Bonding with bonds: Creating a deeper, wider market

India needs a vibrant bond market to fuel its growth ambitions but financial repression is keeping investors and issuers away

Much has been written about the corporate bond market development in the past. There would hardly be any budget speech during the last decade that didn’t announce measures to develop this market. Though there has been some progress in recent years, much needs to be done. There is no way India can meet its growth aspirations without having a deep and vibrant domestic bond market.

Let’s take the example of infrastructure development where there is a crying need for finding viable and sustainable financing options. Can banks alone do the infra financing? The answer is no. Infra project financing has an inherent asset-liability mismatch problem, which has been the root cause for banks accumulating monstrous non-performing assets. Can one depend on budgetary allocations all the time? The answer again is no. The international crude oil prices are highly unpredictable and wouldn’t always be benign to help the government to mop up extra tax revenue to fund infra projects. Add to this the concerns about inadequate public sector execution capacity, inefficiencies and the lack of financial re-engineering. Can the National Bank for Financing Infrastructure and Development (NaBFID) be the solution? To be fair, NaBFID is a newly set up institution and one has to see how it evolves. That said, the past experience with development financial institutions has been disastrous. Also, even in an optimistic scenario, NaBFID’s contribution can at best be the tip of the iceberg given its limited size and scope vis-a-vis the humongous infra funding requirements. 

In a developed and competitive debt market, G-Secs and higher-rated corporate bonds would be competing alternatives for attracting investments. The yield-chasing investor with risk appetite would prefer lower rated corporate bonds. We, however, have a totally distorted bond market because of the financial repression policy and frequent interventions by the Reserve Bank of India (RBI) in the market. Commercial banks are mandated to invest in G-Secs. The huge government borrowings from the market at artificially repressed interest rates crowd out the potential corporate bond borrowings. The financial repression policy needs to end. Let the G-Sec discover its own yield in a free and competitive market. Without ensuring this, it is futile to complain about private sector investment not picking up. True, the borrowing cost for the government will bring in fiscal discipline — something which has not been possible to achieve through various policy pronouncements and the Fiscal Responsibility and Budget Management legislation.

Enhancing the credibility of the corporate bond ecosystem through measures to increase transparency in the primary and secondary markets is important. The Electronic Debt Bidding Platform for bond issuance and the introduction of the “request for quote” mechanism for trading are welcome initiatives and need to be popularised. Debenture trustees and credit rating agencies (CRAs) — the key players in the corporate bond market— must ensure independent due diligence at the time of security interest creation, continuous monitoring of asset cover and timely action in the case of default.

The role of CRAs came in for criticism following the default by a big NBFC in 2018. Much water has flown under the bridge since then and the regulations have been tightened. Non–participation of domestic insurance companies and pension funds in the bond market is often questioned. The answer lies in further enhancing the credibility of ratings. The RBI must allow CRAs access to the Central Repository of Information on Large Credits database, which contains information about the impending default by large debtors. Allowing this access will be a public good.

At present, 95 per cent of corporate bond issuances in the country are concentrated in the top three rating categories (AAA, AA+ and AA), and 97 per cent of the trading is in these categories. Thus, most of the issuers can’t access the bond market. The situation is worse for infrastructure projects, which are in dire need of fund-raising. Infra projects have low ratings, typically BBB, during the initial phase of their lifecycle. There is an urgent need to establish a credit enhancement mechanism for such projects. Development of below AA-rated bond market requires a deeper market for repos, credit default swaps, interest rate derivatives and a growing credit-focussed alternative investment funds. Much has been said for years now but with hardly any progress. 

Unifying the regulatory regime for G-Secs and corporate bonds — both for issuance and trading —makes immense sense. G-Secs have an overwhelming presence in the debt market in India. The pricing of corporate bonds is intrinsically dependent on the presence of a continuous yield curve in G-Secs. The G-Sec market and corporate bond market are at present separated and follow different regulatory regimes. Unifying these markets and having the same regulatory regime for both will result in “economies of scale and scope” leading to greater competition, efficiency and liquidity in the markets.

The RBI came out in November 2021 with a scheme for direct retail participation through its own depository system and trading platform. This is not the right approach as it results in an artificial segmentation of investors in different types of securities. G-Sec is like any other security and with a view to facilitating greater investor participation, it should be issued and traded through the stock exchange mechanism. The country is celebrating the demat revolution — with demat accounts crossing 100 million. The government should issue G-Secs in demat so that the large number of demat holders could easily invest. Why should investors be made to open a separate account with the RBI and go through KYC checks again for investment in G-Secs when they already have a demat account where G-Secs could be held like any other security?

In fact, G-Sec-based exchange-traded funds (ETFs) should be developed to increase retail participation. The lessons learnt would help in developing ETFs for corporate bonds, thereby increasing retail participation there too. 

While ending the financial repression policy might be some time away, unification of the bond market is something that should be initiated forthwith.

The writer is a retired IAS officer and former chairman, Sebi