Corporate Bond in India: The rapid growth of the equity market in India is due to the country’s economic vitality combined with sophisticated state–of–the–art financial infrastructure. The Indian equity market is among the best in the world in terms of market features and depth. In parallel, given the government’s increasing borrowing needs, the government securities market has evolved and expanded over time. In contrast, both market participation and structure have declined in the corporate bond market. The main issuers are NBCs, and companies raise very small amounts of money directly. Many factors contribute to India’s underdeveloped bond market, according to the Economic Survey 2010-11:
- The predominance of banks loans;
- FII’s participation is limited;
- Pensions and insurance companies and households are limited participants because of a lack of investor confidence; and
- Crowding out by government bonds.
According to the Economic Survey 2011-12, there is now enough empirical research to back up Schumpeter’s hypothesis that financial development facilitates real economic growth. The depth of financial markets and the availability of a wide range of products should thus be viewed as essential components of inclusive growth rather than ornaments.
In 2000-01, banks accounted for 14.4% of large firm financing in India, rising to 17.8% in 2010-11. The bond market, on the other hand, has been insignificant. The thinness of the bond market has been partially offset by Indian foreign borrowing, which has increased dramatically over the last decade. In addition, India has a disproportionate amount of secured borrowing. The small size of unsecured borrowing may not appear to be cause for concern at first glance, but it could be a reflection of contract enforcement weaknesses and a lack of adequate information. Lenders would be more willing to give unsecured loans if contracts were quickly enforced and lenders had information on borrowers. The financial markets would gain the nimbleness that they currently lack.
Bond markets are important for emerging economies for a variety of reasons. The fact that they lead to more efficient entrepreneurship and greater value creation is one of the most notable. When an entrepreneur takes out a loan or issues bonds, he or she receives all additional profit over and above the pre-determined repayment amount. As a result, he or she is better motivated to make more informed decisions.
One may be sacrificing efficiency by having a weak bond market. Furthermore, this efficiency gap may indicate that less lending, and thus less investment and entrepreneurship, is possible in the economy. Furthermore, with India attempting to raise $500 billion from the private sector in the Twelfth Plan for infrastructure investment, an active bond market would be a valuable source of capital.
Why the bond market has not developed adequately?
There are a variety of reasons why the bond market has not developed adequately, despite these benefits. One reason is what economists refer to as multiple equilibria.’ Consider the following scenario: the bond market is small. If someone buys bonds with the intention of selling them later, he should expect difficulty. He may not be able to sell the bonds easily because the bond market is not active, so he will keep them simply because he cannot find a buyer. As a result, this may deter someone from purchasing bonds in the first place.
If everyone thinks this way, the bond market will remain thin. As a result, a push is required to nudge the market to a new equilibrium, where people are willing to buy bonds because they know they can easily sell them, creating a self-fulfilling prophecy that keeps the large bond market afloat.
There is currently an effort underway to boost India’s debt and bond markets, and success in this area could give the economy a boost. The corporate bond market is slowly evolving thanks to the Patil Committee’s (2005) recommendations. With bank financing for long-term infrastructure projects drying up and the banking system grappling with asset-liability issues, the need for a deep and vibrant corporate bond market cannot be overstated. The following are recent initiatives taken in 2012-13 to further the development of corporate bond markets.
- Banks are permitted to join SEBI-approved stock exchanges on a limited basis in order to conduct proprietary corporate bond transactions.
- The IRDA has allowed insurance companies to participate in the repo market in order to increase liquidity in the corporate bond markets. The IRDA has also given insurance companies permission to use “credit default swaps” (CDS).
- For AAA/AA+/AA-rated corporate bonds, the minimum haircut (i.e., the difference between prices at which a market maker can buy and sell the security) requirement has been reduced from 10%; 12%; 15% to 7.5%; 8.5%; 10%.
- MFs have been permitted to participate in CDS in corporate debt securities, as users.
- The RBI’s revised CDS guidelines for corporate bonds state that, in addition to listed corporate bonds, CDS will be permitted on unlisted but rated corporate bonds, including those issued by companies other than infrastructure companies.
- Users will be able to unwind17 their CDS-purchased position with the original protection seller at a mutually agreed-upon or FIMMDA (Fixed Income Money Market and Derivatives Association of India) price. If no agreement is reached, unwinding must be done at FIMMDA price with the original protection seller.
- CDS will be allowed on securities with a one-year original maturity, such as CPs, certificates of deposit, and non-convertible debentures with a one-year original maturity.
RBI took a number of steps to strengthen India’s corporate bond market
The RBI took a number of steps to strengthen India’s corporate bond market until March 2020. Many of the Khan Committee’s recommendations to increase investor participation and market liquidity in the corporate bond market were accepted. The RBI has announced the following new measures:
- Commercial banks are allowed to issue rupee-denominated bonds (masala bonds) in foreign currencies to meet their capital needs and to fund infrastructure and affordable housing.
- Brokers who are registered with the Securities and Exchange Board of India (SEBI) and are authorized as market makers in the corporate bond market are allowed to engage in repo/reverse repo transactions in corporate debt securities. This move will make corporate bonds fungible, increasing secondary market turnover.
- Banks have been given permission to increase the partial credit enhancement they provide for corporate bonds from 20% to 50%. This move will make it easier for lower-rated companies to get into the bond market.
- Allowing primary dealers to act as market makers for government bonds will help government securities gain even more traction by making them more accessible to retail investors.
- To make access to the foreign exchange market for hedging in ‘over the counter (OTC) and exchange-traded currency derivatives easier, entities exposed to exchange rate risk were allowed to use simplified procedures to conduct hedge transactions up to a limit of US$30 million at any given time.
- (vi) Investment in corporate bonds is now permitted for pension and provident funds, as well as insurance companies.
- (vii) Investment-grade corporate bonds rated ‘BBB’ or equivalent (as mandated by the Union Budget 2018-19)—until now, only ‘AA-rated corporate bonds were considered investment-grade.
- Introduction of an electronic platform for repos operation in corporate bonds.
- Inclusion of them in the RBI liquidity adjustment facility (LAF).
- FIIs are allowed to invest in corporate bonds through stock exchanges and primary issuance—an overall ceiling of US$ 51 billion (with a US$ 25 billion ceiling for G-Secs).
By March 2020, the corporate bond market had accounted for roughly 32% of total credit to India’s corporate sector (it is believed that in the wake of banks’ unwillingness to lend the corporate houses are going for the corporate bond market). According to SEBI, the outstanding value of domestic corporate bonds in India was Rs.22.3 lakh crore in December 2019, or about 16 percent of GDP. According to the Asian Development Bank, China’s local currency corporate bond market accounts for about 30% of GDP, while Malaysia’s accounts for about 44%. India has a lot of room to grow its corporate bond market this way.