Liquidity Issues in Indian Sovereign Bond Market

Liquidity is one of the most important factors after credit risk that affects the bond yields. The paper uses various measures of liquidity to understand their determinants in Indian sovereign bond market. The Liquidity measured by parameters like Turnover Ratio and Amihud Illiquidity Indicator show that these parameters not only have instantaneous relationship with bond yield but contemporaneous relationship with themselves. Impact Cost is not found to have any explanatory power. Financial crisis had marginal impact on the Indian sovereign bond market. It functioned well during the crisis period without much deterioration in general market liquidity condition as RBI injected large amount of liquidity to the system within a limited time period to ensure stability in the financial markets in India. However, the notion of flight to safety was evident as traders started investing largely in Government bonds shunning credit products as the credit quality in general started to dip. This was duly supported by large issuances of Government bonds. The study also finds that the electronic order matching system for government bonds has been successful in improving liquidity and reducing volatility in the market.