Insights into Editorial: Why no Corporate Bond Market?
24 December 2015
Despite several recommendations being implemented, Corporate Bond Market in India remains to be underdeveloped. There is still anaemic activity in existing corporate bonds, and anaemic issuance of new corporate bonds in relative terms. Added to this is the steadily falling debt to equity ratios of Indian corporate since 1990s, which indicates the reduced activity in the corporate debt market.
What are Corporate Bonds?
Corporate bonds are debt securities issued by private and public corporations.
- Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business.
- When one buys a corporate bond, one lends money to the “issuer,” the company that issued the bond.
- In exchange, the company promises to return the money, also known as “principal,” on a specified maturity date. Until that date, the company usually pays a stated rate of interest, generally semiannually.
- Corporate bond does not have an ownership interest in the issuing company, unlike when one purchases the company’s equity stock.
Significance of Corporate Bond market:
- They provide an important alternative source of funding for corporations, which will enable them to optimize capital structure in an environment of friction.
- Such a market should enable additional cash to fund operations or long-term expansion plans without diluting corporate control.
- Corporate bond market would spur corporate activity and thus economic growth.
- Investors such as pension funds and insurance companies should also welcome corporate bonds as an additional set of instruments in which to invest, providing, in theory, a better overall risk to reward trade-off since there would be more opportunities for diversification.
Why Corporate Bond Markets are underdeveloped in India?
- In India, the development of a corporate bond market has lagged in comparison with other financial market segments due to a number of certain structural issues that include the dominance of the corporate bond issuance by private placements, which accounted for more than 95% of the total issuance of corporate debt in 2014-15, and the issuances being concentrated in the ‘AA’ or higher rating, largely by public sector entities and financial institutions.
- The huge pile of corporate debt that is currently being held in the form of loans, especially by state-owned banks is also posing some problems. At present, banks are not required to mark loans that they make to corporations to market, but are, of course, required to mark corporate bond holdings to market. This obviously makes corporate loans more attractive than corporate bonds as it offers an opportunity for banks’ balance sheets to be shown healthier than they truly are.
- Other reasons: low primary issuance of corporate bonds leading to illiquidity in the secondary market, narrow investor base, high costs of issuance, lack of debt market accessibility to small and medium enterprises, dearth of a well-functioning derivatives market that could have absorbed risks emanating from interest rate fluctuations and default possibilities, excessive regulatory restrictions on the investment mandate of financial institutions, large fiscal deficit, high interest rates and the dominance of issuances through private placements.
What needs to be done?
- Steps such as putting in place efficient trading platforms for corporate bonds could make a difference in increasing the penetration of these instruments.
- Reserve Bank of India could mandate that corporate loans should be marked to market in exactly the same fashion as corporate debt.
- RBI can also attempt to find ways to make corporate loans fungible with corporate debt.
- An independent regulatory organization with a broad mandate on this market should be established.
- Encouraging issuance of zero coupon bonds, providing clarity on taxation issues, including the provision of special quota for retail investors in debt issues and providing reduced transactions costs for retail investors are some of other measures to be carried out.
A well-developed corporate bond market is widely seen as a means of addressing the travails of the existing bank-dominated financial system. For India to have a well-developed, vibrant, and internationally comparable corporate debt market that is able to meet the growing financing requirements of the country’s dynamic private sector, there needs to be effective co-ordination and co-operation between the market participants that include investors and corporates issuing bonds as well as the regulators. Better management of public debt and cash could result in a reduction in the debt requirements of the government, which in turn would provide more market space and create greater demand for corporate debt securities.