For years now, Indian policymakers have made platitudinous comments about the need to develop a genuine market for corporate bonds. Somehow, they never seem to get around to doing it.
The reluctance is rooted in two beliefs. The first assumption is that the government, which doesn’t borrow overseas from commercial lenders, must always have the first claim on domestic savings. Allowing non-state borrowers to tap the same pool of money will leave less for the government, forcing it to pare social spending; the poor will suffer.
And what about expanding capital availability with a little sharing of credit risk with foreigners?
That’s where the second supposition comes in. The monetary authority needs to manage the exchange rate. For it to do that—and still have any hope of controlling inflation— the central bank must exercise control over capital inflows and outflows. And that objective is greatly helped by keeping foreigners out of Indian debt altogether.
But there is one big obstacle. “We’re a capital-starved country and we want to grow,” says Vipul Dalal, who heads Indian broking operations at Elara Capital Plc., a London- and Mumbai-based investment bank.
In the absence of a large local bond market, India has sought to address the challenge of financing growth by allowing local companies to borrow overseas, nudging them to take on currency risk that at least the smaller corporate treasurer in India doesn’t know how to properly hedge.
Why should foreigners be prevented from freely holding Indian debt, arresting the development of a local bond market, while Indian companies are permitted to borrow overseas? That’s simple enough to answer. The latter source is easy to turn off when inflows get large.
That’s precisely what was done in August last year when any Indian company borrowing more than $20 million (Rs80 crore today) overseas was ordered to keep the money abroad; anyone borrowing less than that and seeking to bring the money into India was asked to seek permission from the Reserve Bank of India (RBI).
Indian companies raised only $420 million of overseas debt in February, compared with a monthly average of $2.5 billion in the year through July 2007, before the restrictions took effect. Moreover, very little of the capital borrowed overseas nowadays is for local use.
“How is our economy going to grow 9% or 10% a year without capital?” Dalal asks. Just this week, a committee on financial sector development headed by University of Chicago economist Raghuram Rajan recommended that India “steadily open up investment in the rupee corporate and government bond markets to foreign investors.” This suggestion, if accepted, will free up a part of domestic savings from the tyranny of pre-emption by the state. Besides, allowing foreigners into the Indian bond market will widen the extremely narrow base of investors.
According to Jayesh Mehta, head of the institutional clients group at DSP Merrill Lynch Ltd in Mumbai, fewer than 20 investors account for 80% of the market. That includes 10 banks, one state-owned insurance company and a government-controlled provident fund.
Widening investor base
Foreign investors’ total participation is capped at $4.7 billion—including just $1.5 billion for corporate bonds—by government diktat. In the absence of investors, “adding to the number of intermediaries isn’t going to change the market,” Mehta says.
Mehta has some simple ideas on getting foreigners to participate in the Indian corporate-debt market without much of a risk of large capital outflows or inflows.
One such strategy, he says, could be to allow local debt investors to buy credit-default swaps, or CDS, for Indian companies (whose bonds the investors own) from offshore counterparties. A CDS is a debt investor’s insurance against non-repayment. “Allowing credit-default swaps with offshore counterparties will not result in large net flows,” Mehta says.
Once Indian investors have effectively transferred credit risk to overseas buyers, the capital they have had to set aside for prudential reasons will be free to buy new debt. The domestic bond market will grow.
This is an awfully bad time to be championing either more liberal transnational capital flows or greater access for banks to credit derivatives. And yet, the combination may help in kick-starting the corporate-bond market in India.
Fixing legal loopholes
It won’t be enough, though. There’s much work to be done in fixing ambiguous laws on creditor protection, including—believe it or not—coming up with a definition for a corporate bond. “Capital controls in India have come on top of domestic distortions,” says K.P. Krishnan, a joint secretary in the finance ministry. “We don’t have a specific definition of a corporate bond.”
Besides, the legal process is slow in enforcing the rights of unsecured creditors, and recovery rates are small.
Even with all this, foreigners want in; and India is keeping them out. That must change, and soon.
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