Besides the fiscal stimulus and concessions, what the economy really needs for long-term growth is a more liquid and deep corporate bond market.
Current debates around job creation and growth numbers in India suggest a slight slowdown of the economy. Besides the fiscal stimulus and concessions, what the economy really needs for long-term growth is a more liquid and deep corporate bond market. The fundamental issue that currently plagues the economy is the heavily-leveraged corporate balance sheets that have created such high interest servicing costs that corporates have little money left to invest in new business, which in turn has slowed job creation. An efficient corporate bond market would help companies to raise capital in the primary market and help investors to trade in and out of risks in the secondary market. The old-school way of bank lending by a select few banks funding corporate balance sheets in India must be slowly phased out in favour of a more structured market. A fully functioning corporate bond market would have the following advantages:
1. Lower credit costs across the spectrum: Currently, given the relative illiquidity in the corporate bond market in India investors charge an “illiquidity premium” from the issuer due to the difficulty in exiting investments. A liquid secondary corporate bond market will lead to a gradual decline in borrowing rates as investors demand less of the “illiquidity premium”. Interest servicing costs will go down, allowing money to be reinvested in new projects that create jobs.
2. Better demarcation of credit quality: A liquid and transparent secondary corporate bond market will make more information available to investors to judge individual credit risk, thus leading to better demarcation between good-quality and poor-quality balance sheets. Investors can continue to lend to deserving businesses while businesses are incentivised to keep the quality of the balance sheet high. The current situation of direct bank lending creates a distortion in incentives for corporations. This also leads to deserving businesses not getting access to credit due to the market clubbing good credit with bad given that it has little in the way of measuring credit quality. Increased transparency with a liquid and deep corporate bond market brings down the cost of credit in the economy and helps efficient projects get funded.
3. Wider investor base: A well-developed corporate bond market allows a wider investor base to access the market, with each investor holding a smaller proportion of the total risk. The diversity of investors implies diverse balance sheets with varied asset-liability structures, thereby providing corporations access to the right mix of capital in terms of both structure and duration. Currently, banks with extremely short-dated liabilities are unable to fund long-dated assets, creating inefficiencies and slowing economic growth.
The implementation of the bankruptcy law and the crackdown on shell companies by the government are right steps towards creating an efficient capital market and corporate bond market. A transparent corporate structure will create an efficient capital market for sure, but a lot more needs to be done. Rules on accounting results need to be made even more stringent. The market needs to have faith beyond doubt in corporate results. Concurrently, India needs to deepen the government bond market, which will serve as the benchmark for the corporate bond market.
Additionally, both global and domestic institutional investors must be incentivised to participate in corporate bonds through regulations that make it easier and attractive to invest in corporate bonds. We also need to make the issuing of corporate bonds more attractive by lowering the regulatory costs involved, hence encouraging medium-sized corporates to issue bonds. A deeply liquid and functioning corporate bond market will be an essential pillar to propel the Indian economy forward in the coming decades.