India needs these markets to deepen but that would require better regulatory cohesion
The Indian financial sector has many flaws, but you cannot fault it for tenacity. It has the ability to keep issues relevant for years as works-in-progress. For example, regulators and administrators are still debating the need for a vibrant corporate bond market, years after the advent of financial sector reforms. This topic is like a seasonal migratory bird: it makes an appearance at least once an year.
Reserve Bank of India (RBI) Governor Shaktikanta Das, while addressing Confederation of Indian Industry members recently, said: “Promotion of the corporate bond market, securitization to enhance market-based solutions to the problem of stressed assets, and appropriate pricing and collection of user charges should continue to receive priority in policy attention." Sounds familiar? Successive RBI governors have repeated similar words and tried hard to breathe life into a moribund corporate bond market. In June 2019, former RBI deputy governor Viral Acharya also made a public presentation on Indian capital markets, including corporate bond markets. Conduct a search on RBI’s website and you will find the need for an active corporate bond market figuring at least once a year in some governor’s speech.
Multiple official reports, as well as independent efforts, on activating the Indian corporate bond market dot the financial landscape, outlining why it failed to take off, and offering detailed recommendations.
Governor Das has valid reasons for his new-found optimism. Corporate bond issuances between March and June, according to RBI data, touched a record ₹246,700 crore. Of this, corporates—which means all manner of companies barring non-banking financial companies (NBFCs), housing finance companies and financial institutions—alone raised ₹111,787 crore, or over 45% of the total issuances. NBFCs raised ₹78,964 crore, or 32%. Much of this increased activity, of course, is also due to RBI’s robust liquidity enhancement measures, which include providing liquidity for targeted instruments. This even allowed for secondary market trading in, and primary market issuance of, lower-rated instruments from smaller NBFCs and micro-finance institutions. Secondary market trading in the corporate bond market during March-May averaged around ₹200,000 crore every month, a level not seen since 2008.
But will this sustain after the lockdown? Governor Das’s phraseology —“promotion of the corporate bond market" —implies that there’s still work left to be done. India’s corporate bond market’s penetration—or outstanding corporate bonds as a percentage of gross domestic product—is abysmally low (at around 15%), compared to many of its emerging market peers, like Brazil and Turkey. Das makes special mention of the corporate bond market because it is a key catalyst for infrastructure finance, which he sees as crucial for an economic revival. But we could still be talking about infrastructure finance and corporate bond markets for some time to come, unless the existing mistakes are corrected, an exercise that would have to include fixing the basic structure of infrastructure projects.
In-vogue fiscal economics of the 1990s, combined with a near bankruptcy of the State, popularized the idea of private investment in public infrastructure, based on a public-private partnership (PPP) platform and a “user-pays" revenue model. Under the PPP’s inherently lopsided structure, the State provided most of the equity and assumed all the risk, thus shielding the private sector partner. This peculiarity influenced the financing structure of almost all infrastructure projects, resulting in little corporate debt issuance and over-reliance on bank loans. This spelt trouble for banks since bank deposits are essentially short-term in nature but infrastructure loans are necessarily long-term. A robust corporate bond market would have allowed agents with long-term liabilities (such as insurance companies and pension funds) to invest in assets of matching tenures.
But these institutions are overseen by separate sectoral regulators—such as the Securities and Exchange Board of India (Sebi), the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA). Their rules mandate investment only in high-rated bonds, leaving out a large chunk of infrastructure bonds. And no regulator is inclined to relax the rules for fear of post-retirement harassment by investigative agencies.
Other inter-regulatory turf issues could also bedevil India’s corporate bond markets. For example, the central bank’s latest Financial Stability Report highlights how mutual funds and insurance companies have emerged as large credit providers or corporate bond investors, stepping in to fill the gap left by credit-averse banks. Many of these loans or bonds have gone bad, however, creating systemic instability. But their sectoral regulators do not have the institutional capacity to regulate or supervise these credit actions. They are also unlikely to allow RBI to intervene. Similarly, commercial banks are normally regulated by RBI, but their actions in the corporate bond market are regulated by Sebi. And, given the lack of coordination among regulators, this could well be the ground zero of future systemic instability.