According to news reports, finance minister Pranab Mukherjee is likely to allow banks to provide guarantees for bonds issued by companies. Also referred to as a credit enhancement facility, such a move will lower the cost of funding for companies, and is being touted as an attempt to deepen the corporate bond market.
While there is no doubt that policymakers need to take measures to revive this market, getting banks to guarantee corporate bond issuances is a clear case of going off target. First, the finance ministry doesn’t seem to have taken on board legitimate concerns of the central bank in letting banks provide such guarantees. The Reserve Bank of India had frowned on one such issuance by Tata Motors Ltd, which was backed by a State Bank of India guarantee, with an unnamed official citing that such guarantees distort the pricing of bonds and would hamper the development of the corporate bond market.
In any case, reviving this market in India has more to do with creating liquidity for these bonds in the secondary market. Policymakers have recently taken some good steps in this regard. But more needs to be done to complete the process. Starting December 2009, the central bank and the Securities and Exchange Board of India mandated that entities regulated by them must settle their trades in corporate bonds through clearing corporations of stock exchanges. Regulators for other users of the market such as insurance companies and pension funds have since issued similar directives. This has essentially eliminated counterparty risk that was otherwise involved in the settlement process—trading in corporate bonds is now much safer.
As a next step, the central bank enabled repos or repurchase agreements using corporate bonds as collateral. A liquid repo market provides liquidity for corporate bond investors and is a critical piece in fixing the market. The central bank, on its part, has done well to take feedback and make modifications to its original guidelines on corporate bond repos. Unfortunately, it hasn’t got support from other regulators. Only RBI-regulated entities have been involved in the handful of repo trades that have happened since the modified guidelines were issued about three months ago. Mutual funds and insurance firms, who are large lenders and borrowers in short-term money markets, are still waiting for clear guidelines from their respective regulators.
The finance minister would do well to enable better coordination among various regulators in fixing the secondary market for corporate bonds. Needless to say, a thriving secondary market would spur the primary market for corporate bonds.
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