Time to forge new bonds: Is corporate bond market at an inflection point?

Corporate bond issuance is looking impressive, but the market still has some distance to go before it can be considered deep

Last week T Rabi Sankar, deputy governor of the Reserve Bank of India (RBI), highlighted the fact that the country’s outstanding stock of corporate bonds rose four-fold to Rs 40.20 trillion in FY22, from Rs 10.51 trillion a decade ago, and annual issuance is now closer to Rs 6 trillion, from Rs 3.80 trillion in FY12. Is the corporate bond market at an inflection point?
 

Nearly four years ago, the Securities and Exchange Board of India (Sebi) had said that large companies with ratings of “AA” and above should borrow 25 per cent of their funding needs through the bond market. The idea was to re­duce their reliance on bank finance and lower the cost of fin­ancing. It also addressed another concern: the inability of banks to fuel India Inc’s appetite for funds, given their own capital concerns and the provisioning needs on dud-loans.
 

It was also desirable on its own as a measure — banks being the only lenders is an archaic notion (though it is only the US that has a deep corporate bond market in the truest sense). Then there is the issue of financing the country’s infrastructure. The National Infrastructure Pipeline had envisaged Rs 111 trillion of investments between FY20 and FY25, and all of this cannot flow from banks.
 

The plot so far — in terms of issuance — looks impressive. A note by Bank of Baroda (BoB) Research shows that while growth of bank credit moderated in FY21 to 1.6 per cent, from 7.6 per cent in the previous year, the growth of corporate bond issuance improved to 11 per cent (from 6.1 per cent in FY20). This held true in FY22 too: bank credit growth stood at 8.1 per cent, but corporate bond issuance was up 11.2 per cent.
 

Yet, the corporate bond market could have progressed a great deal more. “A lot of work has been done to deepen and broaden the bond market. But there is a skew towards top-rated bonds. Then you have the issue of who pays for the rating — the issuer or the investor? That issue has not been settled as yet,” says H R Khan, former deputy governor of the RBI, and chairman of the Working Group on Development of the Corporate Bond Market in India (2016).
 

What’s at stake if movement on this front is not fast enough? “To achieve our immense economic potential, we will need large amounts of capital to finance infrastructure investments and value creation,” points out Ananth Narayan, senior India analyst at the Observatory Group (he has also been appointed as a whole-time member of Sebi). “On the debt side, bank loans and external borrowings alone will be insufficient; our corporate bond markets will have to further develop and step up significantly.” The road to a $5-trillion economy will have to factor in the corporate bond market bridge. 

 

Lingering issues
 

A lot of the recommendations made by the Khan Committee and the earlier R H Patil Committee (Corporate Bond and Securitisation, 2005) have been implemented with differing degrees of success. But look at the mode of issuance — private placements accounted for 98 per cent in FY22, up from an already-high 88 per cent in FY12.
 

“The private placement route already offers an escape route from the high cost of public issuance. Stamp duty har­monisation is an issue that has to be addressed by all gov­ernments. In my view, the bond market should be allo­wed to evolve on its own with regulatory impediments being removed,” says Madan Sabnavis, chief economist at BoB.
 

He also believes that by forcing companies to borrow, or insurance companies to invest, “we could have a different set of problems in case of default (the crisis in 2018-2020 has not yet been resolved for investors as yet).” He adds, “It should be remembered that it is only US which has a vibrant corporate bond market while most other developed countries are bank-based.”
 

The total settled value of secondary market trades rose to Rs 14.37 trillion in FY22, from Rs 4.50 trillion in FY11. Sankar, while stating that “secondary trading has not risen in consonance with the size of the market,” however points out an interesting aspect.
 

A report by the Bank for International Settlements Committee on the Global Financial System (Establishing Viable Capital Markets, published in 2019) concluded that the degree of liquidity concerns in the corporate bond markets of the surveyed advanced economies (barring the US) and emerging market economies were similar, on average.
 

Sankar notes that “comparable data on turnover ratios of corporate bond markets of different jurisdictions are not readily available, but approximate assessments do not indicate that the Indian corporate bond market lags its peers in respect of secondary market liquidity.”

 

Persistent clamour 
 

There has been persistent clamour from large companies that corporate bonds be assigned the status of investments qualified for investment under the statutory liquidity ratio (SLR). The reasoning behind this is that banks will chase more such paper and the returns on such investments will be better (corporate bonds carry higher interest rates than government securities).
 

The flip side is that it will also mean that banks need to adhere to marked-to-market norms (unless the RBI says it is fine to hold them until maturity). Also, it would not only squeeze the government’s borrowing programme, but would only bring relief to the top-rated companies.
 

The elephant in the room is the success of the Insolvency and Bankruptcy Code; and its linkage with the bond market is critical. “Currently, highly-rated bonds attract domestic and foreign investors. Certainty of outcome (of resolution) within a realistic time frame will build investor confidence in bonds issued by lower-rated issuers,” says Divyanshu Pandey, partner at S&R Associates. “This will help deepen the primary and secondary bond market. This may be a distant dream, though.” 
 

That is because a key difference between the bond market and the bank-loan market is that in the former (in many cases), bond-holders at the time of default may not have had direct contact with the issuer, because the bonds would have traded through many hands. With everybody pulling in different directions, it becomes so much harder to get a resolution going.

It is time to forge new bonds — and quickly, at that.