India’s Push for Bond Market Reforms Unlikely to Have the Pace It Needs

The Narendra Modi government is increasingly acknowledging that India’s current financial architecture is not fit to support the country’s long-term development ambitions. Speaking at a post-Budget webinar last week, Prime Minister Modi talked about the need to strengthen India’s bond markets to attract stable foreign capital and expand long-term financing options.

“There is a need to ensure predictability, deepen liquidity, and introduce new instruments to manage risk effectively and attract sustained foreign capital,” Modi said.

His remarks echo concerns highlighted earlier in the Economic Survey, presented ahead of the Budget by Chief Economic Adviser V Anantha Nageswaran, which argued that deepening India’s bond markets is essential for achieving the government’s vision of Viksit Bharat by 2047. “A well-developed corporate bond market is indispensable to India’s financial system and its path toward becoming a Viksit Bharat by 2047,” the Survey noted.

An underdeveloped corporate bond market has been a key concern for India, as it places much of the burden of long-term financing on banks. Although the market has grown significantly, with outstanding issuances rising from ₹17.5 trillion in FY15 to ₹53.6 trillion in FY25, an annual growth rate of about 12%, it remains small relative to the size of the economy, accounting for only 15–16% of GDP.

By comparison, corporate bond markets are far deeper in several Asian economies. They amount to nearly 79% of GDP in South Korea, 54% in Malaysia, and 38% in China.

Burdened Banks

India is now aiming for a significant expansion of its manufacturing sector, which the Economic Survey argued is also critical for maintaining currency stability. As of now, the government’s long-standing goal of raising manufacturing’s share in GDP to 25% remains very much distant, with the sector’s contribution largely stagnant at around 16%.

At the same time, the country must finance large-scale investments in emerging and expensive sectors such as clean energy. Taken together, these ambitions suggest that India’s financing needs are set to rise to unprecedented levels.

Even as these demands grow, Indian banks are beginning to show signs of stress. With household savings increasingly flowing into equities and mutual funds instead of bank deposits, lenders are struggling to keep pace with rapid credit growth. The country’s credit-deposit ratio has already climbed to a record 82.3%.

Reflecting this, Finance Minister Nirmala Sitharaman announced measures in the Budget to boost activity in the corporate bond market. These include steps to make corporate bonds easier to buy and sell by ensuring smoother trading and better liquidity, along with new financial tools that help investors manage risk.

Structural Issues

Policy experts, however, believe there are bigger constraints to deepening India’s corporate bond market. “There are structural issues for that, such as the dominance of government securities and the statutory liquidity requirements for banks," says TT Ram Mohan, part-time member of Economic Advisory Council to the Prime Minister and former professor of finance and economics at IIM Ahmedabad. "It is unlikely that those constraints will get mitigated in a hurry."

Through statutory liquidity requirements, banks in India are required to hold a portion of their deposits in government securities and other safe assets, a measure intended to ensure financial stability while also providing a steady source of funding for government borrowing. By directing banks to invest significantly in sovereign bonds, regulators aim to protect depositors and limit excessive risk-taking within the banking system.

In line with this structure, India’s debt market remains heavily skewed toward highly rated borrowers, with AAA- and AA-rated issuers accounting for nearly 85–90% of bond issuances. As a result, the corporate bond market is dominated by public sector undertakings and public financial institutions, reflecting limited investor appetite for lower-rated debt issued by private companies.

The contrast is most striking with the United States. The US has a far deeper and more diversified corporate debt market catering to a wide range of borrowers. Less than 5% of its bond issuances come from AAA-rated entities, while more than 60% fall within the A- and BBB-rated categories.

Institutional investors in India, who manage large pools of public savings, tend to display structural preferences shaped by return expectations, risk assessments, regulatory incentives, and market liquidity conditions. These factors collectively reinforce a bias toward safer assets, limiting the development of a broader risk spectrum within India’s bond market.

One major reason behind these issues is India’s income level. “There has been and there will be, in the foreseeable future, a bias towards systemic stability at the expense of greater innovation,” adds Mohan, who has served on several committees associated with financial institutions including the RBI. “At the present per capita level of the Indian economy, a certain risk-aversion is inevitable. The priority is to protect the principal of savers even if it means relatively lower returns to them.”

But this does not mean that only private debt is having a difficult time. The government, too, is struggling.

Investor Issues

Equally important is the growth of the municipal bond market in India, which provides local governments with crucial funding for public projects, including urban development and infrastructure improvements. These bonds are instrumental in building schools, hospitals, roads and other public utilities, thus directly impacting the quality of life in communities across the nation.

In a report released in November 2022, the Reserve Bank of India highlighted that an underdeveloped municipal bond market has made it difficult for local bodies to bridge their resource gaps. As a result, they continue to rely heavily on loans from the central and state governments, as well as borrowings from banks and financial institutions.

Sitharaman, therefore, also proposed in the Budget an incentive of ₹100 crore for municipal bodies issuing single bonds worth more than ₹1,000 crore, aimed at encouraging the growth of the municipal bond market.

While providing incentives has been one of the key demands from market participants, experts argue that here too, limited investor appetite remains a major hurdle, largely driven by mandates that favour investments in highly rated instruments.

“A major challenge for most of these municipal bodies is that their credit accounting is not up to the corporate standard, and because of that they do not have ratings attractive enough to gain investor’s interest,” said Sunil Kumar Sinha, formerly with rating agency India Ratings and Research, in an earlier interaction with Outlook Business.

Even within public debt, market experts point out that the government’s measures have so far struggled to generate investor interest beyond conventional highly rated securities, a challenge also reflected in the lukewarm response to thematic sovereign green bonds. The experience shows the extent of work still required to deepen and diversify India’s debt markets.

In that sense, the Modi government appears to be moving in the right direction, with Modi urging financial institutions and analysts to help craft practical solutions and rebuild market confidence. The real question, however, is whether these reforms can arrive in time to meet India’s growing financing needs.