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Economic vibrancy coupled with sophisticated state–of–the–art financial infrastructure has contributed to rapid growth in the equity market in India. In terms of market features and depth, the Indian equity market ranks among the best in the world. In parallel, the government securities market has also evolved over the years and expanded, given the increasing borrowing requirements of the government. In contrast, the corporate bond market has languished both in terms of market participation and structure. NBCs are the main issuers and very small amounts of finance are raised by companies directly. The Economic Survey 2010–11, cites many reasons for the less- developed bond market in India—
(i) Predominance of banks loans;
(ii) FII’s participation is limited;
(iii) Pensions and insurance companies and household are limited participants because of lack of investor confidence; and
(iv) Crowding out by government bonds.
The Economic Survey 2011–12 concluded15 that there is now ample empirical research to corroborate Schumpeter’s conjecture that financial development facilitates real economic growth. The depth of the financial markets and availability of diverse products should, therefore, not be treated as mere adornment, but as critical ingredients of inclusive growth.
Banks in India accounted for 14.4 per cent of the financing of large firms in 2000–01, which rose further to 17.8 per cent in 2010–11. The bond market, on the other hand, has been miniscule in comparison. The thinness of the bond market has been somewhat compensated by foreign borrowing done by Indians, which rose sharply over the last decade. Further, India is characterised by a disproportionate amount of secured borrowing. The small size of unsecured borrowing may, at first sight, not seem to be a matter of concern, but it could be a reflection of the weakness of contract enforcement and lack of adequate information. If contracts were quickly enforced and lenders had information on borrowers, they would be more willing to give unsecured loans. This would give a nimbleness to the financial markets
which they presently lack.
There are many reasons why bond markets are important for an emerging economy. Prominent among these is the fact that they lead to more efficient entrepreneurship and greater value creation. When an entrepreneur takes a loan or issues bonds, all additional profit over and above the pre-fixed repayment amount accrues to the entrepreneur. So he or she is better incentivised to take sharper decisions. By having a weak bond market, we may be foregoing this efficiency. And further, this efficiency gap may well mean that there is less lending and hence less investment and entrepreneurship in the economy than is feasible. Further, as India tries to garner 500 billion dollars from the private sector in the Twelfth Plan for investment in the infrastructure sector, having an active bond market would be a valuable avenue for raising money.
There can be many reasons why, despite these advantages, the bond market has not developed adequately. One reason has to do with what economists call ‘multiple equilibria’. Consider a situation where the bond market is small. If someone buys bonds and later wish to sell these off, he anticipates difficulty. Since the bond market is not active, he may not easily be able to sell the bonds and thus he will hold simply because he cannot find a buyer. Hence, this may lead to discourage someone from buying the bonds in the first place. If everybody reasons like this, the bond market remains thin. Hence, the need is for a push that nudges the market to another equilibrium, where people readily buy bonds because they know that they can easily sell these off and this becomes a self-fulfilling prophesy and sustains the large bond market.
There is effort currently on to try to boost India’s debt and bond markets, and success in this can give another fillip to growth. With the intervention of the Patil Committee (2005) recommendations, the corporate bond market is slowly evolving. With bank finance drying up for long term infrastructure projects, in view of asset liability problems faced by the banking system, the need for further development of a deep and vibrant corporate bond market can hardly be overemphasised. Recent initiatives for further development of corporate bond markets, taken in the year 2012–13 are as given below :
(i) Banks allowed to take limited membership in SEBI-approved stock
exchanges for the purpose of undertaking proprietary transactions in the corporate bond markets.
(ii) To enhance liquidity in the corporate bond markets, the IRDA has permitted insurance companies to participate in the repo market. The IRDA has also permitted insurance companies to become users of ‘credit default swap’ (CDS).
(iii) The minimum haircut16 (i.e., the difference between prices at which a market maker can buy and sell a security) requirement in corporate debt repo have been reduced from the existing 10 per cent; 12 per cent; 15 per cent to 7.5 per cent; 8.5 per cent; 10 per cent for AAA/AA+/AA-rated corporate bonds.
(iv) MFs have been permitted to participate in CDS in corporate debt securities, as users.
(v) Revised guidelines on CDS for corporate bonds by the RBI provide that in addition to listed corporate bonds, CDS shall also be permitted on unlisted but rated corporate bonds even for issues other than infrastructure companies.
(vi) Users shall be allowed to unwind17 their CDS-bought position with the original protection seller at a mutually agreeable or FIMMDA (Fixed Income Money Market and Derivatives Association of India) price. If no agreement is reached, then unwinding has to be done with the original protection seller at FIMMDA price.
(vii) CDS shall be permitted on securities with original maturity up to one year like CPs, certificates of deposit, and non-convertible debentures with original maturity less than one year.
Till March 2017, the RBI has taken a number of measures to strengthen the corporate bond market in India. It accepted many of the recommendations of the Khan Committee (August 2016) to boost investor participation and market liquidity in the corporate bond market. The new measures as announced by the RBI include:
(i) Commercial banks are permitted to issue rupee-denominated bonds overseas (masala bonds) for their capital requirements and for financing infrastructure and affordable housing.
(ii) Brokers registered with the Securities and Exchange Board of India (SEBI) and authorized as market makers in corporate bond market permitted to undertake repo/reverse repo contracts in corporate debt securities. This move will make corporate bonds fungible and thus boost turnover in the secondary market.
(iii) Banks allowed to increase the partial credit enhancement they provide for corporate bonds to 50 per cent from 20 per cent. This move will help lower-rated corporates to access the bond market.
(iv) Permitting primary dealers to act as market makers for government bonds, to give further boost to government securities by making them more accessible to retail investors.
(v) To ease access to the foreign exchange market for hedging in ‘over the counter’ (OTC) and exchange-traded currency derivatives, the entities exposed to exchange rate risk allowed to undertake hedge transactions with simplified procedures, up to a limit of US$30 million at any given time.