A recipe for the corporate bond market
4 min read 03 Aug 2016, 12:16 AM ISTSix growth triggers are in place, but six more steps would be necessary to herald a deep funding alternative
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Two recent developments have spiced up India’s corporate bond market.
First is the issue of ₹ 3,000 crore offshore rupee-denominated masala bonds by mortgage pioneer HDFC. And second is the mandate, in early July, by the Securities and Exchange Board of India (Sebi) to use electronic book-building for all bond issues over ₹ 500 crore. The first such flotation, by LIC Housing Finance, sailed through on the National Stock Exchange.
While masala bonds diversify the investor base of rupee bonds and mitigate currency risk, the e-bidding platform marks a quantum leap in transparency, especially in price discovery.
The tide has been turning for a while
These developments reflect a series of ongoing steps by regulators and policymakers towards building a robust corporate bond market.
In the past decade, corporate bond issuances have grown at a compound annual growth rate of 20% to reach ₹ 4.8 trillion in fiscal 2016. Commercial paper (CP) issuances have grown even faster, trebling in the past five years. In terms of outstanding credit to the corporate sector, corporate bonds—including CPs—account for a fifth today. And the share of bonds and CPs in incremental funding has doubled in the past five years, rising particularly fast in the past two.
Today, there are six growth triggers in place, but six more facilitations would be necessary to herald a deep funding alternative for corporates.
The triggers
First is that India’s macroeconomic milieu is becoming conducive in multiple ways. Stable macros, especially durable inflation gains, are crucial here and India is getting there through the flexible inflation targeting and Monetary Policy Committee framework. And an improving fisc will reduce the ‘crowding out’ of corporate borrowings so endemic in the past. Also, a long-standing structural constraint to monetary policy transmission has gone with interest rates on small savings schemes now linked to market benchmarks. For foreign investors, there is also currency stability and good yields in times of negative-to-barrel-bottom rates in the developed world.
Second, Crisil estimates India’s infrastructure build-out requires ₹ 43 trillion over five years to 2020. Nearly a quarter of it—or about ₹ 10 trillion—will have to come from the corporate bond market.
Third is that public sector banks (PSBs), weighed down by bad-loan problems, will find it difficult to offer competitive rates, or grow. To boot, they need ~ ₹ 1.7 trillion of equity by March 2019.
Fourth, some regulations have been favourable such as the Reserve Bank of India’s (RBI) draft framework to enhance credit supply to large borrowers through the bond market, the Basel III liquidity guidelines, and Sebi’s guidelines for municipal and green bonds.
Fifth is the ongoing innovation where new structures (securitization of power transmission utility receivables), new vehicles (infrastructure development funds), and new instruments (hybrids for the insurance sector) would attract more issuers and investors.
Sixth, a credible bankruptcy resolution mechanism is on the horizon with the Insolvency and Bankruptcy Code becoming law. This strengthens creditor rights like never before because it affords greater predictability to recovery, which, in turn, increases investor confidence in bonds. A 2006 International Monetary Fund study (Local Currency Bond Markets by John D. Burger and Francis E. Warnock) shows that countries with better-enforced creditor rights have larger domestic currency than foreign currency bond markets.
Need some crucial facilitations
But even as things improve, half-a-dozen regulatory facilitations have become critical to create the deep source of funds so necessary to build out infrastructure and raise India’s ‘potential’, or ‘trend’, growth rate.
First is that the secondary market needs to be more liquid, and one way to facilitate it is by enabling market making, and encouraging repos in ‘AA’ corporate bonds, like in ‘AAA’ bonds.
Second is to promote credit default swap protection, which can wean investors away from G-Secs to corporate bonds. Here, quick and relentless implementation of the bankruptcy code will be helpful.
Third, to reduce concentration risk in banking, large corporates need to be persuaded to raise a portion of their funding needs through corporate bonds and CPs. The RBI’s move to make it costlier for banks to lend to ‘specified large borrowers’ beyond a defined limit is encouraging.
Fourth, it is imperative that the institutional and market frameworks are strengthened. We need a national bond guarantee fund for credit enhancement, a reliable benchmark yield curve for better price discovery, a credit event reporting mechanism to instill more discipline and transparency.
Fifth, it’s necessary to expand access to a large investor class—insurance companies. Today, there is a limit to what insurers can invest in infrastructure special purpose vehicles (SPVs) based on their net worth, which reduces their appetite, and for bond issuers, shrinks the investor field. Additionally, for a bond to be considered ‘approved investment’ by insurers, the parent has to guarantee even if it is rated lower than the SPV.
Sixth and last, we can learn from the global experience and introduce new instruments such as covered bonds, and determinedly build a deep offshore rupee bond market.
It would be apposite to sum up with a condimental metaphor: the broth of corporate bond market growth is cooking slowly. It now needs the masala of greater regulatory and policy facilitation to turn into a delectable debt dish. Else, corporates will soon be famished for funds.
Pawan Agrawal is chief analytical officer, Crisil ratings.
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