Treasury Today Country Profiles in association with Citi

India’s corporates yearn for deeper bond markets

Taj Mahal, India

According to a recent report by an Asian industry body, India urgently needs to overhaul its bond markets to help companies access funding as the country continues to grapple with twin fiscal and trade deficits.

Over the past decade, India has emerged as one of the key markets in Asia. However, comparatively shallow capital markets continue to impede companies needing access to low-cost finance. It is an issue which has become particularly acute of late given the various macroeconomic difficulties the country’s economy is now facing.

When compared with neighbouring economies within the Asia-Pacific region, it is clear India lags some way behind in terms of the size of the corporate bond market. The corporate bond markets of Malaysia, South Korea, Thailand, Singapore and China each exceed that of India as a percentage of GDP, according to data from Asia Securities Industry & Financial Markets Association (ASIFMA). Of the major economies in the region, only Indonesia has a shallower market for fixed-income corporate debt, the figures reveal.

“In India, the government is a very big issuer, and that tends to crowd out a lot of private sector borrowing,” Vijay Chander, Executive Director for Fixed Income at ASIFMA told Treasury Today. But it is also a bit of a “chicken and an egg” question, he goes on to explain. When an economy has an underdeveloped capital market, non-financial corporates tend to rely heavily on their banks for their financing requirements. Meanwhile, the banks must comply with a Statutory Liquidity Ratio (SLR) which compels them to “buy and hold” a large portion of Indian government bonds, which ultimately crowds out the corporate sector.

The situation poses a huge problem for companies in India. As we have seen in Europe and the US over the past several years, when banks tighten lending, corporates can often find cheaper and more readily available sources of funding on the capital markets. But in India – which has long been a high interest rate country – corporates are forced to rely almost exclusively on the banks for their funding needs. “As a result, when corporates invest in capex they tend to have to pay high rates to borrow,” says Chander. “Of course the larger corporate groups will have good relationships with their bankers and may be able therefore to negotiate better rates, but nevertheless it is not beneficial to them to have to rely so heavily on banks as the major source for financing their business.”

Building a better bond market

One source of comfort for corporates is that the Reserve Bank of India (RBI) recognises that there is a problem and has been reasonably proactive recently in attempting to address it. There are plans to introduce 10-year interest rate futures in order to address the concerns of market participants who could end up with illiquid bonds in the existing delivery based 10-year interest rate futures contract. “That will help,” says Chander. “If banks can trade government bonds and not have to hold to maturity that should free up some capacity to lend to corporates.”

There is a lot more work to do, however. There are signs of a market for high yield corporate debt beginning to develop and easing investment restrictions for pension funds and other institutional investors could help to broaden the investor base and improve liquidity in this nascent sector of the market. In addition, the investor base could also be widened by meeting the need for an international settlement and financing of local bonds. “To further integrate the Indian financial market within the international marketplace, CCPs such as the Clearing Corporation of India will have to be internationally recognised by the European Securities and Markets Authority (ESMA) in order to provide clearing services for all market participants,” ASIFMA states. Chander therefore thinks that it is encouraging that India has applied for recognition by ESMA as any European domiciled bank will need approval from the body in order to trade on an Indian clearing platform.

Finally, ASIFMA would like to see greater development of the ‘classic’ repo market. This is an important component for creating a deep, liquid market not just for government debt but also corporate bonds. Again, ASIFMA is generally supportive of the RBI’s efforts in this space. The RBI has developed instruments such as Collateralised Borrowing and Lending Obligations (CBLOs), which are traded over electronic platforms; however, these are not used in the corporate debt space. “The problem is that it’s only applicable to government bonds,” says Patrick Pang, ASIFMA’s Managing Director of Fixed Income and Compliance. “There is not really a platform for executing trades of repos over corporate bonds.” To enhance transparency and, therefore, liquidity, ASIFMA believes in the development of a ‘classic’ repo market that features the true-sale of collateral and the use of GMRA documentation supported by clear rules on close-out netting on bankruptcy.