In recent times, much
concern has been expressed about the poorly developed corporate bond market in
India, which is seen as hampering the financing of long term investment. There
is much evidence to suggest this is indeed true.
As Chart 1 shows, in
2014, the ratio of loan liabilities (largely to the banking system) in the
total of loan, note and bond liabilities was way higher in India than in its
Asian counterparts and relative to its partners in the BRICS grouping.
What is more, the
increase in bond financing relative to the expansion in bank credit in the
period between 2009 and 2014 (or after the global financial crisis) was much
lower in India than in most other emerging markets of relevance, excluding
Indonesia (Chart 2).
An era has ended
This lethargy in India’s
bond market is not because of the absence of any effort on the part of the
government to promote that market. In fact, the government has also held the
view that a vibrant bond market is a prerequisite for the financing of
long-term investment in the post-liberalisation period.
In the past a large part
of such financing was supported with allocations from the budget in the case of
public sector projects or with credit from the development finance institutions
(DFIs) for private projects. The DFIs themselves were supported with
concessional funds from the RBI and the government, especially the former,
which had a separate window for the purpose. That era has, however, ended.
The government’s failure
to mobilise adequate resources through taxation and its post-reform emphasis on
fiscal consolidation, which limits its borrowing, has reduced its capital
spending.
This requires the private
sector to play a greater role in capital intensive industries and
infrastructure. On the other hand, a consequence of Indian-style financial
liberalisation has been the conversion through reverse merger of the DFIs into
regular commercial banks.
ICICI Bank and IDBI Bank
are all that is left of the erstwhile all-India development financing
infrastructure. This has meant that the burden of financing private investment
in capital intensive areas including infrastructure has fallen on the
commercial banks, especially the public sector banks.
However, the maturity and
liquidity mismatches between the funds sourced by the commercial banks and
investments in large industrial and infrastructural projects has resulted over
time in rising non-performing assets in the books of these banks. So they too
are retreating from financing of investment in these areas.
Hence, besides foreign
borrowing, a liquid bond market has become the only possible alternative to
clear this financing bottleneck and support such investment.
To realise that
alternative, investors looking for long term investment opportunities and
offered the expected yield and the required liquidity as insurance have to be
brought to market in adequate numbers.
Unfortunately, the
penetration of the corporate bond market is almost marginal in the Indian
financial sector. In 2014, while the ratio of bank deposits to GDP stood at 64
per cent, and that of domestic credit to the private sector at 52 per cent, the
ratio of outstanding corporate bonds to GDP was only 14 per cent.
By the end of 2015 while
corporate bond penetration in India was at around 17 per cent of GDP, the
figure was close to 45 per cent in Malaysia and 75 per cent in South Korea.
Moreover, at the end of
2015, government securities (G-Secs, State Development Loans and Treasury
Bills) accounted for 72 per cent of value of outstanding bonds, with corporate
paper (bonds, commercial paper and certificates of deposit) contributing the
balance 28 per cent.
Liberalisation fallout
The weakness of the bond
market is partly the result of a larger failure of the financial liberalisation
agenda. This was the failure to ensure the transition away from a bank
dominated system, through a proliferation of non-bank financial institutions
(NBFIs) that may have turned to the bond market for investment opportunities.
As Chart 3 shows, when compared with South Africa, Brazil and Korea, the
relative importance in terms of asset shares of NBFIs such as insurance
companies, pension funds and other financial institutions was much lower in
India.
This has been a
bottleneck to the entry of saving households into the bond market (and more so
the retail market for equity). The global evidence is quite clear that small
investors are exposed to the debt market through institutions like mutual
funds, insurance companies and pension funds. So the government’s effort seems
to be to use the latter as means to bring a larger share of household savings
into the corporate bond market.
It has done this in the
past by persuading public sector insurance companies and pension funds to
allocate a larger share of their investments to the market for corporate bonds.
In addition, under the new pension scheme of the government, subscribers are required
to choose some level of risk exposure as part of a move from defined benefit to
defined contribution schemes. But, given the fiduciary obligations of
investment managers in these funds, they tend to be cautious when following
government advice.
Further, the relative
importance of these institutions is far less than in many other countries. That
does not help strengthen the corporate bond “market”.
Bank dependence
The Reserve Bank of India
has in recent times attempted to respond to this through a host of measures.
But the most important of those strengthens the problem of “bank dependence”.
Banks are being roped in to render bonds less risky by extending the already
existing partial credit enhancement (PCE) scheme. In September 2015, the RBI
introduced a scheme under which banks were allowed to provide partial credit
enhancement to bonds issued by corporate entities and special purpose vehicles.
This involves providing a
non-funded but irrevocable line of credit linked to a bond issue, which
companies can access to meet commitments in case they find themselves unable to
meet interest or amortisation payments on the bonds. There were conditions set
on this facility including the requirement that the rating of the bond issue
must be “BBB minus“ or better before the credit enhancement and that the
aggregate PCE provided by all banks to any bond issue cannot exceed 20 per cent
of the bond issue size.
The essential aim of the
PCE scheme is to reduce the risk associated with a bond and enhance its rating.
With the banks taking over part of the risk, the bonds can be upgraded to
investment grade, making them eligible for purchase by insurance and pension
funds.
The new measure
implemented also increases the aggregate PCE exposure of the financial system
to any bond issue to 50 per cent (from 20 per cent) of the size of the issue,
with a ceiling of 20 per cent on the exposure of any single bank. Measures such
as this, it is hoped, will help resolve a problem, which has been created by
the government’s own policies, of an unavoidable dependence for finances on a
market that is still to mature. But in the process it is exposing banks,
insurance companies, pension funds, and those who place their savings in these
institutions to increased risk.
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| Banks dominate in India |
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| Tepid market for bonds |
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| The NBFC boom hasn't happened |
