The Reserve Bank of India (RBI) has introduced guidelines for bond forwards, a new financial instrument that is expected to boost demand for state debt and lower borrowing costs for sub-national issuers. The move is seen as a positive step towards deepening the country’s local bond market. Bond forwards are contracts that allow investors to buy or sell bonds at a fixed price on a future date, helping them hedge against interest rate risks.
The RBI’s decision comes after insurance companies increasingly turned to unregulated forward rate agreements (FRAs) to manage their interest rate risks. Unlike FRAs, bond forwards require physical delivery of the underlying securities, providing a more secure and regulated way for investors to manage their risks. The new product is expected to appeal to a wider set of investors, including insurance companies, which have long-term liabilities and are looking to enhance their yields.
India’s states have become significant borrowers in recent years, with their debt levels approaching those of the federal government. This year, state governments are expected to borrow around 12.50 trillion rupees, compared to the federal government’s planned borrowing of 15.82 trillion rupees. The introduction of bond forwards is expected to create demand for state bonds, particularly those with higher yields, such as 10-15 year bonds. The 10-year state-central bond yield gap currently stands at around 30 basis points, making these bonds more attractive to investors.
The availability of bond forwards is expected to help stabilize the additional spreads that investors demand from states, leading to lower borrowing costs for sub-national issuers. Insurance companies, which are expected to dominate this new market segment, will be able to use bond forwards to enhance their yields and manage their interest rate risks. Over time, the product is expected to attract a broader set of investors, including those looking to hedge their interest rate risks or take positions based on their view of interest rates.
The introduction of bond forwards is seen as a positive development for India’s bond market, which has been growing in recent years. The new product is expected to provide investors with a more secure and regulated way to manage their risks, while also helping to deepen the market and increase liquidity. As the market develops, it is expected to lead to more efficient pricing and lower borrowing costs for both federal and state governments.