Fighting For Life

While increased liquidity and slower off-take in non-food credit have inspired banks to buy CPs, corporate sector has rediscovered a cheaper way to raise short-term resources. At the current rate of 13 to 14 per cent, and with the added cost of issuance of about one per cent, money raised through CPs is cheaper by at least 3 to 4 percentage points than traditional bank borrowing. Its a win-win situation, with both investors and corporates happy, says a foreign banker. Some corporates are using the CP to reduce their cash credit outstandings, he points out. Insurance companies and to an extent mutual funds are the other major players in the CP market.

 

Liquidity being the key factor, there are expectations that the CP market will see a lot of activity in the near future. Most players expect the liquidity in the banking system to go up as demand for credit shows no sign of picking up. In addition, they expect the Reserve Bank of India (RBI) to adopt measures that will encourage the growth of this money market instrument. The stand-by facility for commercial paper, which was removed in October 1994, may soon be restored, feels Ashish Pitale, debt research manager at the ICICI Securities and Finance Company (I-Sec). This may not be an undiluted blessing, though. Restoration of stand-by facility may come along with certain conditions, such as capital adequacy for the corporates issuing CPs, points out P H Ravikumar, executive vice president, ICICI Bank. Earlier, the RBI had relaxed conditions attached to the CP issuance, but now may insist on minimum amount of capital for these companies, he explains. He also expects the minimum duration of the paper to be cut from 90 days as of now to 45 days.

Incidentally, if these changes come about, it would be a second policy reversal in as many years. Having introduced the instrument for the first time in 1991, the RBI went on encouraging its usage by relaxing the parameters. In consonance, the primary CP market kept growing and reached its peak in September 1994 when the outstanding CP amount was a staggering Rs 4,500 crore. Then, in October 1994 credit policy the RBI took a sudden U-turn: it asked banks not to extend the stand-by guarantee to companies issuing CPs. Simultaneously, it also removed the automatic restoration of bank credit limits on maturity of the paper. Apparently, the RBI did this to make the instrument stand on its own merit.

It was the stand-by guarantee and not the credit rating that had inspired the investors confidence in commercial paper, says P A Ananthanarayanan, finance manager, Asian Paints, a company that is a regular issuer in the CP market. With this facility gone, the instrument became riskier for the investors and lost much of its charm. Some banks were willing to offer an alternative like revolving underwriting facility, but at a cost around one to two per cent. Since this reduced the extent of benefit that companies derived from CPs, this did prove to be a success.

Tightening of liquidity since 1994 too, did not help the growth of the CP market. Earlier, banks were keen to invest in CP because the low call rates afforded them an opportunity to arbitrage between the two. The subsequent high rates in the call money market robbed banks of this opportunity.

Little wonder then that the CP market plunged sharply after October 1994. The outstanding CP amount fell to Rs 604 crore at the end of March 1995 and further to Rs 76 crore at the end of March 1996.

No big boom

If the expected changes materialise, will the CP market boom again? Well, there will still be a few ticklish issues remaining which indicate that it is not going to be a picnic time for the players. For one, since the amount that a company can raise through the CP is linked with its cash credit limits, the RBI policy of reducing this component of the maximum permissible bank finance (MPBF) over a period of time has automatically reduced the potential size of the market. And even under the present dispensation, there are bottlenecks. Currently, a company can convert its entire 40 per cent cash credit limit into CP but that is only a theoretical proposition. No corporate body would like to totally dissociate itself from its bank and therefore would not utilise the full CP potential, points out Ravikumar. In fact, he says that some banks try to discourage their clients from going the CP route for fear of losing business. Banks, as investors, are also not very keen on an instrument which do not provide them with entry into any consortiums, nor does it result in additional fee-based business.

Another factor that may prevent the CP market from achieving its full potential is the differential rates of stamp duty levied on primary issues of CP. This has stifled the growth of a true inter corporate market in CP as the rates discriminate against corporate investors. When a primary CP is issued to a bank, the stamp duty is levied at the rate of five paise per Rs 100 of face value. In contrast, when the CP is issued on either an insurance company , mutual fund or a commercial company, the rate applicable is much higher at 25 paise per Rs 100 or 0.25 per cent. This is why companies prefer to issue CPs to a bank. On average the banking industry holds more than 80 per cent of the outstanding CPs at any given point of time. Thus, insurance companies, although usually cash rich, are not the first preference of companies issuing CPs. Unless this anomaly in the stamp duty rates is removed, it is difficult to visualise the CP market growing into an inter corporate market.

Yet another factor that stands in the way is the absence of a an active secondary market. The secondary trading in CP has remained low for the last two years. The debt market department of the National Stock Exchange recorded trading volumes in CPs of Rs 27 crore per month during 1994-95, Rs 49 crore in 1995-96 and Rs 10 crore in the first five months of the current financial year. These are no great volumes, considering the size of the primary issuances, says a senior banker. It is also for this reason that the maturity of this paper has remained confined to the minimum permitted period of three months, though the rules permit a longer maturity. He adds that banks with liquidity are willing to invest in CPs of three months and not for longer maturities.

In spite of hurdles in the growth of CP market, a change is perceptible in the way banks and corporates look at this instrument. Some of the new banks see a distinct business possibility here. Since these late comers on the scene find it difficult to break into the consortia that are financing the blue chip companies, they would like to finance at least their CP programmes. That is, at least one way to get blue chip assets, say some of them.

As for corporates, they were earlier reluctant to issue CP as their credit limits would be correspondingly reduced and not restored automatically. However, with rising liquidity among banks, they feel more confident of winning back their limits. Blue chip companies need not unduly worry on thisaccount as banks too need good clients, according to Ananthanarayanan of Asian Paints.

Additionally, some corporates have begun matching their CPs with the seasonality of their products. Take the case of Asian Paints, for instance. It makes sense for the company to raise money through the medium of CP, at rates cheaper than bank finance, when the demand for its product is on the upward curve.We do not mind even if our cash credit is not restored immediately after our CPs mature because by that time our money requirement too has gone down, says Ananthanarayanan. This logic should apply to other companies as well, whose products have seasonality of demand, he adds.

What would be the future scenario like for the commercial paper? One thing seems certain. Not all companies desiring to raise money from the CP market will succeed. Banks are wary of second rated companies and are only entertaining requests from the top rated ones. We are going only for the best ones, says Ravikumar of ICICI Bank. And as for the growth of the market, players advocate liberalisation. The CP market will continue to operate in periods of easy money market conditions as long as current regulations are in place. The CP instrument can develop as a financial tool to be used by banks and corporates all year round if there is a change in regulations regarding MPBF limits, concludes, McGowan of Hongkong Bank. Agrees Ashish Parthasarathy, head of money markets at HDFC Bank: So long as CP is treated as part of bank finance, it will not grow to its potential. But there is hope yet. Since it is the declared policy of the RBI to ultimately do away altogether with the cash credit system, CP will naturally play a more important role. Now is the time for the market to master the nuances of pricing, buying and selling the paper.

Changes in policy relating to Commercial Paper

January 1990

CP introduced via notification IECD.1/87(CP)-89/90 dt. 11.12.1989

July 1990

Tangible net worth of companies issuing CP reduced from a mini-mum of Rs 10 cr>