The Hindu Business Line : Benefit from the bond market

The corporate bond market acts as an instrument to channelise people’s savings into productive investments. In the process, the company, the investor and the financial system as a whole, benefit.

Parvatha Vardhini C.

As an investor, you are often told to include debt instruments as part of your portfolio. While you will be familiar with the bank fixed deposits, provident funds and post-office schemes, the corporate bond route to debt may be an unfamiliar one.

You might have heard of it — if you have invested in ‘balanced funds’ offered by mutual fund companies which, in turn, invest a part of your money in bonds. Otherwise, ‘corporate bonds’ may not ring a bell, as the debt market in India is not as vibrant as its equity counterpart; to most people, it is synonymous with government securities.

To make the debt market more popular, SEBI, the market regulator, has recently drafted proposals that make it easier for companies to make a public issue of debt through the primary markets.

As the corporate bond market gets set to become more inviting, lets get down to brass tacks and figure out the nitty-gritty of these instruments.

Why is a bond market essential?

A discerning reader might wonder why at all companies need to raise money through bonds from the public when they can readily borrow from banks. After all, they are there in every street corner and are vying with each other to support every possible financial need!

True, but one look at a bank’s balance-sheet will tell you that they can tailor their loans only according to the deposits they get.

This means that if a company needs money for, say, a long-term infrastructure project with a high gestation period, a commercial bank may not always be willing to meet that need.

A short-term deposit that can be withdrawn at any time on the liability side of the balance-sheet and a long-term illiquid loan on the asset side will create a maturity mismatch and result in cash flow troubles for the bank.

Too much bank lending of this kind could brew a crisis where companies may be denied credit, leading to postponement of economic activity. This is where bonds step in, as an essential alternative to bank borrowing.

Benefits every stakeholder

The corporate bond market acts as an instrument to channelise people’s savings into productive investments so as to bring about economic growth. In the process, the company, the investor and the financial system as a whole, benefit.

For the company, money raised through bonds do not require an intermediary like a bank as the company gets it directly from the investors. Hence, it helps raise funds at a lower cost. For the investors, unlike traditional bank deposits, there exists an opportunity to benefit from bond price movements as interest rates change.

For the market as a whole, the existence of transparency norms, rating and disclosure requirements will help reduce to a great extent, the inherent risk related to the exposure.

Bond market in India

Globally, bond markets are many more times the size of equity markets, and rightly so. In India, although the debt market as a whole is bigger than the equity market, more than 80 per cent of it is dominated by government securities.

This anomaly can partly be attributed to the presence of development financial institutions (DFIs) such as ICICI, IFCI, IDBI which, until the last decade, readily provided them with long-term finance, limiting the need for a full-fledged bond market.

Besides, illiquidity, strict regulatory requirements, ceilings on exposure by insurance companies and FIIs and credit rating (in order to determine risk profiles) have been some of the reasons why public issue of bonds haven’t been commonly used; companies have resorted more to private placements.

SEBI’s latest initiative is expected to provide the bond markets with an impetus to growth.

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