A political choice: India's stunted bond market beyond technical fixes

Developing a deep corporate bond market requires the political will to relinquish control over credit, not technical fixes

For more than 20 years, the development of a deep and liquid corporate bond market has served as a recurring motif in India’s Economic Surveys and finance ministers’ annual Budget speeches. For observers of Indian finance, this induces a profound sense of déjà vu. Despite a dozen-plus high-level expert committees and countless working groups producing mountains of recommendations, the market remains stubbornly underdeveloped. It is largely illiquid and restricted to a few top-rated issuers. 

To understand this stagnation, one must look at the stark contrast with India’s equity markets. Over the last 35 years, India has created a near world-class equity market. The nation moved from the abolition of the Controller of Capital Issues to a modern, technology-driven ecosystem with T+1 settlements. Why did the state successfully revolutionise the market for equities while repeatedly failing to ignite the bond market? 

The answer is not found in technical minutiae like stamp duty or bankruptcy mechanics, but in the political economy of fiscal dominance, the institutional incentives of the state, and the politics of reforming the Reserve Bank of India (RBI). All of these translate into a lack of genuine political will. In that sense, the “missing” bond market is a feature rather than a bug of our financial system. 

To understand corporate bond markets, we first need to understand the paradox of the Indian government securities, or G-Sec, market. In standard finance theory, rising debt levels should increase credit risk, leading to higher borrowing costs and potential credit rating downgrades. However, recent research by IIT Roorkee Professor Manish Singh shows that India presents a fascinating departure from this theory. The combined debt of the Union and states was projected at a high 81.92 per cent of gross domestic product for 2024-25, from 72 per cent in 2000-01. Yet the interest rate for new Union government securities actually fell from 11.77 per cent in 2000-01 to 6.96 per cent in 2025. 

Simultaneously, several states are experiencing near defaults, delays in salaries and pensions, and India’s long-term foreign currency credit rating sits just one notch above “junk” status. Yet, the cost of government borrowing remains remarkably stable or on a downward trend. 

Unlike the 2022 “Liz Truss” episode in the United Kingdom — where the gilt market revolted against unfunded tax cuts and forced a Prime Minister’s resignation in just 44 days — the Indian bond market fails to penalise fiscal excess. This disconnect between debt levels and pricing is maintained through “financial repression,” where the state structures the financial system to guarantee itself cheap credit. 

The government manages this by ensuring a “captive” audience for its debt. Over 85 per cent of government borrowing is sourced from state-owned banks, insurance companies like Life Insurance Corporation, and pension funds like the Employees Provident Fund Organisation. The state utilises both micro and macro-prudential regulations to force these financial institutions to hold G-Secs. By restricting foreign participation and limiting foreign currency borrowings, the domestic market is insulated from global market discipline. As recent research by Chitgupi et al of XKDR shows, only 5 per cent of the buyers of government bonds purchase them voluntarily; all others represent forcible resource flows to the Indian state. 

The underdevelopment of the corporate bond market is a direct consequence of this distorted G-Sec market. This architecture allows the state to neutralise market forces, but it comes at a significant cost to the broader economy. The implications are threefold:

• Forcing domestic capital to absorb massive amounts of government debt starves the private sector of investment funds. This perpetually stunts the growth of a diverse corporate bond market, as there is simply less “oxygen” left for private issuers.

• A functioning corporate bond market relies on the sovereign yield curve as a reliable, risk-free benchmark. Because G-Sec yields are artificially suppressed by captive buying, the benchmark itself is distorted, making it impossible to price corporate credit risk accurately.

• Since the bond market is prevented from penalising fiscal profligacy, the economic pressure manifests elsewhere. Evidence suggests that higher debt leads to higher depreciation of the Indian rupee. This currency risk makes external borrowing far more expensive and unpredictable for Indian enterprises, further handicapping their global competitiveness.

A deep and liquid bond market would transition India from a bank-centric system to a market-centric one, triggering a massive shift in institutional power. In the current bank-dominated system, the government retains significant allocative power. Because state-owned banks are a “cozy club,” the executive can subtly direct credit to politically expedient sectors or favoured entities. Bond investors, by contrast, are “ruthless pricers of risk”. They do not practice regulatory forbearance, nor do they restructure loans based on “calls from Delhi”. 

Furthermore, a flourishing bond market would shift regulatory gravity from the RBI to the Securities and Exchange Board of India (Sebi). Both the Ministry of Finance and the RBI are the primary beneficiaries of the status quo; the former gets cheap funding, and the latter maintains its grip on credit allocation. 

Officials favour the status quo and politicians go along, even though this harms gross domestic product growth. By suppressing the bond market to protect the state’s borrowing costs, the competitiveness of the manufacturing and services sectors has been sacrificed. Genuine reform would require the state to relinquish this control and allow the aggregate forces of supply and demand to decide who gets capital and at what price. 

The “long game” for reform must involve three critical steps:

• Free the bond market and let fiscal excess have a price.

• Generate signals that both markets and citizens can use to hold the state accountable.

• Focus the state on providing genuine public goods rather than managing a distorted financial plumbing system.

When the state needs vast resources in a crisis, in the present system, there is no place to go. Big changes are required in financial and economic policy to bolster the strategic depth of the Indian state and GDP growth. Until there is serious political will to relinquish the state’s power to direct credit, the corporate bond market will remain a recurring, unfulfilled promise in our economic surveys.

The author is an honorary senior fellow at the Isaac Centre for Public Policy, and a former civil servant