In its recent research report, Morgan Stanley predicted that India will be included in global bond indices in early 2022 and this will lead to huge foreign inflows in the Indian onshore corporate bond market in the medium-to-long term.
According to Crisil, outstanding corporate bond market in India is expected to double and reach ₹65-70 lakh crore by 2025. Given the vacuum created by erstwhile development finance institutions (DFIs) such as ICICI and IDBI in the long-term corporate credit market, the government’s thrust on infrastructure financing to boost economic growth, and recent improvement in India’s ease of doing business, the time is ripe for developing a deep, liquid and vibrant corporate bond market.
Indian corporate bond market has been ‘small’ in size despite policy push through recommendations of various high-level committees, and many structural reforms. Specifically, it is saddled with supply as well as demand side issues: crowding out by issuance of G-Secs, private placement, persistent inflation coupled with higher interest rates, information asymmetry, limited diversified basket of instruments, illiquid secondary market, non-availability of repo options, absence of broad investor base, and lack of credit default swaps/insurance.
Besides, the recent credit defaults of Srei Infrastructure Finance Limited, Dewan Housing Finance Limited (DHFL), and Infrastructure Leasing & Financial Services (IL&FS) may spill over to the banking sector and hurt the corporate bond market.
Since 2008, corporate bond market has been witnessing higher investment flows mainly due to calibrated simplification of procedures, sophisticated clearing and settlement of trades, focus on better disclosure standards, issue of exotic bonds (Masala bonds, Green Bonds, etc.), and raising the quantitative limits for foreign institutional investors.
While primary corporate bond issuances were of ₹7.8 lakh crore during FY2020-21, outstanding corporate debt stood at ₹35.1 lakh crore (18.2 per cent of India’s GDP) as of December, 2020. However, developed countries such as the US (123.47 per cent ), South Korea (74.3 per cent ), and Malaysia (44.5 per cent ) had higher corporate debt market to their GDP ratio in 2018.
Further, the Indian bond market has been dominated by sovereign bonds and the corporate bond market has a smaller share (27 per cent ) during the last decade. This calls for a power shift since an efficient corporate bond market complements a sound banking system and provides an alternative source of finance to the real sector, diversifies risks (mitigating asset-liability mismatches), and reduces financial sector fragility.
Financial literacy and education: According a survey conducted by Standard & Poor’s in 2015, over 76 per cent of adults in India do not even understand the basic financial concepts like interest rate, inflation, and exchange rate. Though some of the people are financially literate, they are not necessarily digitally savvy. Therefore, audio-visual contents/booklets may be developed as part of the digital/financial literacy drive, which will be a prerequisite for development of corporate bond market in India.
Incentives for retail investors: Indian corporate bond market is dominated by a few institutional investors and professional fund managers. Further, it is mainly concentrated in financial services sector (72.1 per cent) rather than manufacturing sector. Post-demonetisation, though there is a spurt in retail participation in equity market, corporate bond market is yet to receive a similar wave. Hence, the government may think of tax incentives to channelise household savings into financial assets such as corporate bonds from real estate and gold.
ESG framework: Corporates following the ESG (Environmental, Social, Governance) framework may have greater strategic freedom and will be the primary choice of market-savvy investors. Corporate bond market will get a fillip if ESG compliance is promoted by the policy makers. According to Crisil, ‘AAA’ rated companies in India constitute just 0.85 per cent of the market, the lowest among the emerging economies.
Credit guarantee enhancement: As on date, credit guarantee fund scheme exists for MSMEs (Micro Small & Medium Enterprises) to extend collateral-free credit. Similarly, the government may think of credit guarantee enhancement for corporate bonds through creation of an earmarked fund by collecting cess from the cash-rich companies. Besides, market for credit default swaps needs to be developed.
Maintaining price stability: The government’s massive public debt needs to be gradually downsized for effective transmission of monetary policy in order to crowd in private investment. This will reduce inflation, and the cost of borrowing of the corporates, and lead to higher real returns to the investors.
Enhancing liquidity: Over 90 per cent of the trading in the secondary market takes place in respect of the corporate bonds with ‘AA’ rating and above. Also, insurance and pension funds hold the bonds till maturity. As a result, the market is shallow, with the absence of market makers, lack of liquidity, and consequent pricing anomalies. Therefore, tri-party repo market may be developed for corporate bonds to provide liquidity for the participants in the market. The regulators may act in unison to allow ‘A’ rated corporate bonds as collateral to expand the universe of issuers and expand the investor base.
Functional autonomy: Stakeholders such as independent directors, and credit rating agencies should have functional independence to improve corporate governance, accounting as well as auditing standards, financial reporting systems, and legal protection; this will certainly boost the investors’ confidence and attract more participation. For instance, the rating fee of credit rating agencies should be borne by other than the issuer of corporate bonds; SEBI (Securities & Exchange Board of India) may pay this fee from its investors’ education fund.
In sum, a well-developed corporate bond market may better assess the intrinsic worth of investment demands because of the disciplinary role of free market forces.
Further, a dedicated corporate bond index enables real time monitoring of the market and fosters price discovery, thereby increasing investor’s buoyancy. Since India is being considered as a new manufacturing hub of the world, a deep, liquid and vibrant corporate bond market is the need of the hour.
Srikanth is Associate Professor and Director (Finance), DDU-GKY, National Institute of Rural Development and Panchayati Raj, Hyderabad, and Prasad is former Assistant General Manager, SBI. Views expressed are personal