At long last, the Indian bond market is showing signs of life, facilitating a fund-raising of ₹6.7 lakh crore in FY17, a 36 per cent jump over the preceding year’s figures. For the first time in recent history, fund-raising through bonds also overtook incremental lending by banks this past year. Bond issuances, at ₹2.3 lakh crore in April-July 2017, has been buoyant in recent months. A vibrant bond market, without doubt, has many positive spin-offs for the economy. Domestic borrowers can gain access to alternative sources of credit without over-reliance on banks. Competition may force banks to more promptly transmit RBI’s rate actions. Savers can look forward to a larger menu of fixed-income options. But while the supply of bonds is plentiful thanks to stalled bank lending and low rates, it is demand-side constraints that need to be addressed to ensure this bond boom sustains.
For one, it is noteworthy that over 95 per cent of borrowers have taken the private placement route to issue bonds in the last two years, while public offers have stagnated at about ₹30,000 crore annually. Privately placed bonds are non-transparent on their pricing and deal terms, and effectively prevent non-institutional investors from participating. SEBI tried to address this issue by mandating an electronic book mechanism for large private placements last year, but less than half of issuers take this route. Two, despite rising volumes of funds raised, the bond market remains elitist, with the lion’s share of money cornered by large industrial groups with high credit ratings, banks and, of late, the State governments. Small-/mid-sized firms and those with low credit ratings have scarcely any access — though India has no dearth of indebted companies. The lack of appetite for lower-rated bonds can largely be traced to the over-supply of sovereign bonds as well as the restrictive investment mandates and risk-averse behaviour of institutional investors (banks, insurance companies, pension funds and the EPFO) who are the key long-term bond buyers. Three, despite the boom in primary market offers, the secondary bond market remains relatively illiquid and shallow. This can also be traced to the buy-and-hold strategies of most institutional players, with only foreign portfolio investors and mutual funds pursuing relatively active strategies.
Of course, a quick-fix solution to keep the bond boom going would be for the RBI to relax its current ceiling for FPIs in corporate bonds, which has recently been exhausted. FPI money has flooded domestic bonds this past year, chasing wide rate differentials and a strong rupee. But as these flows are highly volatile, it is good to see the RBI taking a gradualist approach to relaxing this limit. Improving retail investor participation, nudging domestic institutions to upgrade their credit appraisal systems and take a deeper plunge into this market is a tough ask. But then such structural changes may deliver a more sustainable boost to the bond market than the immediate steroid shot of FPI flows.