are a consumer of a particular wafer brand and you only like to eat those wafers and not others. So you being an individual consumer would not have much demand for the wafer packets every day or every week, only a little number of packets 10, 20, or 50.

So if you were to go directly to the wafer manufacturing company to ask for 20 packets, then probably the manufacturer would deny you because you are a single consumer and the manufacturer only deals in boxes of wafer packets. So the manufacturer would ask you to purchase boxes from him rather than just purchasing packets. For you, it would be difficult to buy boxes because you might not be able to consume them all or afford to buy them all at once and hence you only prefer packets. So, for that, you need to go to a retailer because even a wholesaler would not be able to fulfill your little order as they too deal in large orders. So for fulfilling orders of an individual, retail merchants exist. So what does a retailer does is that he places a large order from a wholesaler or from the manufacturer itself and then distributes it in little quantities to an individual consumer.

Similarly, RBI functions as a wholesaler/manufacturer and caters only to the retail merchants like Primary Dealers (Banks & Money Market Brokers).

The Complex Process:

For investing in G-Secs what the retail investor has to do is to approach their bank and request to open an account with them to invest.

On the day of the G-Sec issue, the bank would collect orders from various retail investors and submit one collective bid totaling the amount of the individual orders.

For instance, if Mr. A placed an order for ₹1000, Mrs.B placed for ₹5000, Mr. C for ₹2000 and Ms. D for ₹7000, then the bank would place one bid of ₹15000 and upon allotment to the bank, the bank would distribute it proportionately to the investors in the amount they applied for.

Points to be noted here is that only 5% of the total issue size of G-Secs is reserved for retail investors and that too only for selected securities. Upon oversubscription, the bank would have to make a pro-rata allotment and if the issue was under-subscribed then the balance would be added to the non-retail quota. If you did not understand the process, this could also be the reason why RBI had to step in to create a separate platform because of the current complications.

Plus Points:

This move seems as a major structural reform and it definitely can be if executed right. India will only be one of the very few countries that will allow direct retail participation in government securities. The advantages of this platform are covered below.

Advantage For the Government and the RBI:

With the launch of this platform, the government will have access to a money tap that might provide infinite money supply whenever needed. Because G-Secs are the most secured investment option, hardly anyone avoids them. It is because the securities are backed by the government and thus carry no default risk and also no credit risk and hence are preferred by all types of Investors. And launching this platform will ease up the investment process for retail investors. This will broaden up the base of investors who invest in G-Secs and thus more money for the government.

RBI is called 'The Debt Manager of the Government' and this platform will also ease up the compliance for the RBI as the funds will become more accessible. The platform will be a huge support as the government plans to raise ₹12 lakh crores next financial year from the markets as announced in the budget. This will help to finance the deficit of 6.5% of the GDP that the government expects.

Advantage for the investors:

For the investors, as mentioned it will be very much useful because it will open up a new Investment Avenue in which retail investors can easily invest. It could emerge as the most preferred investment option for retirees to park their retirement funds. With the Investing process for Mutual Funds and Equity Shares getting quick and hassle-free, it was high time that something similar was available for the debt side of the Investment. And RBI just did that. Let us hope RBI does it quickly and does it the way that Investors rejoice it.

So that is it for this week's FinMail, keep hoping and keep learning. We will see you next week.