the issuance of short term dollar or yen denominated debt by infrastructure companies, if left unhedged, could be severely problematic in case of rupee depreciation. therefore, we have encouraged companies that do not have foreign exchange earnings to either issue long term dollar bonds, fully hedged shorter term bonds, or rupee denominated masala bonds abroad. the first issues recently of masala bonds reflect a coming of age of indian debt that has been insufficiently remarked upon – for the first time in recent decades, the rupee ’ s value is trusted enough in international markets that corporations can issue there in domestic currency. going forward, we hope a more vibrant masala bond market abroad will complement a vibrant domestic corporate bond market. even though fdi flows are enough to cover our current account deficit, we are also encouraging inflows into the debt markets to improve depth and liquidity. we have progressively expanded fpi limits in government debt, and recently specified how these limits will expand for the foreseeable future. we have also opened up investment in state government debt, and laid out the medium term plan for those limits also. in general, our aim is to liberalize steadily, but in a thoughtful way, continuously asking how further liberalization will strengthen our domestic markets. we have not been persuaded by every market plea. for example, a number of investment banks want a dollar denominated g - sec issued internationally – ostensibly to create a benchmark dollar yield curve for indian instruments. while i agree such an instrument would be attractive for investors in the yield - starved world, i am not persuaded it is useful for india. when much of the emerging world would love to move from issuing dollar debt to issuing in bis central bankers ’ speeches its own currency so as to avoid currency risk, i don ’ t see why we should move the other way. instead, let us build out an international quasi - sovereign rupee yield curve, so that rupee issuances can be priced easily. it is with this in mind that we have allowed banks to issue masala bonds yesterday, with bank bonds being a good quasi - sovereign proxy. liquidity of course, not all parts of the rupee yield curve are liquid, even in the domestic g - sec market. at the very short end, we are trying to bring more liquidity and better pricing through the auctioning of term repos. at the longer end, we have been trying to focus on more illiq

##atility of the corporate sector, it is difficult to find plausible risk preferences that can rationalize the high level of the historical equity premium. also, we observe that required returns appear to vary over time, but we do not understand all the reasons for the fluctuation. both of these problems complicate our interpretation of what implications, if any, movements in equity markets have for the macroeconomy. the equity - premium puzzle is not the only aspect of the behavior of financial asset prices that is difficult to reconcile with economic theory or experience in related markets. a second puzzle is the " credit - spread puzzle. " the spread between a corporate bond and a similar - maturity treasury bond compensates an investor for the risk that the bond ’ s issuer will default and recoveries on the defaulted bond will be low. credit - risk spreads vary substantially over the cycle, and right now they are on the low side of historical experience. however, over long periods, actual percentage losses on corporate bonds have been well below historical averages of credit spreads at all maturities, especially in the high - grade, short - maturity segment of the market. again, it is difficult to reconcile this observation with standard models of investor preferences. other explanatory factors, such as the different tax treatment of corporate and treasury bonds, appear to explain only part of the puzzle. a third puzzle concerns the behavior of financial market volatility. volatility and measures of expected volatility derived from options prices vary over time but not in ways that are easy to link to economic fundamentals or to the variation of expected returns in asset markets. moreover, the relationship between financial market volatility and the volatility of macroeconomic variables such as gdp is not well understood. a fourth puzzle related to the pricing of risk concerns the term premium, which is the additional compensation that investors require to hold longer - term securities. we estimate from the treasury market that the term premium has declined substantially in recent years to unusually low levels, which has contributed to the inversion of the yield curve. but we do not understand why, and consequently we do not know to what extent we are seeing a permanent decline in the term premium – perhaps due to a general reduction in the volatility of economic activity and inflation over the past twenty - five years. or we may be seeing a temporary decline due to the influence of recent macroeconomic conditions or special factors affecting the demand for long - term bonds. in addition to these