While it is true that the Indian corporate debt market has transformed itself into a much more vibrant trading field for debt instruments from the elementary market that it was about a decade ago, there is still a long way to go. At the current time, when India is endeavouring to sustain its high growth rate, it is imperative that financing constraints in any form be removed and alternative financing channels be developed in a systematic manner for supplementing traditional bank credit.
While the equity market in India has been quite active, the size of the corporate debt market is very small in comparison to not only developed markets, but also some of the emerging market economies in Asia such as Malaysia, Thailand and China. A liquid corporate debt market can play a critical role by supplementing the banking system to meet the requirements of the corporate sector for long-term capital investment and asset creation.
Some of the constraints facing the Indian corporate debt market are structural while some emanate from regulatory roadblocks. These issues systematically categorised into supply-side, demand-side, secondary-market and risk hedging related.
Development of the domestic corporate debt market in India is thwarted by a number of factors, the prominent ones being 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 and AAA rated bonds which in turn also prevent retail participation and aggravate the dependence on bank financing. Total corporate bond issuance in India is highly fragmented because bulk of the debt raised (more than 90% of the issuances) is through private placements.
Apart from the supply-side constraints, there are also several demand-side issues. For instance, the investment norms of insurance companies, banks and pension funds in India are heavily skewed towards investment in government and public sector bonds.
Under the eligible Statutory Liquidity Ratio (SLR) investments, banks are required to hold 24% of their liabilities in gold, cash and government securities. Insurance Regulatory and Development Authority (IRDA) Investment Amendment Regulations, 2001, which covers life insurance, pension and general annuities, unit linked life insurance, general insurance and re-insurance businesses, mandates that life businesses require that at least 65% of assets be held in various types of public sector bonds; non-government investments, if allowed, may not exceed 15% in unapproved assets and approved assets do not include corporate bonds rated below AA. As a result, a major part of investments for life and pension businesses is being held in G-Secs and other approved securities, which are relatively safe instruments
Furthermore, the market preference for very safe AA and above rated assets has resulted in a thin market for lower rated bonds. This has resulted in the exclusion of small and medium enterprises, which are generally rated below investment grade of BBB, from the debt market. The secondary market activity is also marginal with most of the volumes dominated by the top 5-10 names. Thus, the corporate debt market in India faces a ‘chicken-and-egg’ dilemma with a shallow secondary market failing to beget a healthy demand among the investors, thereby resulting in lower volumes and vice versa. Although the trading volumes have increased in the recent times, they are significantly smaller than those in G-Secs and equities.
Finally, the Indian corporate debt market is also constrained by lack of adequate risk management products, be it credit default swaps (CDS) or interest rate futures (IRF)
Development of long-term debt markets is critical for the mobilisation of the huge magnitude of funding required to finance potential businesses as well as infrastructure expansion. Despite a plethora of measures adopted by the authorities over the last few years, India has been distinctly lagging behind other developed as well as emerging economies in developing its corporate debt market. The domestic corporate debt market suffers from deficiencies in products, participants and institutional framework.
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. Issues such as crowding of debt markets by government securities cannot be addressed by market participants and regulators alone. 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.
Clearly, the market development for corporate bonds in India is likely to be a gradual process as experienced in other countries. It is important to understand whether the regulators have sufficient willingness to shift away from a loan-driven bank-dependent economy and also whether the corporations themselves have strong incentives to help develop a deep bond market. Only a conjunction of the two can pave the way for the systematic development of a well-functioning corporate debt market.