With the kind of yields that Indian corporate paper can fetch, even if they?re from blue chip names, foreign investors should be flocking to the corporate debt market. A one-year commercial paper, for instance, can fetch as much as 9.5% and even if the investor forks out a small amount to hedge the position, it?s still a tempting return. In fact, three-month money too has been relatively expensive in the last six months. However, despite the attractive returns to be had, there haven?t been too many takers for corporate bonds. Right now, foreign investors hold approximately $21 billion worth of bonds (both gilts and corporate paper). Anecdotal evidence suggests that the quota for gilts of $10 billion has been taken up, so that would mean FIIs hold roughly $11 billion worth of corporate bonds. Most of these would be of the variety that don?t have any restrictions on the duration and for which the quota is $15 billion. Typically, FIIs prefer to put their money in short-term paper, so the infrastructure bonds, which need to have a residual maturity of five years and for up to $25 billion, haven?t really excited them.
In the meantime, the government wants infrastructure debt funds (IDF) to be set up and the first option is to raise funds through a trust. The structure, which resembles that of a mutual fund, should be registered with Sebi. The trust, the guidelines say, would issue rupee-denominated units of a minimum maturity of five years and, since these units can be listed on the stock exchanges, investors can exit if they find a buyer. Indeed, the guideline that the fund have a minimum of five investors, each holding not more than 50% of the net assets, is fairly liberal as is the specified minimum investment of R1 crore. The construct is not really complex and the process of investing should not be tedious either.
However, the guidelines do not talk of a waiver of the dividend distribution tax (DDT), which is currently applicable for mutual fund schemes. That could make these funds a non-starter because if a DDT is levied, then it would make the returns on the scheme that much less attractive because currently DDT is at a fairly steep 24%. So, if foreign investors are to be encouraged to invest in these funds, then the returns need to be made a little more tempting, perhaps through some concession on DDT, especially since they will also incur a hedging cost on their exposure. Also, while the units will be listed, it may not be easy for investors to exit at a reasonable cost, at least till the market is a liquid one. That could prove to be a bit of a dampener.
The second way in which an IDF can be set up is through an NBFC that can issue either rupee- or dollar-denominated bonds, again of a minimum maturity of five years. The structure is fine except that the funds can be invested in projects only a year after they have been commissioned, which suggests that the funding envisaged is more in the nature of take-out financing.
It means that banks will continue to take on most of the credit risk in the initial stages of the project, as is happening now, since the insurance companies have their own constraints. What?s hard to understand is why these NBFC IDFs can fund only those projects that have been set up as a PPP (public private partnership) and not projects sponsored either by a state-owned company or a private sector firm, especially when the total exposure of banks to the infrastructure space, at the end of May 2011, was approximately R5.5 lakh crore, or 15% of the total non-food credit, making them increasingly vulnerable to an asset-liability mismatch. Since the idea is to encourage foreign investors to invest in the country?s infrastructure build-up, the requirement for which is estimated at $1 trillion during the 12th Plan, it?s surprising the guidelines do not allow investments in the early stages of a project and exclude projects that are coming up exclusively either in the private or public sectors. In fact, the NBFC route could attract foreign money because the withholding tax is just 5%.
However, since the paper will be of a minimum maturity of five years, foreign investors would like the comfort of an active secondary market. Indeed, the fund managers of the IDFs too should be able to access quality paper and be able to trade in them. Even if the funds are inherently of a long-term nature, a fund manager must be able to buy or offload paper, as and when he chooses, without it costing him too much. Right now, the market lacks depth; the turnover in corporate bonds, on the NSE, in the first three months of 2011-12, was just over R36,000 crore, while turnover in each of the last two years has been R1.5 lakh crore. In fact, even the market in gilts, which commands a disproportionately high share of the total turnover in bonds, is not as liquid as treasurers would have wished. This market is critical since the yield on the 10-year bond is the benchmark for all other rates in the system. It is another matter that price discovery may not be totally efficient, given that banks are mandated to hold 24% of their net demand and time liabilities in the form of gilts. In sum, it could be a while before foreign investors start financing a bigger chunk of our infrastructure.
shobhana.subramanian@expressindia.com