A committee set up by the Reserve Bank of India has suggested that India should make it easier for foreign investors to own Indian government bonds.
In a draft report released late Thursday, the committee noted that just a few investors hold most Indian government bonds, and many of the bonds are rarely traded in the secondary market. Making it easier for foreigners to own them could improve liquidity.
"There is an urgent need to address the issue of secondary market liquidity in the (government bond) market," the report said.
An illiquid secondary market means that bond investors who may want to sell their holdings may find it hard to get out and have to pay higher prices. Also, bond prices in the secondary market, determined by demand and supply for a particular bond, help determine the price of new bonds to be issued.
To make trading in the secondary market more robust in the government bond market, the RBI report recommended several steps, including greater participation from foreign investors. The report is now accepting public comments through June 22.
It proposed that the cap on foreign institutional investors for owning government bonds be raised gradually, from its current level of $15 billion. Another recommendation was to allow foreign investors to buy government bonds directly from bondholders, as opposed to only through a broker.
The report also suggested revisiting a rule of the Securities & Exchange Board of India that effectively forces foreign institutional investors to hold the bonds they buy till maturity and thus limits their capacity to trade.
Bond investors welcomed these recommendations.
Foreign participation in India's debt market "is sorely needed," said Killol Pandya, head of fixed income at Daiwa Asset Management (India) Pvt. in Mumbai. But Mr. Pandya noted that the RBI report didn't set any timelines for achieving these goals. "I only hope that action is taken on the report sooner rather than later," he said.
The RBI report said that while issuance of Indian government bonds has increased over the last five years, trading in the secondary market has not risen much over this period. Some 80% of outstanding government bonds are held by banks and insurance companies, which typically hold on to them for years.
The report found that the trading volume for Indian government bonds was much lower than that of government bonds in Mexico, Brazil and Korea. In India, just five bonds account for 86% of the total trading volume. There are 92 government bonds outstanding currently.
Among other measures to help make the market more robust, the RBI panel suggested increasing participation by individual investors, who currently have little ownership through mutual funds. "To make a beginning, and since inflation affects the poor and middle class significantly, (government) may consider issuing inflation-indexed bonds specifically for retail/individual investors," the report said.
The interest on such bonds would be periodically revised to adjust for inflation.
Write to Shefali Anand at shefali.anand@wsj.com
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