Corporate Bond Market - Budget 2019

Why in news?

In Budget 2019, the Finance Minister has announced fresh measures to boost the development of India’s corporate bond market.

What are corporate bonds?

Corporate bonds are debt securities issued by private and public corporations.
Companies issue corporate bonds to raise money for a variety of purposes.
A buyer buys a corporate bond, and lends money to the "issuer," the company that issued the bond.
In exchange, the company promises to return the money ("principal") on a specified maturity date, and meanwhile, pays the stated rate of interest.
Notably, a corporate bond does not involve an ownership interest in the company, unlike when one purchases the company's equity stock.

How has the corporate bond market been?

The development of the corporate bond market has been only stunted in the last few decades.
This remains the case in spite of the efforts by policymakers over the last three decades.
Successive budgets and at least half a dozen committees mandated by the government, the RBI and the SEBI in this regard have largely failed.

What is the reason?

For years, the investor base in the corporate bond market has been narrow.
It is only marked by banks, insurance companies, pension retirement funds and now mutual funds.
The FPIs are now prominent buyers of top-rated bonds given the attractive returns especially in the backdrop of a strong rupee.
But notably, most of these investors do not trade but hold these investments until maturity.
So, with few buyers in the market or market makers who offer buy or sell quotes constantly, there is little liquidity in this sector.
There is little or no incentive for market making.
Also, a majority of the bonds issued by companies are privately placed with a select set of investors in India rather than through a public issue.
This is done to both save time as well as avoid greater disclosures.
[Foreign investors can now invest up to Rs 3,03,100 crore in these bonds.
But so far, only a little over 67% of this limit has been utilised.]
Another limiting factor has been the varied stamp duty in states on debt transactions. This will soon be sorted out with a uniform rate.

What are the implications?

Banks - In most international markets including the US, trading volumes in the debt market are much higher than those in stocks.
Liquidity, too, is quite high with enough buyers and sellers willing to buy bonds.
This enables companies to raise funds across different maturities including for infrastructure projects with long gestation periods.
However, in India, there is an absence of a well functioning corporate bond market.
So, the burden of financing infrastructure projects such as roads, ports, and airports is more on banks and the general government.
This, in turn, puts lenders such as the banks under pressure as reflected in the rise of bad loans.
E.g. in banks, such investments create an asset-liability mismatch
In other words, they are buying into long-term assets, such as a highway, with short-term liabilities i.e. deposits of 3-5 years maturities.
Eventually, this results in inefficient resource allocation. Besides, it also weakens the bank balance sheets.

Liquidity - In the Indian equities market, the daily volumes of traded stocks are high, signifying liquidity or enough opportunity for both buyers and sellers.
Unlike this, the debt market is dominated more by trading in government bonds or securities.
Most of the demand for these securities is from investors such as banks that have to mandatorily hold these bonds as part of regulatory norms.
Over time, more Indian companies (both listed and unlisted ones) have started issuing bonds that offer semi-annual interest payments to investors.
But these bonds are not traded much, due to a limited investor base and low liquidity.
This, in turn, leads to lower volumes of their trades compared to the other segment of the capital market.

The aim of the government and regulators now is to boost the liquidity and volumes and make the debt market more vibrant.

What are the recent proposals?

An action plan would be put in place to deepen the market for long-term bonds including for deepening markets for corporate bond repos, credit default swaps, etc.
This will be taken up with a specific focus on the infrastructure sector.
The Foreign Portfolio Investors (FPIs) will also be allowed to invest in debt securities issued by Infrastructure Debt Funds.
Also, a Credit Guarantee Enhancement Corporation, for which regulations have been notified by the RBI, will be set up in 2019-20.

How will a Credit Guarantee Enhancement Corporation help?

The proposed new corporation will help companies boost their credit rating.
This, in turn, will enable them to raise funds at cheaper rates.
By allowing repurchase agreements or repos in AA rated bonds or securities, volumes could go up in the corporate bond market.
[Repos allow a company to raise funds by offering its securities and agreeing to repurchase it later.]
More importantly, it can help improve liquidity especially if the RBI, like many other central banks, uses it for its repo operations.
The other measure of allowing FPIs in debt securities for infrastructure could help offer an exit option for such investors and improve liquidity.
Similarly, policymakers want to develop the segment for credit default swaps.
This will mean protection against the possibility of a company or issuer defaulting on a repayment option.
The measure thus offer comfort to an investor willing to take a risky bet.
This protection, in the process, adds volumes to the market.

What are the other measures at boosting bond market?

Since 2016, the RBI has been emphasising on the importance of corporate bond market.
It had asked bigger companies to raise part of their long-term borrowings from the corporate bonds market rather than from banks.
New norms since then make it mandatory for companies with large exposures to raise 25% of their incremental or fresh borrowings from the bond market.
Regulatory rules also make it necessary for any company that plans to raise debt funds of over Rs 200 crore to execute it on an electronic platform.
This is expected to improve transparency as well.

Source: Indian Express