A pack of regulatory measures by the Reserve Bank of India (RBI) gives a big boost to Indian bonds — both local and the offshore rupee-denominated ones (masala bonds). Some are designed to encourage, even push, borrowers to the bond market in the medium term. Others, like allowing domestic banks to issue ‘masala’ bonds (offshore, rupee-denominated bonds) for meeting additional Tier-I, Tier-II capital requirements, open a new channel for banks to raise resources besides helping develop this nascent market. Changes such as authorisation of platform for corporate bond repos and legal amendments to allow RBI to accept corporate bonds under the liquidity adjustment facility (LAF) will increase liquidity; so will the eased tenor and counterparty restrictions in the repo market and direct access of foreign investors to negotiated dealing and order-matching mechanism.
The list doesn’t end there, but is sufficient to illustrate a determination to build a robust market for Indian bonds in India as well as overseas. With all these measures, will this finally happen?
At the outset, it has to be acknowledged that in all these welcome reforms, authorities are still compelled to shift large borrowers away from bank finance towards bond financing by force. In the coming times, a firm will not be allowed bank loans beyond Rs.25,000 crore in 2018 and Rs.10,000 crore in 2020 without extra provisioning and capital by banks. This means costlier bank funds past these limits, pushing specific borrowers to bond finance; currently, many of these firms, rated AAA or AA, issue bonds intermittently under favourable market conditions and mostly through private placements.
Only time will reveal how these incentives alter financing structures between bank and bond finance. But if public bond issues, which entail stricter disclosures and other requirements, turn out marginally cheaper, bank credit could well remain the preferred funding option for its familiarity and easier access. Indeed, the RBI’s hope and intention is to simultaneously advance bond market development so that issuance costs decline, liquidity and trading picks up and more firms issue bonds at regular intervals to make for a vigorous market. In that event, the expansion in corporate bond supplies will require equal up-scaling of demand from buy-side participants. Here, the government can contribute by easing investment restrictions on bulk investors like insurance and provident fund companies.
One outcome could be a migration of higher-rated borrowers from the banks, who could be left with low-rated firms and thus be affected. Banks are major participants in the bond market and therefore can still take exposure to large borrowers through the bond route, especially as they would now have to provide lower capital, and repos in corporate bonds are permitted, which increases market liquidity. Investors will still cluster around the highest-rated firms for credit rating rules are unchanged for bulk-buyers like banks, insurance companies and provident funds; below-AA rated firms elicit no interest for these reasons.
How much will Masala bond issues help the banks? Here, relative interest costs attached to a currency matter. With rupee interest rates being far higher, banks may not find it all that attractive; diversification motives may elicit some interest, as in the case of firms like Housing Development Finance Corp. Ltd NTPC Ltd that have recently issued Masala bonds. The larger signal here is that banks can participate in the new offshore, rupee-bond market; a wider pool will help evolve pricing benchmarks so essential for market development.
Renu Kohli is a New Delhi-based economist.