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In his budget speech in 2005-06, then finance minister P. Chidambaram announced formation of a High Level Expert Committee on Corporate Bonds and Securitisation, but little has changed in the corporate bond market since then. That committee, headed by R.H. Patil, pointed to many issues plaguing the market and gave out recommendations to correct the same.
It was followed by a committee headed by former Reserve Bank of India (RBI) deputy governor S.S. Tarapore; it also recommended a number of changes. The spurt in the economy and the ever-growing need for infrastructure funds should have led to some substantial changes in the corporate bond market, but that has not quite happened.
The familiar pattern repeats itself: it remains just talk. The lack of adequate liquidity and diversified investor base and a skewed market structure are problems that have dogged the market.
Where's The Liquidity?
Compared to equity markets, the bond market is not exactly active. According to data with the Securities and Exchange Board of India (Sebi) the number of issues and amounts involved go up steadily year-on-year. But even if they are listed on the exchanges, they are not traded, which is the definition of liquidity.
Harihar Krishnamoorty, head of treasury at FirstRand Bank, says in today's context, high inflation keeps most investors away; one-year bank deposits give you a better rate of return. "The yield curve is not steep and bonds give you the same return as short-term investments like deposits," he says. But most agree that regulatory (including tax) issues make them unattractive to retail investors. Other problems keep long-term institutional investors like pension funds and insurance companies away. There are government stipulations that restrict investments of these funds in corporate bonds.
Do companies like them? After all, they need debt capital. Again, the legacy of market structure appears to have played spoilsport. "Corporate India's primary source for borrowing is the bank financing channel," says Nirav Dalal, head of fixed income and debt capital markets at Yes Bank in Mumbai. He finds the increased corporate interest in issuing bonds over the past two or three years encouraging.
Going Private Vs Public
Most issuers choose to operate in the private placement market to cater to sophisticated institutional investors — otherwise known as qualified institutional buyers — whose business is managing financial risk of this nature.
Public sector undertakings like NTPC, Power Finance Corporation and the Indian Railway Finance Corporation (IRFC) — to name just a few — are big users of this market. There are fewer disclosures, and much cheaper to do business; while there are very few public issues of corporate bonds, there are an increasing number of investment bankers who cater to the needs of the private placement market.
"Private placement works economically for most companies," says Kaustubh Kulkarni, Standard Chartered Bank's director of capital markets. Meeting the disclosure standards of public issues comes at a high cost, but it would be an error to conclude that it means lower transparency. Of the corporate bonds listed on the National Stock Exchange, 12 are public issues, while nearly 200 are listed as private placement.
LIC Housing Finance made 30 bond issues last fiscal (FY 2010-11) through private placements, while PFC did 16 issues. According to Prime Database, there were 806 private placements in FY11 — compare that to 67 public issues, including initial public offerings.
Even for institutional investors, ratings are an important determinant of investment attractiveness; they prefer AAA (triple A) or at least AA+ ratings. That expectation can often be a big deterrent for companies with lower credit ratings to offer bonds. "Companies should issue even lower-rated bonds, rather than worry about the rating itself," says Arjun Parthasarathy, an independent analyst. "Trading should be encouraged in all kinds of bonds.
Janak Desai, ING Vysya Bank's country head for wholesale banking, concurs. "Financial institutions should focus on getting their investment teams to analyse the creditworthiness of corporate bonds of all hues, and thereby expand the market," he says. Investing in only triple A bonds makes for lazy credit risk analysis.
Restructure The Market
Recently, the RBI released the final working guidelines for over-the-counter single name credit default swaps (CDS) for corporate bonds. The guidelines will become effective in October. CDS essentially swap or transfer the risk of a credit default by an underlying party from a buyer to a seller. Think of it as insurance; the buyer of a swap pays a quarterly premium to the seller, who commits to make good any credit default by a third party.
CDS got a bad name in the credit crisis of 2008. Sebi has increased investment limits by foreign institutional investors in corporate bonds; apart from bringing in the money, they also bring knowledge about managing credit risk.
Some remain concerned about the ability of CDS to provide boost to the corporate bond market, given interest rate futures in 91-day Treasury Bills (which too were introduced recently) are yet to pick up; many seem apprehensive about the complexity of derivatives.
In the background is the realisation that some of the huge capital needs for building the physical infrastructure that will make India a developed country will not come in unless an active working bond market with its own efficient infrastructure is in place. Maybe it is time to think differently about how we can get there. Time is running out, and we do not want to become the Siberia among emerging markets.
(This story was published in Businessworld Issue Dated 01-08-2011)