Late last week the PM observed that India?s infrastructure sector needed access to long-term finance facilitated by a robust domestic debt market. For some time now, there have been suggestions that the FII (foreign institutional investors) limit for investing in corporate bonds be upped from the current $15 billion. FIIs have been buying Indian paper as though it?s going out of style; between January and now they?ve picked up just under $5 billion of corporate debt and gilts together, while the cumulative number for both has crossed $12 billion. Most of the money, however, is in paper with shorter-term maturities; understandably, no one is willing to take an interest rate risk at a juncture when rates are poised to move up. The other reason, of course, is that the debt market in India, especially the corporate bond market, remains lethargic.

This, at a time when volumes in the equity markets are exploding. Data culled from the Sebi Web site indicates that volumes these days are averaging Rs 3,500-Rs 4,000 crore; that?s less than a billion dollars a day. Of course, this may be a five-fold increase over the volumes clocked four or five years back but that?s no consolation. Just for some perspective, as of 2009, the size of the worldwide bond market (total debt outstandings) was an estimated $82.2 trillion, of which the size of the outstanding US bond market was $31.2 trillion, according to BIS. Also, nearly all of $822 billion average daily traded volume in the US market takes place between broker-dealers and large institutions in a decentralised over-the-counter (OTC) market. However, a small number of bonds, primarily corporate, are listed on exchanges. Back home, too, most of the deals are put through on the OTC but since a reporting structure was put in place, a couple of years back, there?s been greater transparency. As dealers point out, at least one can figure out the spread that an AAA corporate is paying, over the benchmark gilt rate. If the corporate bond market had a little more depth, it is possible that FIIs would be willing to take longer-term bets on Indian companies. Of course, only the best names will attract their attention.

As far as attracting money for infrastructure spending goes, the other suggestion that has been doing the rounds is to allow banks to float infrastructure bonds that don?t attract reserve requirements. Since banks are by far the biggest lenders to the infrastructure space today, they could do with some respite, given that they?re in danger of creating asset-liability mismatches for themselves, lending as they are for 10 years-plus while borrowing at average maturities of three years or less. Floating non-SLR bonds or non-CRR bonds will not just bring down their cost of borrowing, it will also mitigate the potential for asset-liability mismatches, if these are issued for the longer term. But this won?t be easy to do because individuals will be reluctant to trade their three-year fixed deposits (FDs) for ten-year bonds, unless they have an exit route. Few individuals will want to hang on to the bonds for such a long time, not only because it will mean taking on an interest rate risk but also because, unlike FDs, these can?t be liquidated by paying a penalty. This is where a liquid debt market comes in. There is no reason why we can?t have a vibrant secondary market for bonds floated by banks and companies that can be traded on the NSE. Companies today are hobbled because they can?t mop up money when they want; they are forced to rely on banks, other lending institutions and the overseas markets that are only too willing to hold the bonds till maturity. Since the coupon on most bonds is usually attractive, there is little incentive to trade.

Individuals today are exposed to the corporate and government debt market primarily through mutual funds and insurance firms. Some of this intermediation is quite needless and eats into the individual?s returns. Ideally, bonds should be available on tap because there are enough wealthy in this country who would love to buy Tata Steel paper, provided they were sure they could sell the paper without losing money. The same would be true of SBI paper. Today, illiquidity adds to the cost of the company issuing the bond, because the interest rate demanded by a bond investor builds in not just the premium for the risk of not being paid on time or in full, but also the risk of not being able to resell the bond for what it is worth. This needs to change.

The biggest obstacle, as far as corporate bonds are concerned, is the stamp duty, which varies from state to state and the ease of transactions is essential if the market is to work. Also, paper could be standardised without put and call options and a fixed interest rate again perhaps to facilitate more transactions. India may be close to becoming a $2 trillion economy, but without a vibrant bond market, it could be a while before we?re on our way to becoming a $10 trillion economy.

shobhana.subramanian@expressindia.com