The $1.5-trillion Indian debt market has grown rapidly over the past decade, largely due to issuances by the central and state governments. The government securities to corporate issuances ratio is about 75:25, reflecting the nascent and subdued state of corporate bond markets in India. With lack of comprehensive participation, the debt market remains smaller than the Indian equity market, which is an anomaly from other large global markets where the debt market size outstrips the equity market.
Most companies in India tend to fund themselves through bank borrowings and, with lax controls and tortuous legal processes, this has led to large non-performing assets on bank balance sheets with high exposures to single borrowers, putting the stability of the Indian banking structure at considerable risk. Pushing companies to fund themselves through corporate fixed income issuances will move accountability and responsibility to corporates and encourage healthier means of financing.
With rich equity returns over the last decade, high interest rates available through bank deposits, and booming property prices earlier, Indian investors had not ventured to the equally lucrative fixed income market due to lack of understanding, access and liquidity. Caps on the amount of actual foreign fund flows permissible into both the sovereign and corporate rupee-denominated securities has also meant limited foreign fund flows. While caps have seen incremental raises in the last few years, these have not been enough to include Indian bonds in global emerging market fixed income indices, further limiting the foreign fund flow into this space.
Some impetus was given a couple of years ago when the Reserve Bank of India gave permission to banks to use their corporate bond holdings as collateral against their overnight repo credit facility, and to companies to issue rupee-denominated bonds in offshore markets. Still, with a GDP to corporate bond ratio at just over 20%, one of the lowest in the world when compared with both emerging and developed economies, there is an urgent need to push measures to boost both demand and supply of corporate issuances.
Similar to fixed income markets globally, most of this market remains outside the reach of domestic investors due to its illiquid nature and large issuance size. Even institutional investors in India tend to buy sovereign issuances to hold; they rarely follow the “mark to market" policy as practised by investors globally, which further increases illiquidity.
The illiquidity of the fixed income space was long a theme even in developed markets and about a decade ago, the concept of fixed income exchange-traded funds (ETFs) gained traction and is now a popular concept in most developed markets, especially in the US.
ETFs based on fixed income indices can bring liquidity and ease of access to a market with inherent opacity due to lack of exchange trading on the underlying securities. Indices standardise and democratise an investment space, consolidating the fragmented nature of information in a consistent and transparent manner.
When buying a bond, investors may be forced to hold to maturity, which is when they get their money back. Bond ETFs based on indices pre-define the term of the bonds to be held and typically bonds are sold 12 months before their maturity to maintain a consistent and fixed term range. New bonds are constantly being bought and old ones sold to maintain this consistency and give investors access to a diversified and continuously renewed investment portfolio. While coupon payments for single bonds can be half-yearly, bond ETFs typically pay out monthly dividends since the underlying securities will be paying out coupon payments on different cycles. Finally, even if an underlying bond is illiquid, the bond ETF itself will remain liquid with its real time exchange-traded characteristics.
In the last 10 years, the US bond ETF assets under management have grown to over $600 billion and are growing at a faster clip than even the robust equity ETF space.
In view of the urgent need to give a kick start to the moribund corporate debt market in India, the Indian government is mulling the idea of working with an asset manager to launch a bond ETF that holds securities from corporates where the government has large stakes. Somewhat similar to the concept of the Bharat 22 and the CPSE ETF, a cycle of issuances from corporates can be used to constantly feed the ETF.
This has several advantages. Corporate bonds can be sold far more effectively and with a wider reach than single issuances. Domestic liquidity can be created in the market with large involvement of institutional investors like pension funds and insurance companies as well as retail investors. Finally, corporates can create a regular cycle of issuances with a consistent and regular stream of funding, ensuring fiscal discipline.
Alka Banerjee is CEO, Asia Index Private Ltd