Corporate Bond Market

By moderator July 10, 2019 14:23

In this year’s Budget, Finance Minister Nirmala Sitharaman has announced fresh measures to boost the development of India’s corporate bond market.

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    • In her Budget speech, the FM had said that an action plan to deepen the market for long term bonds including for deepening markets for corporate bond repos, credit default swaps, etc, with a specific focus on the infrastructure sector, will be put in place. 
    • She said Foreign Portfolio Investors (or FPIs) will also be allowed to invest in debt securities issued by Infrastructure Debt Funds. 
      • The availability of cheap foreign currency abroad and the need for huge amounts of funds at home are driving the government to tap the overseas markets.
  • The FM also stated that a Credit Guarantee Enhancement Corporation, for which regulations have been notified by the RBI, will be set up in 2019- 20.
  • Policymakers want to develop the segment for credit default swaps. 
    • This will mean protection against the possibility of a company or issuer defaulting on a repayment option and thus offering comfort to an investor willing to take a risky bet and, in the process, adding volumes.

Corporate Bond

  • The term “corporate bond” is not strictly defined. Sometimes, the term is used to include all bonds except those issued by governments in their own currencies. Usually, a corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, M&A, or to expand the business.
    • The term is usually applied to longer-term debt instruments, with the maturity of at least one year. 
    • Corporate debt instruments with maturity shorter than one year are referred to as commercial paper.

Corporate bond market

  • Unlike the Indian equities market where the daily volumes of traded stocks are high, signifying liquidity or enough opportunity for both buyers and sellers, the debt market is dominated more by trading in government bonds or securities. 
    • Most of the demand for these securities is from investors such as banks that have to mandatorily hold these bonds as part of regulatory norms.
    • Over time, more Indian companies —both listed and unlisted ones — have started issuing bonds that offer semi-annual interest payments to investors.
  • For years, the investor base in the corporate bond market has been narrow – marked by banks, insurance companies, pension retirement funds and now mutual funds.
  • The FPIs are now prominent buyers of top-rated bonds given the attractive returns especially in the backdrop of a strong rupee.

The issue with the bond market in India

    • Despite existence for long, bonds aren’t traded much, due to a limited investor base and low liquidity. This, in turn, leads to lower volumes of their trades compared to the other segment of the capital market.
      • In most international markets including the US, trading volumes in the debt market are much higher than those in stocks. 
      • Liquidity, too, is quite high with enough buyers and sellers willing to buy bonds with low credit ratings in the hope of receiving a big payoff. 
      • This enables companies to raise funds across different maturities including for infrastructure projects with long gestation periods.
    • A majority of the bonds issued by companies are privately placed with a select set of investors in India rather than through a public issue; this is done to both save time as well as avoid greater disclosures.
    • Foreign investors can now invest up to Rs 3,03,100 crore in these bonds and so far only a little over 67 percent of this limit has been utilized.
      • In 2019-20, investments by foreign funds in stocks have aggregated Rs 28,268 crore and Rs 10,949 crore in debt. 
  • Most of these investors do not trade but hold these investments until maturity.
  • Another peeve has been the varied stamp duty in states on debit transactions
    • This will soon be sorted out with a uniform rate.
  • Credit rating agencies: Failure of IL&FS subsidiary that had the highest rating defaulted on its obligations exposing credit rating agencies and, in turn, hurting institutional investors who bought into these and other similar bonds.

Impact of the absence of the bond market

  • In India, given the absence of a well-functioning corporate bond market, the burden of financing infrastructure projects such as roads, ports, and airports are more on banks and the general government. This, in turn, puts lenders such as the banks under pressure as reflected in the ballooning of bad loans.
    • For instance, in banks, such investments create an asset-liability mismatch. 
    • In other words, they are buying into long-term assets, such as a highway, with short term liabilities, that is deposits of three- to five-year maturities.
    • Eventually, this not only results in inefficient resource allocation but also weakens the bank balance sheets.

Benefits of opening corporate bond markets

  • Large borrowing by the government keeps interested rates and the cost of operations of firms high and crowds out private debt. 
  • Such an exercise will lead to a lower cost of borrowing for firms at home, as part of the government debt will come from abroad.
    • The money can be used to fund the government’s infrastructure and social sector schemes.
  • A foreign bond issue calls upon the government to be fiscally responsible and not stoke inflation while chasing growth. 
  • It will also increase foreign investors’ faith in the Indian financial system.

Challenges with the opening of Corporate bond market

  • Large, rapid capital inflows can lead to volatility and play havoc with currencies. The government could choose who it wants to place the bonds with. 
      • It may also be advisable to lay out a road map for future bond issuances.

Credit Guarantee Enhancement Corporation

    • The proposed new corporation will help companies to boost their credit rating, which, in turn, will enable them to raise funds at cheaper rates.
      • By allowing repurchase agreements or repos (that allow a company to raise funds by offering its securities and agreeing to repurchase it later) in AA rated bonds or securities, volumes could go up in the corporate bond market.
    • It can help improve liquidity especially if the RBI, like many other central banks of the world, uses it for its repo operations.
  • The aim of the government and regulators is to boost the liquidity and volumes and make the debt market more vibrant.

Steps need to be taken

  • Mandatory issuance of corporate bond: Since 2016, the RBI has made the point that the bigger companies would have to raise part of their long-term borrowings from the corporate bonds market rather than from banks. 
    • New norms should make it mandatory for companies with large exposures to raise 25 percent of their incremental or fresh borrowings from the bond market.

Use of electronic platform: Regulatory rules also make it necessary for any company that plans to raise debt funds of over Rs 200 crore to execute it on an electronic platform. This is expected to improve transparency as well.

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By moderator July 10, 2019 14:23