Arvind Mayaram: Fuelling growth with corporate bond

To achieve higher growth rate, reliance on banks with challenged balance sheets will not be adequate

Globally, the availability of finance from banks and financial institutions is shrinking. With hardening of the prudential norms under the Basel regime, a substantial part of the much needed long-term finance, both equity and debt, would have to come from the capital markets. For India to achieve a higher economic growth rate and invest heavily in infrastructure, reliance predominantly on banks with challenged balance sheets will not be adequate.

The Indian bond market, as compared to those of other peer Asian countries, has a very small share in the total debt of the nation. Even though in India bond issuances in terms of numbers grew at a compounded annual growth rate of 20 per cent over the past decade, corporate debt stands at only 7.5 per cent of the gross domestic product as of March 2016. However, in Korea it stood at 76.5 per cent, Singapore at 32.3 per cent and China at 21.23 per cent during the same period.

Looking at the bigger picture we can identify several fundamental factors that must be taken into account while moving forward. First, fiscal consolidation leading to lower sovereign borrowings leaves more room for corporate bonds. The corporate bond market gets a leg-up as the interest rates come down and the fiscal deficit targets are achieved. The play on spreads across the credit curve becomes more attractive. Second, development of bond markets needs sustained participation of long-term institutional investors right across the credit curve. Third, a sound bankruptcy regime is a prerequisite for deep bond markets. Fourth, stressed balanced sheets due to high indebtedness of major corporates is a major constraints. Fifth, the centrality of banks in the financial system suppresses the growth of the corporate debt market. Finally, but not the least, the tax regime for financial instruments remains one of the key drivers of investor sentiment.

Several of these factors have been addressed in recent years. These include broad adherence to fiscal deficit targets, the passage of the bankruptcy law and a nudge by the Reserve Bank of India (RBI) to induce corporates to source some part of their debt from the bond markets. However, for most of the borrowers, domestic bond issuance remains costly and cumbersome compared with bank lending. Corporates prefer raising funds through private placements but private placements lack transparency and access is not available to a large pool of investors. The huge supply of government paper in the country is also one of the major impediments.

The following measures would make the bond market more vibrant and deeper.

Illustration: Ajaya Mohanty

First, by adhering to international best practices the credit rating agencies would make the markets more transparent and attract both domestic and foreign issuers and investors.

Second, following emerging international practice corporate bonds should be treated as eligible collateral for liquidity operations. The RBI should also explore the option of considering bond as collateral to bank depending on the rating of the bonds.

Third, the RBI should take measures to increase banks’ exposure in corporate bonds. Banks are holding on to excess SLR (statutory liquidity ratio) paper to the extent of four-five per cent voluntarily, a part of which ought to be deployed in higher rated corporate debt.

Fourth, to attract more issuers to access the bond market it should be mandated that large corporations raise a substantial proportion of their funding through bonds and commercial papers.

Fifth, the offshore rupee bond market should be encouraged. The Chinese government played a key role in developing the RMB offshore bond market, which has expanded more than five-fold, since it began in 2007 in Hong Kong.

Sixth, stringent entry eligibility criteria will ensure that only serious players having the necessary expertise, infrastructure, sound financial background, et al become debenture trustees. The Securities and Exchange Board of India may create minimum benchmark pricing for debenture trustees to prevent them from compromising on the quality of investor protection they provide. The issue of conflict of interest in the case of banks-promoted trustee companies providing trusteeship services to their principles should also be addressed.

Seventh, to further deepen the distribution network there should be an emphasis on domestic participation. With the latest government demonetisation move, more and more money is entering the banking platform, which channelised into bond markets.

Eighth, to achieve the objective behind the Bankruptcy Code, issues such as early notification of rules, development of insolvency professionals, tribunal/court infrastructure, quick redress of transitional problems etc. should be urgently addressed.

Ninth, development of different types of bonds such as green bond, municipal bond, social impact bonds and covered bonds should be allowed to permit diverse investor interests to take a recourse to bond markets.

The tenth and final recommendation is on tax reforms. The scope of Section 80C can be expanded to include corporate bonds of other entities as well. Treating corporate bonds and debentures on a par with equity for tax on long-term capital gain would have a positive impact.

The writer is former finance secretary and chairman, CUTS Institute for Regulation & Competition