The somnolent Indian corporate debt market is set for some serious rousing as the finance ministry is working towards significantly bringing down the stamp duty rates on debt instruments to a mere one-sixth of the current rates.
Once through, the move would translate into the highest stamp duty on debentures going down to 0.0625% from the current 0.375% ad valorem (or as a percentage of issue size). The stamp duty on promissory notes would also go down from 0.05% to a miniscule 0.0083%.
The proposal, in line with global practices, would bring down the cost of issuing these papers and eliminate the arbitrage that currently exists because of the inter-state variations. The reduction in duties would also help India Inc raise funds domestically, as corporate bonds would become relatively more attractive compared to government bonds, which are cheaper as they are exempt from paying stamp duty. This would come as a much-needed fillip to the corporate bond market, which is still small as compared with the equity market in India. While the country?s stock market capitalisation as a percentage of GDP rose to 108% since 1996, the bond market increased to a mere 43.4% of the GDP, according to a recent ADB report. Within the bond market, the corporate bond market stands at an insignificant 3.2% of the GDP. Government bonds make up for most of the issuances, at 38.3% of the GDP.
In fact, India?s corporate bond market lags behind those in most emerging East Asian countries (see chart), with Vietnam and Indonesia being the only two countries where corporate debt issuances are lower than India. Apart from boosting corporate interest in the domestic debt market, the stamp duty cut is also expected to encourage retail investors look at the debt market more closely, though experts point out that it will take a lot more to generate genuine retail interest.
For instance, cumbersome regulatory requirements for public issue of corporate debt means companies prefer using the private placement route. If the private placement is done with 49 investors or less, a company can raise money much faster rather than file multiple documents with the regulator and await approval. In the first three months of 2008 alone, companies privately placed debt of nearly Rs 35,000 crore, while no public issues took place ? leaving the retail investor out of the market.
Prithvi Haldea, managing director Prime Database, points out: ?At present, most companies raise funds through institutional markets as these have easier regulatory requirements. But to encourage retail investors, the government will also have to make the debt market more efficient, simplify disclosure norms and also come out with a mechanism for retail distribution.?
While North Block has been working on rationalising the stamp duty rates and making them uniform all through the country for some time, it is only now that it is taking a call on a new rate structure. To expedite the process and to ensure cooperation of the various states, the matter is likely to be entrusted to the empowered committee (EC) of state finance ministers. The terms of reference of the EC is being suitably amended to incorporate this additional mandate.
The EC is responsible for coordination and consensus amongst states on a number of taxation related issues such as value added tax, central sales tax and the proposed goods and services tax. It will also have to sort out the issue of compensation for states as the proposed rationalisation is expected to lead to substantial revenue losses for many of the states. ?Since stamp duty is mainly a state subject with different states levying the duty at different rates, it is necessary to bring a consensus amongst them on the issue before we can go ahead with it,? a source close to the development said.
Finance minister P Chidambaram in the Budget had proposed to have ?a seamless national market for securities? and had said he would request EC to work with the Centre to create a pan Indian market for securities. In its effort to expand the corporate bond market, Budget 2008-09 has already exempted corporate debt instruments issued in demat form and listed on stock exchanges from tax deducted at source. However, analysts feel that only the rationalisation of stamp duties will not help deepen the corporate bond market and other issues also need to be addressed. ?By rationalising the duties, the government will remove a major impediment for developing the domestic market. But other measures such as allowing greater foreign inflows are also needed,? Abheek Barua chief economist, HDFC Bank said.
?While a cut in stamp duties will help, the government needs to implement the Patil Committee recommendations, many of which are still pending such as bringing all players on a common trading platform,? Haldea stresses.
The RH Patil committee on corporate bonds and securitisation had originally suggested that stamp duties on various debt instruments be rationalised and made uniform. Two other high-powered committees have also pushed for reforms in the debt market that would help in raising funds required for key areas such as infrastructure.
The Percy Mistry committee report on making Mumbai an International Financial Centre has also the ?missing? markets for debt, currency and derivatives, and the inadequate universe of institutional investors that are strategic weaknesses in the country?s financial sector. Raghuram Rajan committee on financial sector reforms has proposed a number of changes such as encouraging domestic institutions such as pension funds and insurance companies to invest in corporate bonds, increasing the foreign investment limit in these bonds, lowering their issuance cost and reducing the preference of banks towards loans to bonds. It had suggested eliminating restrictions on participation of foreign investors in the domestic corporate bond market, reducing transaction costs along with cutting down the stamp duty.