BackBudget aims to deepen the bond markets, and nudge corporates to capital markets
Institutional investors coming into the lower-rated corporate bonds can aid the much-needed liquidity in this space and help in better price discovery
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Among other announcements towards deepening India’s corporate bond market, was the one to consider A-rated bonds as investment-grade securities. The finance minister in his Budget speech said that corporate bonds rated BBB or equivalent are investment grade. However, he recognised that in India the regulators only permit bonds with ‘AA’ rating as eligible for investment.
He then urged the concerned regulators to consider that it is time to move from AA- to A-grade ratings. This has relevance for all kinds of investment funds like pension funds, insurance funds and mutual funds; which invest in corporate bonds across different schemes. According to Lakshmi Iyer, head fixed income, Kotak Asset Management Co. Ltd, “The move will allow development of the corporate bond market in a more comprehensive manner, along with the proposal that 25% of the total borrowing of corporates be from the debt capital market. So far this segment was held captive largely by the banking sector. Now we can expect more corporates to come to the capital markets to raise funds and it gives access to investors like insurance companies and mutual funds."
Corporates have the option of borrowing from banks, non-banking financial companies (NBFCs), capital markets or any other source.
In the latest Budget proposals, the finance minister spoke about the Reserve Bank of India (RBI) nudging the corporates to look at the bond market for raising funds and also mentioned that the capital market regulator Securities and Exchange Board of India (Sebi) should consider mandating at least 25% of the total borrowing for a company to be from the capital market.
The highest credit rating that a bond can receive is AAA, which signifies very strong financial position and ability to pay interest obligations on all its outstanding loans.
In the hierarchy, next come AA, then A and then BBB rated bonds. Globally, bonds rated BBB are considered investment grade. This does not mean that there can be no default from issuers of these bonds. It does signify a lower probability of default. It’s only when a bond is rated C or D, which is default rating, that there is cause for concern. However, we have seen that even a security rated AA can slip into C and D rating directly. Rating downgrades can also happen post a default in due payments. This is the reason that in an underdeveloped debt market, where available research is also limited, institutional investors are overly cautious about taking exposure in securities rated below AA. Mutual funds and insurance companies invest in AA and A rated securities. However, the overall allocation relative to AAA-rated securities is low. The Employees’ Provident Fund Organisation (EPFO), which has a large portfolio of corporate bonds, has a mandate to invest in corporate bonds up to a rating of AA. Investment in lower-rated bonds have to be covered by a credit default swap, which comes at an additional cost.
Many industry experts suggest that the announcement made in the Budget is more inclined towards relaxing this restriction, which the EPFO is guided by.
Additionally, there is bound to be higher supply if the mandate for corporates to raise more funds through capital markets comes into play. This additional supply could be very welcome in the AA and A rated space and that needs to be taken up for investment by institutional investors.
According to R. Sivakumar, head, fixed income, Axis Asset Management Co. Ltd, “Across the banking system, there is a limit on how much can be lent to large corporates. Now, more issuances are likely to happen in the capital market space. The government is likely trying to ensure that all the agencies act in concert, as this shift happens." The deepening of India’s corporate bond market has been a long-time ask and these specific measures can help in this direction.
Institutional investors coming into the lower-rated corporate bonds can aid the much-needed liquidity in this space and help in better price discovery.
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