In a macroeconomic environment of inflation, declining output growth, increasing cost of credit, uncertainty about the future direction of the interest rates, and an increasing gap between the domestic and global interest rates— which is denting the global competitiveness of domestic companies—it is imperative that some attention be paid to the happenings in the domestic corporate bond market.
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As far as the size of the bond market in India is concerned, the outstanding bonds issued total around Rs 38.75 trillion with current market capitalization of Rs 38 trillion. As regards its structure, the outstanding corporate bonds are just about 5% of total bonds. In relation to the size of the economy, corporate bonds as a percentage of the gross domestic product (GDP) are as low as 3%. The dominance of government is overwhelming as it accounts for over 80% of the outstanding bonds.
This makes the corporate bond market in India small, though it has been far more stable than many other economies with a more developed bond market. It is efficient, but lacks the critical characteristic of being accessible. And in the current situation of a contractionary monetary policy it is accessibility that will determine how it can be effectively used to supplement growth.
From the perspective of flow of funds, the savings of the private corporate sector, which are close to 10% of GDP, are much more than what is being accessed by through bonds. The basic problem with the current market structure and the financial policy is that it is not even fulfilling its role of intermediation properly, let alone leveraging. This constrains the capability of companies to raise debt at a time when banks are becoming conservative in their lending to productive enterprises.
Of late, in the absence of the erstwhile development financial institutions and reluctance of banks for infrastructure financing, some policy initiatives have been taken for increasing access of the infrastructure sector to funds. But what this has meant is that there is almost nothing incremental for the non-infrastructure corporate sectors.
Insurance companies have been mandated to invest at least 15% in infrastructure debt. But this is restricted by the Insurance Regulatory and Development Authority to only AA and above rated paper despite recommendations by many committees to the contrary. For instance, the Deepak Parekh committee recommended allowing investments in BBB infrastructure paper.
Even though this may be understandable, especially in view of what has happened globally, there are contradictions between the prudential/regulatory guidelines and the requirements on ground: infrastructure paper, at least in initial periods, will have a lower rating due to inherent risks associated with the nature of the sector.
As far as banks are concerned, in addition to the inherent caps in investments due to statutory liquidity ratio requirements, and the mark-to-market norms—which makes them reluctant investors—their appetite for corporate paper is virtually killed by the regulator’s assignment of risk weights. For instance, for the BBB-rated paper, the risk weight is 100%, compared with 20% for AAA paper.
The real problem emerges when these regulatory and prudential norms— which have been conceived and designed to keep the cost of government borrowings low—are seen in conjunction with the fact that the maximum number of AAA-rated entities in an economy with a $1.75 trillion GDP is not more than 150.
If the sovereign-owned enterprises and financial firms are excluded, this number will shrink to a handful of not more than two dozen AAA companies. Going deeper, if a couple of groups are excluded, the universe of AAA-rated companies shrinks to a little over a dozen.
Of the 6,200 rated entreprises, less than 15% are A and higher rated; B/BB/BBB-rated entities comprise nearly 75% of the total. In other words, the overwhelming majority are virtually excluded from accessing the bond market.
The norms, quite understandably, get more stringent when it comes to securitized instruments under external commercial borrowings (ECB).
In addition to a blanket ban on ECBs for on-lending, investment in capital markets or in the real estate sector, there are end-use restrictions, which effectively mean that it can only be accessed by companies for financing capital expenditure at project stage. Even the AA-rated companies don’t find it easy to avail of this in the absence of guarantees, or letter of comfort by banks (except in case of small and medium enterprises and the textile sector) because the project stage is the riskiest part.
As such, even as the end-use may continue to be restricted, it may be useful that bank guarantees be allowed at least for investment grade companies, which otherwise are not able to raise funds without them. Not only will this bring down the cost of finance, but it will also provide a greater and more diversified access to credit markets.
Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at email@example.com