Issues and Challenges for Corporate Bond Market in India

In India, corporate bond market has less significant growth for decades. As of now, it contributes to only 14% of the gross domestic product (GDP). When compared this figure with the bank assets (89% of GDP) and equity markets (80% of GDP), it is very small. No wonder, banks and equity markets are dominating sources of capital for business in India. Though, various committees have given recommendations to increase the contribution of corporate bond market very little has changed on the ground.

Defining Corporate Bond market

Bond markets are a financial market in which the corporate, governments and individuals are provided with the issuance and trading of debt securities. The securities may be government-issued securities and corporate debt securities. The bond market is also called as debt market or credit market. Corporate bond markets is a part of capital markets that deals with corporate bonds. Corporate bonds are simply transferable debt instruments issued by an entity/company to a broad base of investors (banks and other financial institutions).

Pillars of corporate bond ecosystem:

• Institutions (securities market regulator, banking regulator, credit rating agencies, clearing houses, stock exchanges etc.)
• Participants (investors on the demand side and issuers on the supply side)
• Form and features of instruments.

Salient features of corporate debts

• Bank borrowings:Corporate borrowings from banks and other financial institutions for various business purposes.
• Bonds: Corporate bonds are issued by an entity to abroadbase of investors.

Features of corporate bonds

Some of the features of corporate bonds are as follows:

• Like equity instruments, they are issued to the public.
• They are listed on stock exchanges.
• They are traded in secondary markets.
• They are transferrable.
• They have a very broad base of issuers (companies, conglomerates, multinationals etc.) and investors (retail participants etc.)
• They come under the purview of security market regulators.

 Why flourishing corporate bond market is necessary?

To begin with, the implementation of Basel III capital requirements will increase the capital requirements of the banks and will force them to tighten lending. In such circumstances, bond markets can be instrumental to cater to the financing requirements of the growing Indian economy.

Secondly, corporate bond markets can be a blessing for the infrastructure projects and financing requirements of small and medium enterprises as they require long term financing which the banks with asset-liability constraints cannot provide.

Thirdly, the banks are riddled with the rising Non-performing assets and their financial condition is deteriorating since 2013. A 2013 report of Fitch Ratings predict even more deterioration in the future. In this scenario having a financial system dominated by banks will prove disastrous for the Indian economy. Moreover, Indian banks are currently not in a position to expand their lending till they clear their balance sheets.

Fourthly, corporate companies tend to place heavy demand on bank funds. This may leave small enterprises out of funding. Hence, it would be prudent to move to a financial system in which corporate debt market plays a significant role. By doing this, the banks will be in a better position to finance smaller enterprises.

Lastly, according to the World Bank, corporate bond market will be capable of relieving the stressed banking system in a developing country. But it will need strong institutional and regulatory support.

Recent trends in corporate debt markets in India?

• Reserve Bank of India in 2011 has reported that listed corporate debt forms only 2% of GDP.
• Our size of the debt market is significantly lower than the markets of other emerging economies like Malaysia, Korea and China.
• The large issuers in the corporate debt market is dominated by quasi-government entities like banks, public sector oil companies and other government sponsored financial institutions.
• The corporate debt market in India is regulated by Reserve Bank of India, the Securities and Exchange Board of India and the IRDA.
• SEBI works to reduce costs and improve transparency in the corporate debt market and the IRDA makes sure the participation of insurance companies in the corporate debt set up.
• Indian bond market is dominated by fixed rate coupon bonds and the average of the bonds is only 5 to 7 years.
• There do notexist vibrant corporate debt market which has led to excessive foreign borrowings leading to severe foreign exchange losses.

Measures in the Budget

What were the measures proposed in this year’s budget to revive corporate bond market development? What are its criticisms?

In this year’s budget six proposals were made for the development of corporate bond market:

• Electronic platform for private issuance
• Extending foreign investment to unlisted debtsecurities
• Extending foreign investment topass-through securities.
• Platform for corporate bond repurchase agreement (repo) and consolidated reporting platforms.
• RBI to encourage bond financing by large borrowers
• Life Insurance Corporation of India (LIC) to set up a credit enhancement fund for infrastructure projects.

Criticisms

All the measures suggested in this year’s budget are not new and they are likely to have less impact on the growth of the bond market. The suggestions like electronics platforms for issuance, trading, settlement and reporting were all recommended by the R.H. Patil committe in 2005. These suggestions could have been implemented earlier without waiting. Moreover, there are no unlisted bonds to allow foreign investments into as SEBI has made mandatory listing od bond private placements in 2008. In addition, without sorting out the regulatory and taxation issues associated with securitization market, merely allowing foreign investment will not help reviving the corporate debt market.

What are the hurdles in reviving the corporate bond market in India?

• Crowding out by government bonds is a major impediment to the development of corporate bond markets. Huge public debts crowds out corporate borrowing. As the cost of borrowing increases the bond markets become unviable source of funding. However, some scholars do conclude that development of government bond market has positive effect on the corporate bond market.
• Lack of diversity in the instruments and supply side issues are the other factors which hampers the development of corporate debt markets in India.

What is the way forward?

The World Bank has listed seven necessary components whose absence is likely to have adverse impacts:

• Disclosure and information system,
• Credit rating system,
• Effectivebankruptcy laws,
• Market intermediaries,
• Institutional investors,
• Trading system and clearing platforms, and
• Depository system.

Secondly, there is an immediate need for fundamental reforms in financial markets, public finance and regulatory governance. Though these are herculean tasks, without achieving these it would be difficult for developing a flourishing bond market.

Thirdly, there is a need to establish inter-regulatory coordination. For instance, a platform for corporate bond repo was proposed by SEBI but it was not approved by RBI.

Fourthly, the government should stop using financial institutions as a captive investor pool for government bonds in order to finance its deficit. This coupled with governance issues crowds out private sector financing needs.

Fifthly, implementation of the Indian Financial Code proposed by the Financial Sector Legislative Reforms Commission, the Insolvency and Bankruptcy Code, dismantling of the capital controls needs to be urgently undertaken.

Lastly, diversification of instruments and awareness among the investors are needed to increase the investor base in this market. All the stakeholders like RBI, SEBI, and finance ministry must coordinate and cooperate and develop Indian corporate bond market.

Conclusion

Robust and vibrant corporate bond markets are imperative to ensure stability of financial system in a country. It will help in mitigating the financial crisis and provides for the credit needs of corporate sector. The structural reforms require a long term commitment on the part of the government. Only then Indian corporate bond markets will flourish as expected.