Indian retail investors have historically been moderately risk-averse in their investing habits. Their savings have always found place in savings accounts, gold, fixed deposits, and real estate. However, in the capital marketplace, investors have increasingly found comfort in equities, as opposed to corporate bonds. While equity markets underwent a complete makeover in terms of infrastructure, trading regulations, product availability, and technology; the bond market is yet to move up the curve.
Corporates are heavily dependent on banks to finance their long-term funding requirements. In the lending market, banks enjoy almost complete control. Bank credit was 63% of GDP in FY16. However, with Indian banks undergoing rigorous balance sheet restructuring and Basel III enhancing capital requirements, bank credit is likely to get conservative.
An impeding question facing India is whether creating a debt market for the corporate sector across sectors, to suit the needs of multiple investor classes would facilitate price discovery and compliment bank lending? Alan Greenspan (2000) said bond markets are like “spare tyre” in an economy where banks are tending towards conservative lending and regulating credit more than before. One may argue that if banks are unwilling to finance, why would an investor put its skin in the business?
Indian corporate bonds worth R491,885.4 crore were issued in FY16 of which 93.1% of corporate bonds are placed privately, where the cost structure is modified to suit both the investor and issuer in question. Retail participation stood at a mere 6.9%. The now-decommissioned 12th Five Year Plan (2012–17) pegged funding requirements for infrastructure projects at $1 trillion. This should encourage corporates to explore bonds as an alternative route.
Bonds provide long-term sources of funds to corporates by connecting investors with borrowers based on their risk appetite, time to maturity and yield expectations. Unlike equity, corporate bonds shield the business from market volatility, thereby adding stability to the source of funding. Since bonds can be issued based on specific financing requirements, asset liability mismatch can be addressed on the corporate balance sheet. A well-developed domestic bond market would shield corporates from exchange rate fluctuations, that arise when businesses borrow overseas through ECBs and ADR/GDRs. Debt financing can also be used by issuers as a tool to gain investor confidence about certainty of future operating cash flows.
Debt issuance however, has its own impediments making it a route less travelled by borrowers. Underwriting of the issuance, rating, primary dealership and liquidity in the secondary market are few concerns of a corporate bond issuer.
Bonds provide investors with significantly higher protection from information imperfections that characterise financial markets, primarily on account of repayments covenants and route of recourse available for investors. Moral hazard is limited since the borrower has to repay only a fixed amount as against sharing profits with the shareholders. Debt is a favoured form of investment in firms with limited track record or not listed on any exchange. Since bond investors appear before equity holders in the hierarchy of creditors, the risk of adverse selection is also mitigated considerably. This is in line with the risk averse investor community in India. However, in view of limited availability and awareness of debt instruments, low riskiness is not enough to interest investors.
The RH Patil Report on Corporate Bonds, also referred to as the “Bible of Debt Market” had cited complex stamp duty structure, lack of awareness and stringent investment norms on insurance and pension funds as key reasons for underdeveloped corporate bond markets in India. Some of the other challenges that lie ahead for an India Inc. issuer on ground include:
n Awareness: The issuers will need to educate retail investors about debt instruments and the risk associated with them. The issuer would need to have a convincing script, that communicates basic tenets of debt instruments including low risk to underlying capital and coupon pay-outs.
n Product mix: Reliance on privately placing the bonds with a selected few investors has caused corporates to issue tailor-made instruments. This trend will have to dilute and issuers would have to structure vanilla instruments meant for consumption across the investor community
n Junk bonds: Unlike high-risk penny stocks, there are no buyers for junk bonds that promise high yields. Bond issuances would need to articulate the risks and route of recovery in the event of default. Debenture trustees with power to enforce the contract would address some of the investor concerns during an eventuality.
Recent public bond issuance by DHFL attracted subscription of R19,000 crore (total issuance size: R4,000 crore). Retail participation was oversubscribed 6.18 times. Not only was the subscription rated AAA, it also had a category of Inflation indexed bonds (three-year tenor), with a lower limit to protect investors if inflation falls sharply. Inflation indexed bonds were first of their kind in India, bellwether to innovative bond markets in future. Primary bond markets in India are critically hinged on rating and built-in investor protection.
With implementation of the Bankruptcy Code and high infrastructure investment in the pipeline, we may expect India Inc. to diversify its portfolio of borrowers and thereby inject the much-awaited activity in corporate bond market. With banks coming under the asset quality radar and borrowers looking for long-term financing, bond market may begin to move northwards, even if it is in baby steps.
Indian corporate bonds would facilitate price discovery and optimising cost of capital for businesses. The role of regulators is critical to development of debt markets in India. Nevertheless, we can’t deny that participation of both lenders and borrowers will be a key determinant in evolution of Indian corporate bonds.
By Gunja Kapoor, Pahle India Foundation.