A developed corporate bond market is the need of the hour for India as an eight per cent economic growth cannot be achieved without a robust corporate capex cycle, more so as sole reliance on bank loans is not warranted, particularly when bank lending has been squeezed, noted a recent ASSOCHAM-Ashvin Parekh Advisory Services LLP (APAS) joint study.
“Given that PSBs (public sector banks) continue to face profitability and capital related challenges in the near to medium-term, overall banking sector credit growth is expected to remain subdued, thus vibrancy in the debt markets is critical to ensure a steady supply of credit to the various sectors of the economy,” said an ASSOCHAM-APAS joint study titled, 'Essentials of investing in corporate bonds.'
On the policy side, the study noted that bank lending rates are inefficient in passing through changes in the interest rates by the central bank. “Further reforms from the central bank are required if more firms are to gain access to the bond market.”
There is a dire need for a more efficient credit market to pass through shifts in monetary policy, it said. The study also impressed upon the need to encourage investors to invest in corporate bond market as it plays an important role in supporting private sector growth through efficient allocation of capital, favourable funding terms, flexible term structures, financing at lower cost and a scalable source of financing. It also said that a more developed bond market might allow more firms access to cheaper or more efficient debt capital, through a higher risk-taking culture among investors.
The study further noted that developed bond markets would create a new asset class in India that attracts foreign capital. “It would be an efficient allocator of capital and bring more firms into the market.” The report stated that a vibrant corporate bond market will ensure a win-win situation for all. Ability of companies to access the market is one of the key challenges being faced in developing corporate bond market in India.
Besides, perceived risks of the market framework is another challenge in this regard. “The various risks are interest rate, reinvestment, inflation, credit/default, rating downgrades and liquidity.” Determining the relative cost and return of participating in the market and ability to effectively match supply and demand are other challenges in developing bond market.
The study also highlighted that the Securities and Exchange Board of India (SEBI) and Reserve Bank of India (RBI) have taken various initiatives to develop the market for corporate bonds in last few years.
“While the corporate bond primary issuances have increased via the private placement route, the secondary market still appears to be thin and lacks liquidity. The dominance of passive investors is one of the reasons for such a thin secondary market.”
The study suggested that for developing corporate bond market, the aim should be to minimise moral hazard by corporates and increase participation of individuals by reducing their adverse selection.
“By having a default recovery framework and put/call options embedded in bonds, the risk perceptions of individual investors/issuers can be reduced, so that higher required certain returns would incentivize investing in corporate bonds, till the time more investors come in and Indian corporate bond market attains critical liquidity levels,” it added.
The study further said that all the measures and required regulations should be in place and regulatory authority should focus on minimizing information asymmetry to the extent possible so that price discovery process accelerates. The study also highlighted the need to institute robust mechanisms that ensure transparency and continuous information availability about the corporate entities issuing the bonds.
Disclosure requirements should ensure adequate, timely and credible information about the financial condition of the issuer, it said. “In the short run, intermediaries need to be incentivised to provide market-making services to increase liquidity in the market.”
Amid other suggestions, the reported noted, it is crucial that the market is as broad-based as possible in terms of issuers, investors and instruments. Besides, there needs to be a speedy and smooth recovery process for defaults. Issuance costs need to be contained for volumes to increase and returns to be high for investors.
Further, the report highlighted that deepening of Indian corporate bond market is critical to meet the funding requirement of the infrastructure sector. “Increased participation by insurance companies and pension funds can also help deepen the Indian corporate bond market and meet the increasing funding requirement for the infrastructure sector.” It also recommended for liberalising investment policy guidelines of insurance companies and pension funds.