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Lower-rated companies are likely to improve ratings on their bonds owing to the Partial Credit Enhancement (PCE) Facility, announced in this year’s Union Budget, making them more appealing to institutional investors such as insurance companies,
mutual funds, and pension funds, which typically invest in bonds rated AA and above. However, market participants have sounded caution, saying the success of the product depends on structural adjustment and market reform.
Union Finance Minister Nirmala Sitharaman last week said the National Bank for Financing Infrastructure and Development (NaBFID) would set up a credit enhancement facility for corporate bonds for infrastructure.
According to market participants, this will get financing from pension and insurance funds, which are seeking long-term investment but are restricted by norms requiring them to invest only in paper with at least an “AA” rating. These investors invest predominantly in government bonds. However, as the government moves on fiscal consolidation, issuing sovereign paper will be limited. As a result, these funds need to explore other investment avenues, with bonds carrying credit enhancement emerging as a potential option for long-term investment, they said.
However, the success of PCE hinges on the regulatory landscape since current norms of the Reserve Bank of India say the guarantor of the bonds has to allocate capital for 100 per cent of the bond amount instead of just the guaranteed portion. This has a bearing on the commercial viability of the product.
Reforms, including refining the methodologies of credit-rating agencies, developing robust secondary-market infrastructure for improved liquidity, and introducing flexible tenor structures that align with diverse investor preferences, need to be done. “The product will gain traction if it makes commercial sense. If the issuer can secure a favourable rating after accounting for the guarantee charge, there could be uptake. However, the success of the product will also depend on investor appetite,” said Karthik Srinivasan, group head, financial sector ratings, Icra.
According to Venkatakrishnan Srinivasan, founder and managing partner, Rockfort Fincap LLP, while PCE is a forward-looking reform that promises to deepen India’s bond markets and diversify infrastructure financing, its success depends on regulatory agility, cost optimisation, and the creation of a robust secondary market.
Market participants say firms that own infrastructure assets without a high credit rating and raise funds through the domestic debt market face a limited investor base because long-term investors, such as insurance companies and pension funds, cannot invest in them.
Credit enhancement can help these issuers achieve a market-acceptable rating, albeit at a cost. This, in turn, enables them to issue bonds more easily and reduce borrowing costs. As a result, the corporate bond market can expand, providing investors with a broader range of investment opportunities.
For instance, entities like Power Finance Corporation, REC, and the National Bank for Agriculture and Rural Development enjoy strong credit ratings (AAA) and secure funding at rates comparable to or even better than state-loan rates. These institutions, being quasi-sovereign, can access capital at sovereign-equivalent rates. If any of them provides credit enhancement to a corporate-bond issuer, it would significantly improve the issuer’s rating and market appeal, according to market players.
“PCE can allow companies to work towards upgrading ratings. So in a corporate bond, every firm does not get the best of the rating but in the market, a lot of people would like to buy only higher-rated bonds,” said Ajay Manglunia, MD & head fixed income, InCred capital financial services.
“If credit enhancement gets traction, it has the potential to deepen and broaden the corporate bond market,” he added.
