Indian companies are turning more to junk bonds to meet funding needs

Companies using such securities raised more capital in 2022-23 than at any point in the last 8 years

Legendary financier J P Morgan used high-yield debt to help consolidate the US steel industry in 1901. The tycoon facilitated finance for building the Panama Canal, helped form General Electric (GE) and arranged capital for the US treasury when it was running out of money in 1895. He is credited as one of the first to understand the potential for corporate use of high-interest debt.

Corporate bonds rated below the lowest investment grade ‘BBB’ are called junk bonds. They allow companies to raise capital, even for risky ventures, though investors demand high interest rates as compensation given the higher chance of default.

Indian companies using such securities have mopped up more capital in 2022-23 than at any point in the last eight years. Indian companies raised Rs 16,703 crore by issuing junk bonds, in 2022-23, shows regulatory data  as of February 2023. The amount is 45 per cent higher than the annual average for the previous five years as seen in chart 1.

The shift towards lower rated paper is also playing out in investment grade securities which are not considered ‘junk’. The share of the highest grade AAA-rated companies has fallen from 81.5 per cent in the previous five years, to 70.6 per cent in 2022-23. The share of second-rung AA-rated companies has risen from 13.6 per cent to 22.5 per cent as of 2022-23. The share of A-rated and BBB-rated companies, the next in the hierarchy of creditworthiness, has increased to 5.6 per cent of the overall value of corporate bonds with a maturity of one year or more, from 4.4 per cent over the previous five years (chart 2).

The change in preference may be explained by the fact that the outlook for many companies has improved. Around two companies saw an upgrade for every company downgraded so far in 2022-23. Upgrades boost returns for bond investors. Though the momentum for such upgrades has moderated, it is better than the roughly equal number of upgrades and downgrades seen in the years immediately before the pandemic (chart 3).

The recent increase in funding share for lower rated companies, junk or otherwise, has some caveats. Companies are still short of the Rs 31,000 crore that they raised through junk bonds in 2014-15, the previous high. Some of the rising share for lower rated companies is also because AAA-rated ones have raised less than Rs 9 trillion as of February, half of the previous years’ amount.

A slew of bond platforms are bringing more individual investors to high-yield debt. This may help lower-rated Indian companies raise money at better rates than they would otherwise get, and hopefully without the negatives of the US 1980s junk bonds boom.