Corporate bond spreads widen 30-35 basis points in July over G-Sec

Spreads between the 10-year government bonds and equivalent maturity corporate bonds widened in July as economic activities picked up pace and companies headed towards the bond market to raise resources at a time when banks still remained risk-averse in lending.

The rise in the spread is visible across rating classifications, AAA to BBB-, by 31 to 36 basis points (bps), or 0.36 percentage points, indicating that firms will now have to pay higher cost to raise money from the markets.

Bond dealers say the spreads will likely rise in the future as the Reserve Bank of India (RBI) manages the government borrowing programme by keeping yields low through regular secondary market bond purchases, but the corporate bond market won’t get an equivalent amount of support.

Corporate bonds are driven mainly by two factors — domestic liquidity and foreign portfolio flow. At Rs 5.5 trillion of excess liquidity, the system has more than adequate liquidity, but foreign portfolio investors (FPI) are taking away money from domestic debt on a net basis since the fiscal year 2018-19.

In 2020-21, FPIs brought in a net $36.18 billion of funds in the domestic market. But they had taken out a net $6.7 billion from the debt market, including government debt, state development loans, and corporate bonds. In this fiscal year, FPIs have liquidated over $1 billion of their investment in debt on a net basis.

In the case of corporate bonds, FPIs have utilised just about 22 per cent of their overall limit of Rs 5.74 trillion, the data shows. The outflow from the debt segment, particularly the corporate bond segment, would likely be even more this year as the US Federal Reserve talks about rate normalisation.

“The flows to the emerging markets will get impacted this year as the large-scale fiscal spending on infrastructure in the USA would open up several opportunities for investors. Hence, the FPI flows to India would be lower than last year and our expectation is that they could be in the region of $18-22 billion. Here, too, the flow will be more to equity than debt,” said Madan Sabnavis, chief economist of CARE Ratings.

There was a rapid transmission of policy rate cuts of the RBI during the pandemic period. In response to the RBI’s 135 bps rate cut, the five-year AAA-rated corporate bond yields had fallen 175 bps, showed RBI’s July bulletin.

“The fall was sharper for the corporate bonds as the liquidity was plentiful. Through long-term repo operations (LTRO) and its various forms, the RBI went into overdrive to bring down the borrowing cost for the corporate sector. This year, those facilities are not there, and the firms also do not need money immediately other than for working capital. And hence, some readjustment in spreads can be expected,” said a corporate bond arranger.

The huge liquidity overhang last year benefitted the highest-rated firms the most last year. AAA-rated commercial papers maturing in three months were being raised for rates below 3 per cent, which is even below the overnight reverse repo rate (3.35 per cent) of the RBI. The rates have since then hardened and are now a little below the repo rate of 4 per cent for the same firms.