Govt moving to energize sluggish corporate bond market
September, 07th 2009
India's latest moves to revitalize its lacklustre corporate bond market are expected to attract more investors and give cash-strapped companies better access to financing, but market watchers say further steps such as tax reform would give an even bigger boost to activity.
Trading in interest rate futures began last week and Finance Minister Pranab Mukherjee said in August the government may soon allow repurchase deals (repos) on corporate bonds, which would enable investors to borrow short-term funds by pledging securities as collateral.
The absence of a vibrant corporate bond market has largely limited Indian companies to equity and bank loans for funding, meaning financing for the costly, long-term infrastructure projects that India desperately needs has been hard to come by.
"If more trading in corporate bonds takes place, if there's more liquidity, it would be easier for companies to raise funds," said D.K. Joshi, Principal Economist with rating agency CRISIL.
An underdeveloped corporate bond market has also meant that companies with long-term liabilities, like those in the insurance industry, have few investment choices, unlike their counterparts in other emerging market powerhouses such as China, where bond markets are slowly thriving amid a steady flow of reforms.
Government efforts in recent years to launch an order-matching dealing system and a settlement platform have fizzled, and India's $200-million-a-day corporate bond market remains dominated by issues from banks and state-run companies.
India has been taking gradual steps to add depth to its financial markets, though local and foreign investors say it still has a long way to go to catch up with other countries.
The government has also sought feedback from bankers on the possibility of scrapping the 20 percent withholding tax on interest earned by foreign investors in local bonds, which could lure more overseas players to the corporate bond market.
Analysts say a similar measure by South Korea in May has already helped it attract more foreign money. Net purchases of Korean bonds by foreign investors rose to 9.5 trillion won ($7.7 billion) in June, from 3 trillion won in May.
"I have raised this with the regulators. So, hopefully there should be some steps coming up in the next three to six months," said Jayesh Mehta, managing director and country treasurer at Bank of America.
"Authorities have been taking a lot of market feedback. Its just a question of time. It will change the scenario for corporate bonds."
Indian companies sold about $42 billion in bonds in the 2008/09 fiscal year. By comparison, South Korean companies listed local currency bonds worth about $185 billion in 2008 and Chinese firms sold $132 billion.
CHEAPER TO TAKE OUT A LOAN
The launch of repos would make it easier and less expensive for smaller firms to raise funds and make the market for corporate bonds more liquid, ensuring a vital flow of supply and demand.
"Right now, an illiquid market makes the yield curve steeper. This restricts investors' ability to raise funds through corporate bonds," said Mahendra Jajoo, head of fixed income and structured finance at Tata Mutual Fund.
Among private companies, a few big blue-chip firms such as Reliance Industries are able to raise funds in the debt market at relatively cheap rates, but there has been little investor appetite for other issuers and pricing is unattractive.
A company with an "AA" rating might need to pay interest of as much as 14 percent a year to sell a five-year bond in India, compared with 11-12 percent on a bank loan. A similar issuer in South Korea would pay around 6.4 percent. .
"The capacity of lower-rated companies to borrow remains low," said S. Krishnamurthy, treasury head of cement maker ACC Ltd, which issued 2 billion rupees of bonds in December 2008.
And equity can be cheap, with Indian stock valuations among the highest in Asia.
A flood of government bond issuance to fund stimulus spending programmes, meanwhile, is also threatening to crowd out private-sector borrowers, while a lack of market depth and limited variety of products has kept investors away.
However, some market watchers say the logjam in the corporate bond market is slowly breaking apart as private companies attract investors by offering higher returns.
Recent issues from the non-bank private sector include Punj Lloyd, which raised 6 billion rupees ($123 million) of three- and five-year bonds. The coupon rate on the company's bonds was about 150 basis points higher than those offered by state-run firms.
Tata Steel raised 5 billion rupees in a domestic 10-year bond issue in May. But secondary market liquidity in Tata Steel's bond, as with other corporate issues in India, remains thin as bond investors -- banks, insurers and pension funds -- typically buy and hold.
"The first step is a very well-defined yield curve, which India has for the government bond market," Ranodeb Roy, Morgan Stanley's Head of Interest Rate, Credit and Currency division for Asia Pacific, said recently.