Economics Prelims cum Mains

Why a corporate bond market

Context of the topic:

  • In this year’s Budget, Finance Minister Nirmala Sitharaman has announced fresh measures to boost the development of India’s corporate bond market.

Theme of the topic: The topic analysis the need in India for a well developed bond market, and the measures being proposed for that.

 

What are corporate bonds?

  • Corporate bonds are debt securities issued by private and public corporations.
  • Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business.
  • When one buys a corporate bond, one lends money to the issuer (the company that issued the bond). In exchange, the company promises to return the money, also known as principal, on a specified maturity date.
  • Until that date, the company usually pays a stated rate of interest to the buyer, generally semiannually.
  • While a corporate bond gives a bond contract from the company, it does not have an ownership interest in the issuing company, unlike when one purchases the company’s equity stock.

What is the importance of a corporate debt market?

  • Corporate debt market enables companies to raise funds across different maturities including for infrastructure projects with long gestation periods.
  • In India, there is absence of a well functioning corporate bond market, which puts the burden of financing infrastructure projects such as roads, ports, and airports more on banks and the general government.
  • This, in turn, puts lenders such as the banks under pressure as reflected in the ballooning of bad loans.
  • For example, in banks, such investments create an asset-liability mismatch i.e. they are buying into long-term assets, such as a highway, with short term liabilities, that is deposits of three- to five-year maturities.
  • Eventually, this not only results in inefficient resource allocation but also weakens the bank balance sheets.

 

Background:

  • Despite many efforts by the policymakers over the last three decades, growth has been stunted in the development of the corporate bond market.
  • Successive budgets and at least half a dozen committees mandated by the government, the RBI and the Securities and Exchange Board of India (SEBI) to work out measures to develop this market have largely failed.
  • This called for the need of fresh measures to boost the development of India’s corporate bond market by the government.

Why has the Indian corporate bond market failed to take off?

  • Narrow investors base in the corporate bond market. This, in turn, leads to lower volumes of their trades compared to the other segment of the capital market.
  • FPIs are now prominent buyers of top-rated bonds but these investors do not trade but hold these investments until maturity.
  • With few buyers in the market or market makers who offer buy or sell quotes constantly, there is little liquidity.
  • To both save time as well as avoid greater disclosures, a majority of the bonds issued by companies are privately placed with a select set of investors in India rather than through a public issue.
  • Also, the development of a corporate bond market is conditional upon a well-developed and liquid government bond market. This is because, a market-determined risk-free (government) yield curve is needed to serve as a benchmark for pricing corporate bonds.

 

Proposed measures by the Finance Ministry:

  • An action plan to deepen the market for long term bonds, with a specific focus on the infrastructure sector will be put in place. These includes deepening markets for corporate bond repos, credit default swaps etc
    • Credit default swaps will mean protection against the possibility of a company or issuer defaulting on a repayment option and thus offering comfort to an investor willing to take a risky bet and, in the process, adding volumes.
  • Foreign Portfolio Investors (or FPIs) will also be allowed to invest in debt securities issued by Infrastructure Debt Funds.
    • This step should help offer an exit option for such investors and improve liquidity.
  • A Credit Guarantee Enhancement Corporation, for which regulations have been notified by the RBI, will be set up in 2019- 20.
    • The proposed new corporation will help companies to boost their credit rating, which, in turn, will enable them to raise funds at cheaper rates.
    • By allowing repurchase agreements or repos (that allow a company to raise funds by offering its securities and agreeing to repurchase it later) in AA rated bonds or securities, volumes could go up in the corporate bond market.
    • It can also help improve liquidity especially if the RBI, like many other central banks of the world, uses it for its repo operations.

Other steps taken to boost the bond market in the recent past:

  • Since 2016, the RBI’s new norms make it mandatory for companies with large exposures to raise 25 per cent of their incremental or fresh borrowings from the bond market.
  • This policy has been put in place to force corporates to go to the bond market and to ease the pressure on banks.
  • Regulatory rules also make it necessary for any company that plans to raise debt funds of over Rs 200 crore to execute it on an electronic platform, which is expected to improve transparency.

Image result for corporate bond market

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