The biggest stumbling block to boosting liquidity is that insurance companies and pension funds hold on till maturity
Three Indian subsidiaries of Vodafone recently mopped up some Rs 7,700 crore via bonds; the amount was a small one for the telecom behemoth but caused a bit of a stir in the usually quiet corporate bonds market. While volumes in this space now average Rs 6,000 crore a day, they’re not much larger than they were some time back; also, it’s miniscule compared to what companies need. But the market today is in a sweet spot. With banks refusing to drop loan rates, companies prefer bonds. And with interest rates across the world way lower than in India—yields for AAA paper are at 8.50%—foreign investors are flocking here; over the past year, they have increased their holdings by $20 billion.
That can be seen in the numbers: last fiscal; Rs 4.04 lakh crore of corporate bonds were privately placed, a 90% jump in five years. And in the last six months, companies have mopped up Rs 2.6 lakh crore. For perspective, outstanding loans to the corporate sector at the end of June stood at Rs 26.30 lakh crore and accounted for approximately 40% of total loans.
However, daily turnover in the secondary market, crucial for imparting transparency in pricing and an exit option, has increased by a measly 10% to Rs 6,000 crore. Usha Thorat, former deputy governor of the Reserve Bank of India (RBI) and a member of the first committee tasked with suggesting ways to develop the corporate bonds market says the first step is to increase liquidity. “Although growing annually by more than 20%, the market remains largely one in which paper is privately placed,” Thorat observes.
The biggest stumbling block to boosting liquidity is that the biggest investors—insurance companies and pension funds—buy paper and hold on till maturity. The committee, headed by RH Patil, had suggested bonds be compulsorily listed to boost liquidity and transparency since mutual funds and foreign investors would be more comfortable. “The limitation of the market is the abysmal lack of liquidity and depth and this is the biggest deterrent for us,” says Leo Puri, MD of UTI Asset Management, who oversees more than Rs 60,000 crore worth of debt assets.
Quantum of Solace
Arun Srinivasan, who oversees fixed income investments of ICICI Prudential Life Insurance Company as executive vice president, offers two solutions. Provide an anonymous trading platform and nudge companies to re-issue existing bonds. “If we want to buy a 10-year government bond, the choice is between two papers but there are at least 10 corporate bonds from the same issuer,” Srinivasan explains, thus robbing them of liquidity. Umesh Rewankar, MD and CEO of Shriram Transport Finance Corporation, which borrows regularly through public issuances of bonds in addition to private placement, believes as more and more public issuances are launched, retail investors would also invest given that bonds typically provide higher returns than bank deposits.
Market makers akin to primary dealers in the government bond market could also help. Shashikant Rathi, senior vice-president and head, investments, ALM and capital markets at Axis Bank believes intermediaries such as Axis Bank, Edelweiss Securities, A.K. Capital and other such bond houses can take on the role of market makers and provide liquidity. “The market requires psychological comfort in the beginning,” Rathi explains. The Patil committee had recommended as much along with changes in taxation, a trading platform and mandatory listing. But little has happened.
The single most worrying factor for any bond investor even today is a hassle free exit and the absence of hedging instruments to guard against interest rate and credit risks. Mutual funds, FIIs and even some banks and bond houses struggle to find willing buyers in bearish times, thus risking losses on their trading books.
Market players advocate introducing credit default swaps (CDS), allowing banks to offer guarantee to corporate bonds in order to up the rating. The Clearing Corporation of India will host a trading platform for interest rate swaps from August onwards. “I think that CDS market should be kick-started. You never know what wags what. The futures market may boost the cash market,” observes B Prasanna, MD, ICICI Securities Primary Dealership that helped arrange issuances worth more than R10,000 crore since April and is number three in the league tables.
Buyers do not have the confidence to put money into first time issuers since recovery—should the company run into trouble—is a problem in the absence of a bankruptcy code. Large balance sheet distress also leaves investors shy of picking up any new paper rated below AAA. As Thorat say, there is a need for a bankruptcy code as SARFEASI is not applicable for corporate bonds.
Today, if a firm defaults creditors are left high and dry. Which is one reason why—unlike in the US or even in Malaysia and Thailand —companies with ratings of below AA struggle to raise funds. The market for sub-investment grade is non-existent. Insurance companies by rule can invest only in papers rated up to AA.
Tomorrow never dies
But there’s hope. Puri of UTI AMC points out that the RBI’s move to lower the banks’ requirement to hold gilts will nudge investors towards corporate bonds.
Also as Rathi of Axis Bank says, it’s easier to strike deals via placements since regulators have eased the norms.
That’s clear from the many issuers in recent times, many first-timers: Hindalco, Vedanta, JP Associates, Kesoram, Piramal, Tata Power, Tata Motors and Reliance Jio all debuted over the last two years. Even those with lower ratings such as Dalmia Cement and Talwalkars wet their feet in 2014. This was partly triggered by the introduction of the base rate system which disallowed banks from lending below a certain rate. That gave bonds a clear cost advantage over bank loans as yields reflected the changes in policy rates far more quickly—in 2014-15 bonds were cheaper by as much as 100-150 bps. If this trend holds, bonds will take off but only for top-rated firms. For the rest though, it could be a long while before they bond with investors.