A strong corporate bond market is on the cards

The idea of having a vibrant corporate bond market is well accepted in India. It would provide an alternative platform for raising debt finance and reduce dependence on the banking system. But it never really took off, largely because of policy and regulatory impediments. A number of committees such as the R.H. Patil committee (2005), Percy Mistry committee (2007) and Raghuram Rajan committee (2009) studied various aspects of the issue and made recommendations, but the progress has not been as desired.

Consequently, the responsibility of providing debt capital has largely rested with the banking sector. This has resulted in several adverse outcomes such as accumulation of non-performing assets, lack of discipline among large borrowers and inability of the banking sector to provide credit to small enterprises. But all this could change, as the odds are now beginning to shift in favour of developing a strong corporate bond market. And here is the evidence.

Last year, the Financial Stability and Development Council sub-committee constituted a working group under the then Reserve Bank of India (RBI) deputy governor H.R. Khan with representation from the government and other regulators. Its brief was to review the recommendations of the previous committees and suggest ways for implementation, as well as make further recommendations. The committee submitted its report earlier this month.

Moving swiftly, last week RBI announced a number of steps that will strengthen the corporate bond market. For instance, it increased the limit for the partial credit enhancement that banks can offer to corporate bonds. The central bank also came up with measures that will discourage banks from lending to large borrowers after a point, and signed off on the idea of accepting corporate bonds while lending under the liquidity adjustment facility, though this will require changes in the RBI Act. It also eased restrictions for foreign investors.

These steps will help generate activity in the market. If large borrowers are pushed to raise funds from the market, it will increase issuance over time and attract more investors, which will also generate liquidity in the secondary market.

While RBI has taken a welcome lead, developing a vibrant corporate bond market is not the sole responsibility of the central bank. Therefore, it is reasonable to expect that other stakeholders will complement RBI and address all outstanding issues. For example, as noted by the Khan committee, frequent issuances by the same company can be clubbed together to create liquidity and re-issuance may not be considered as a fresh issue. Among other things, the market also lacks a reliable benchmark yield curve, which makes pricing of corporate bonds difficult.

But even as there are a number of technical issues that needs attention, structurally, things are falling into place for the corporate bond market. The Narendra Modi government intends to significantly increase investment in the infrastructure space, which will require massive funding and it’s now clear—if there was ever a doubt—that banks are not suited to fund such investments. Therefore, it is possible that the government will nudge all stakeholders to act. The implementation of the Bankruptcy Code will also help improve confidence and participation.

One of the reasons why the corporate bond market never really took off in India is because of high fiscal deficit and the government’s funding needs. The combined fiscal deficit has persistently remained on the higher side, which has affected the availability of funds and crowded out private sector issuance. This problem may also get addressed as the government has committed to maintaining fiscal discipline. It has also constituted an expert committee under veteran policymaker N.K. Singh to suggest new fiscal rules. It is likely that the committee will consider all aspects of government finance, including the ability of the financial market to fund fiscal deficit without crowding out private investment. Further, banks are dealing with a high level of non-performing assets and are not in a position to service the borrowing needs of the corporate sector. This will force companies to look for alternatives. In fact, the move has already started. According to Citi Research, less than 45% of incremental debt financing happened through the banking system last fiscal.

This is not to suggest that things will work for the corporate bond market overnight, but conditions are becoming more favourable. A regulatory and policy push at this stage can solve a lot of problems for the Indian economy.

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