RBI Strengthens Rate Markets through Structural Reforms

The Reserve Bank of India's (RBI's) measures for the development of the fixed income and currency markets is a step in the right direction and can help broaden the market over the medium- to long-term, says India Ratings & Research (Ind-Ra). Ind-Ra believes that these initiatives along with the successful implementation of the bankruptcy laws can help broaden the markets, assuming some of the other issues relating to reissuances, stamp duty and asymmetry of information are addressed in the interim.

Ind-Ra expects higher rated corporates to directly benefit in the short-term; however the investment guidelines for most investor classes will require changes, to move down the credit curve. Ind-Ra believes that financial institutions will remain the primary source of funding for corporates, particularly stressed corporates. Ind-Ra estimates that the number of borrowers above the threshold of INR100bn debt obligation aggregates 50 - out of which potentially 24 are either stressed or fairly vulnerable.

RBI's measures include, allowing lenders to issue masala bonds, to accept corporate bonds under the liquidity adjustment facility, higher ceiling on credit enhancements and providing Foreign Portfolio investors (FPIs) direct access to bond trading platforms.

The measures are likely to give a flip to the lower rated category bonds in the long run since unlike in the developed markets, the Indian corporate bond market is characterised by issuances from higher rated corporates both in terms of public and private placements. While in the developed bond markets, the appetite for speculative/non-investment grade bonds remains high and they are issued and traded widely. In the Indian bond market however it is not as easy to place a bond below 'AA category'.

The increase in the aggregate partial credit enhancement ceiling to 50% from the earlier 20% will help corporates to raise money through bonds. In most developed bond markets, corporate bonds are permitted to be used as collateral for liquidity operations. Allowing corporate bonds as collateral for liquidity operations will improve the demand for corporate bonds, from the perspective of banks subscribing to these bonds. This will help develop a robust secondary market for 'AAA rated' bonds (assuming the final guidelines restrict it to AAA paper). However, this is unlikely to result in investors moving down the credit curve due to uncertainties relating to recoveries and asymmetry in information sharing. In a scenario, where AAA papers remain in short supply due to bank investments, it could help in the gradual process of migrating down the rating curve. This is a landmark step for the debt markets and will take India's corporate bond market regulations closer to the global best practices.

Pension/provident/gratuity funds are major investors in the Indian bond markets and look for long term investments. Ind-Ra believes that the investment policies of these funds need to be aligned with the regulatory changes. The last time changes were made to the investment policies of these funds it resulted in some debt market issuers migrating to the bank loan market. Ind-Ra believes that unless investment policies of these funds are aligned with other regulatory changes, it will be difficult to develop a deep and vibrant corporate bond market in India.

With the change in the issuance guidelines for masala bonds - allowing banks to raise funds overseas as AT1 and T2 capital, India banks can take advantage of the negative sovereign yield (of most sovereigns) and use this opportunity to tap the international markets. Ind-Ra estimates that 'Banks need to raise INR710bn through AT1 Bond in FY17-18, assuming credit growth of 8%-9%'. Ind-Ra believes that any issuance through this route will vacate space for the borrowings of lower rated banks in the domestic market.

Ind-Ra believes, giving direct access to FPI in the trading platform will add more vigor, especially in the shorter end of the curve. However, it will also mean faster transmission of shocks. Moreover, wide divergences in the normal ticket sizes for FPIs and retail investors compared to the normal market lot of INR50m and the price impact may together deter large scale participation in the near term.

Listed corporates can now park short term surplus cash under the repo facility with banks and primary dealers. Corporates holding on to high short term cash balances or parking funds with banks may turn to this window; however with better returns from liquid funds this mode is unlikely to witness a shift in volumes from MFs to banks.

Powered by Capital Market - Live News