CP issuances down on low investor appetite

Despite the high loan rates, the issuance of commercial papers (CPs) is yet to pick up, primarily owing to the lack of investor appetite. Spreads between a CP and bank loan of a similar maturity have narrowed to 25-50 basis points (bps) from 200 bps in the last couple of years.

Base rates of most banks have touched 10 per cent after the Reserve Bank of India's (RBI) policy rate increases since March 2010. The interest rates on CPs have also increased by around 200 basis points since then.

“Spreads between the interest rates on bank loans and commercial papers have narrowed significantly over last two years. There was a gap of around 200 basis points, which has now reduced to 25-50 basis points,” said HD Khunteta, director (finance), Rural Electrification Corporation.

Companies would now prefer bank loans over CPs, since the terms of repayment for banks loans can be negotiated at a later stage. However, CPs would have to be repaid on the redemption date. The terms on CPs are determined by market conditions, and this restricts negotiation on both the rate and the tenure.

When short-term rates are high, companies tend to stay away from the CP market. “Only non-banking financial companies and top-rated companies tap the CP market,” said Khunteta. Currently, the rates on one-year CPs range from 10 per cent to 10.4 per cent, depending upon the company’s ratings.

The lack of participation from mutual funds, which are major investors in CPs, has also contributed to the concerns. “Investments from mutual funds have come down because of the overall liquidity being dried up, and also because of the new regulatory cap on bank investments in liquid funds,” said Nitin Jain, managing director and co-head (fixed income), Nomura India.

On May 3, RBI had mandated banks to limit their investments in liquid schemes of mutual funds to 10 per cent of their net worth. Banks were asked to comply with the new regulation in six months. “Currently, bank investments in liquid funds are higher than the permissible levels. So, these funds would not come back once banks start withdrawing,” said a bond dealer with a domestic brokerage.

Market participants expect interest rates to peak in the long term. The sentiment was reflected when the yield curve on interest rate swaps was inverted. “The one-year overnight indexed swap (OIS) has risen to 8.20 per cent from 7.85 per cent before the May 3 rate increase. On the other hand, the five-year OIS, which shot up to 8.41 per cent immediately after the policy decision, has now come down to 8.15 per cent,” said economists at Standard Chartered Bank.