Strengthening India’s Bond Market

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By Pavithra Manoj,

The bond market in India is still not completely developed, even after several committees being formed throughout the years to augment the bond market. This means that the bond market is unable to share the credit burden that the banking system in India is currently facing. Since there is an absence of a well functioning bond market in the country, it is the banks and the government that take on the task of financing infrastructural projects like roads, airports, bridges and ports. This puts the banks under pressure, since they are buying into long-term assets such as bridges or highways that have a long gestation period, while they entertain short-term liabilities such as deposits of 3–5 years. This invariably creates an asset liability mismatch. This in turn leads to inefficient resource allocations on the banks’ part and ultimately weakens their balance sheet. This pressure, then, is reflected in the increase in bad loans among the banks. This whole scenario is part of the Twin Balance Sheet problem prevailing in the country, where, on one side, the companies are weighed down by high debt, and on the other, the balance sheets of PSU banks are weakened because of alarmingly high bad loans in the form of non-performing assets (NPAs), eventually causing a slowdown in the credit cycle.

It is not that companies have not tried resorting to non-bank sources of financing such as External Commercial Borrowings (ECBs), Commercial Papers (CPs), and so on. India’s share of non-bank credit to total new debt did rise from around 20 per cent in 2015 to 53 per cent in 2016. Prior to 2012, most of the non-bank credit came from ECBs. But after the rupee depreciated and weakened, the source of financing was shifted to CPs. Commercial Papers are not a long-term source of financing, but rather a short-term source, and so, Corporate Bonds were determined to be the most suitable source of long-term financing for projects with long gestation periods. Therefore, the bond market in India should be strong enough to be a source of long-term financing. But what exactly are corporate bonds? Corporate Bonds are a form of debt financing. They are debt securities issued by both private and public corporations as a major source of capital. But, for a company to be able to issue corporate bond at a reasonable and favourable enough coupon rate, it has to have some sort of consistent earnings potential. Each company has a credit rating attached to it. If a company’s rating is high (BBB or higher), then the bond issued by it is an investment grade corporate bond. These bonds are deemed less likely to default and therefore will fetch the investors a lower interest rate as compared to high yield bonds with lower credit ratings (BB or lower), as they carry a higher risk of defaulting, but have the potential for higher income.

The Indian corporate bond market has failed to take off due to the fact that, for years, the investor base in the corporate bond market just included banks, insurance companies, pension retirement funds and mutual funds. And most of these investors do not trade in corporate bonds, but rather hold them until maturity resulting in very little liquidity in the market. Also,most of the corporate bonds issued by the companies are issued through the private placement route, which means that they are privately paced with a select few investors rather than through a public issue in India. This is mainly done to save time and because it involves fewer disclosures and low costs of issuance, and is much faster as compared to issuing it publicly. This ultimately does nothing to strengthen the bond market as bonds are being issued through private routes. Several measures have been taken over the years in an attempt to amp up the bond market in India. In 2016, RBI made it mandatory for large companies to raise at least 25 per cent of their fresh borrowings from the bond market and also companies those plan to debt finance over Rs 200 crore to execute it on an electronic platform to ensure transparency. It was also made clear that there is a need for bonds to be acquired easily, either with foreign investors being allowed to trade directly without involving brokers or maybe with retail investors encouraged to trade more in the bond market. Another way to expand the market was to increase the liquidity prevailing in trading in bonds by allowing brokers to take part in the bond repo market. Banks were also encouraged to issue new bonds, such as masala bonds to increase the size of the market and the volume of trading in the market. Banks were also suggested to be roped in to ensure the bonds were made less risky by extending the Partial Credit Enhancement (PCE) scheme which allowed the banks to extend a line of credit along with an issue of a bond, so that companies can meet commitment in case they are not able to meet interest payments. But there are a few conditions set in order to extend this facility, such as the bond rating should already be a BBB minus or better in order to be eligible, and that the total PCE cannot exceed 50 per cent of the issue size of the bond. The

main aim of PCE is to eventually reduce risk and enhance the overall rating of the corporate bond.

The 2019 Budget too included mentions about measures to deepen the Indian corporate bond market and to increase the depth of the secondary bond market in order to help it function better. Nirmala Sitharaman has stated that the Central Government would be working with RBI and SEBI to allow AA rated bonds to be eligible to be considered as collateral in the RBI under its Liquidity Adjustment Facility (LAF), a monetary tool, especially overnight operations, as risks would be minimal. This will in turn ensure there is higher liquidity in the market. She also announced that a Credit Guarantee Enhancement Corporation will soon be set up this year to further deepen the bond market. Whether these measures, announced as a part of the current budget, will be different from the ones made in the previous budgets which were consequently faced with lukewarm responses can only be witnessed as the year progresses.

(Pavithra Manoj was a Research Intern at Centre for Public Policy Research. Views expressed by the author is personal and need not reflect or represent the views of Centre for Public Policy Research)