The Hindu Business Line : Why bond markets need a leg-up

A vibrant corporate bond market can play a critical role in providing the much needed long-term funding for infrastructure development and corporate growth and help to divert the country’s savings to spur capital formation.

SEBI’s recent move to settle corporate bond trades via the clearing agencies will give a huge boost to volumes.

Vikram Kotak

The Indian financial sector is rapidly transforming, marked by strong economic growth, robust markets and greater efficiency. However, compared to its world-class equity markets, India’s corporate bond market is still in an embryonic stage, both in terms of the market participation and infrastructure.

From 1996 to 2008, the ratio of equity market capitalisation to GDP has more than trebled to 108 per cent while that of bond market has less than doubled to 40 per cent of GDP. Out of this, the ratio of corporate bond market to GDP is merely 3.9 per cent.

Among developing countries, it is only South Korea that has a reasonably well-developed corporate bond market (61.8 per cent of GDP). Total corporate bond issuances by Indian companies in 2008 stood at around $37 billion against $185 billion by South Korean companies and $132 billion by Chinese companies. While primary issuances have been significant, the issuer base is narrow and issuances are dominated by private placement and financial companies. The secondary market, therefore, has not developed commensurately. During FY09, average daily volume in corporate bond was merely 0.1 per cent of total issuances.

The evolution of G-Sec market has shown the impact that reforms can have on market development. It has grown at a CAGR of over 79 per cent since the introduction of electronic trading. The RBI and SEBI have been taking commendable measures to develop corporate bond market.

Some of the key developments over the past decade include dematerialization of holdings, increased transparency from compulsory reporting of trades, revamping of disclosure requirements for public offers and linking local rating agencies to international rating agencies. As a result of this, trading in corporate bonds increased by over 50 per cent year on year to Rs 1,48,747 crore in FY09.

In a much desired move, SEBI has recently stipulated that all trades in corporate bonds should be cleared and settled through the National Securities Clearing Corp or the Indian Clearing Corp with effect from December 1. This move will immensely increase market volumes and encourage more companies to issue bonds since it will remove the settlement and counterparty risk and assist better price discovery. It will also facilitate repos in corporate bonds.

Further, it will benefit investors, who are looking for alternate assets to diversify their financial investments. The extent of retail interest in bonds was seen in the recent Rs 10 billion bond issue of Shriram Transport Finance Co Ltd, which was oversubscribed over 4.5 times within a day of opening. To provide further fillip to bond market, the authorities are examining possibility of uniform stamp duty and speeding up of issuance procedures.

International experience proves that institutional investors are mainstream traders of bonds once the market reaches a satisfactory level of standardisation, transparency and depth. In no other economy, FIIs can enjoy such high spreads in debt instruments as available in India. AAA corporate bonds are available at over 9 per cent against 4-5 per cent available elsewhere. Despite this, FIIs have not fully utilized their investment limit of $15 billion in bonds.

They have invested $9 billion in debt market, less than 6 per cent of their current equity holdings of $140 billion. Aided by reforms on the front of clearing & settlement, improving market liquidity and better price discovery, FIIs’ participation in the corporate bond market may improve. This may provide them an incentive to stay invested if and when the down cycle in the equities take place, thereby marginalizing systemic risk posed by sudden outflow of foreign capital.

Steps towards creation of new markets such as exchange traded interest rate, foreign exchange derivatives contracts and plain-vanilla single-issuer Credit Default Swap will also add to market depth. Measures to encourage public offers and increase retail participation along with the development of market makers like that in government securities will further aid market development. The 20per cent withholding tax on interest earned by foreign investors in local bonds should be lowered to lure foreign capital. Within a month of removal of withholding tax by South Korea (May 2009), net purchases of Korean bonds by foreign investors rose by over 300 per cent to $7.7 billion.

From the perspective of developing countries like India, a vibrant corporate bond market can play a critical role in providing the much needed long-term funding for infrastructure development and corporate growth and help to divert country’s savings to spur capital formation.

In the recent global credit crisis, we saw a complete seizure of the overseas funding window (ECB, FCCB) for India Inc.

A situation like this could have been averted if the country had a well functioning corporate bond market.

In my opinion, the thrust laid by the authorities on the development of the corporate bond market will change the rules of the game and drive this segment of the financial market to a higher growth trajectory.

(The author is Chief Investment Officer, Birla Sun Life Insurance. The views are personal.)

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