Indian households saved 22 % of the gross domestic product (GDP) in FY11. About half of their savings went to physical assets such as gold and real estate. Financial savings comprised of 13% in currency, 47% in bank deposits, 24% in insurance, 9% in pension and provident funds (PF) and 7% in small savings. A majority of the financial savings is unlikely to earn real returns in FY12. This composition reflects that Indians are great savers but poor investors.
Increased allocation to physical saving is also proving the point that financial savings probably have not given adequate real returns to Indian households. Inadequate real return on financial savings is mostly hitting the retail investors. High networth individuals (HNIs) are able to generate far higher real returns due to a combination of factors such as the scale and size of investment, borrowing capacity, superior knowledge and range of investment products. The Indian society is experiencing widening inequality as HNIs are able to compound their already higher wealth at a faster pace than the retail investor is being able to do with their meagre wealth.
Corporate bonds can provide adequate real returns to investors. Corporate fixed deposits (FDs) were a part and parcel of an average investor’s life in a not so distant past. The corporate FD market lost its appeal and diminished in size as investors looked at coupon rates rather than safety, distributors bothered for incentive rather than client interest and regulations were bypassed through innovative structures such as the plantation scheme. Focus on return on principal rather than return of principal lead to decline of the corporate FD market.
The corporate bond market could have easily filled the void left by corporate FDs. However, in spite of several steps taken by regulators to develop the corporate bond market, it remains a glass-half-full-or-half-empty story. Introduction of trading and settlement system such as negotiated dealing system for gilts, hedging products such as interest rate futures, increased foreign institutional investor (FII) participation has deepened the corporate bond market. A lot of thinking has been done to further develop the corporate bond market, but it has not been converted into actions.
Some steps can be taken to deepen the corporate bond market, which is necessary to migrate physical saving to financial saving and provide long-term financing for infrastructure development.
• Include corporate bonds as an acceptable security in collateralized borrowing and lending obligation with reasonable margin.
• Allow pension and PF trusts to invest in higher credit corporate bonds from the limited freedom of investing in dual highest credit rated bonds.
• Allow pension and PF trusts to sell the shorter maturity corporate bonds in the market to create liquidity at the short end and appetite for investment at the long end.
• Incentivize insurance companies to sell the shorter maturity corporate bonds in market to create liquidity.
• Introduce netting in corporate bond settlement (delivery versus payment III) like in the gilt market encouraging efficient utilization of capital.
• Expand interest rate futures across the maturity spectrum to generate liquidity.
• Introduce speedy and sure enforcement of security. Investor’s confidence on measures like section 138 in case of cheque bouncing has evaporated in the time consuming process of law. A high-yield market can’t develop in India, unless there is surety of enforcement of security. A lot of doubts are prevailing about fundamental matters like options and sell of pledged securities, among others. These fears are pushing investors towards highest rated bonds, depriving lower rated issuers from market access.
• Encourage larger size of issuance by capping stamp duty on issuance and allowing re-issuance of security.
• Lay out clear processes for attracting FII flows in infrastructure debt starting with simpler definition of infrastructure and asset-backed model of financing.
• Bring OIS (swap for hedging) market on the exchange to facilitate better participation as well as reduce the settlement risk.
• Reduce the cost of retail distribution of bonds. It can be done through combining the initial public offer process with placement through the exchange or online platform. Allow appropriate advertisement for secondary placement of bonds to gain traction from retail investors.
• Popularize structured products through generic exchange-traded products.
Retail investors’ participation in Indian equity markets has declined over the last two decades as their experience has been unpleasant. Entry in a bullish market and exit in a bearish market along with wrong stock selection has caused this unpleasant experience. Structured products could act as a good bridge for money moving from fixed income to equity by providing safety of debt and partial return of equity. An exchange-based distribution will bring the much-needed transparency in structured products and enhance retail participation.
Nilesh Shah is president (corporate banking), Axis Bank Ltd.
We welcome your comments at firstname.lastname@example.org