India Inc faces costlier borrowing as corporate-govt yield gap widens

The yield spread between the AAA-rated 5-year corporate bond and the 5-year government bond narrowed by 7 basis points in August

Indian companies are staring at an increase in their cost of borrowing this festival season, with the spread between yields on corporate and government bonds beginning to widen.

In what could be early signs that borrowing was getting costlier for companies, the yield spread between AAA-rated corporate and government bonds has widened by 2 basis points and 4 basis points, respectively, for 3-year tenure and 10-year tenures in September so far. The spread for the 5-year tenure has remained unchanged.

By comparison, in August, the spread between the AAA-rated corporate bonds and the corresponding government securities had narrowed amid tighter liquidity concerns. The yield spread between AAA-rated 5-year corporate bonds and 5-year government bonds had narrowed by 7 basis points, whereas the spread for 3-year and 10-year bonds had narrowed by 2 basis points and 5 basis points, respectively.

Corporate bonds typically command higher prices than government securities. This premium, referred to as the spread, reflects the disparity in the yields between corporate bonds and government securities with matching maturities. The spread serves as compensation for the increased default risk usually associated with corporate bonds.

“The spread may increase due to tight liquidity. Also, after the Shapoorji Pallonji deal, there may be demand for higher yield as that paper is trading in the market at 16 per cent. Credit growth is there, and besides banks, non-banking financial companies (NBFCs) are trying to tap the market through various sources,” said Venkatakrishnan Srinivasan, bond market veteran and founder of Rockfort Fincap. “The extent of the widening of the yield spread will depend on the supply-demand factor,” he further said.

In July, Shapoorji Pallonji Group raised Rs 14,300 crore from a clutch of investors at 18.75 per cent by issuing BBB- bonds.

With tax outflow starting from September 15, coupled with credit demand during the festival season, the spread is likely to rise. NBFCs are looking to tap the bond market to raise funds to meet their credit disbursement requirement.

“Corporate bonds in both AAA and credit space continue to trade at compressed spreads. With the approach of the busy season and lower net government borrowing in H2 (October-March), these spreads could face upward pressure,” stated a report by Bandhan Mutual Fund.

According to the existing schedule, the central government aims to borrow a total of Rs 15.43 trillion through bond sales in the current financial year, with approximately 42 per cent of this amount planned to be borrowed during the October-March period.

“The yield spread may widen if there is liquidity shortage, but going forward, far from here, they (yield) will remain high for longer. The yields are not expected to come down anytime soon, but also they will not move up significantly,” said Ajay Manglunia, managing director and head Investment grade group at JM financial.

The surplus liquidity in the banking system fell to Rs 41,706 crore on Monday, against Rs 86,093 crore on Sunday, despite the Reserve Bank of India’s decision to discontinue the incremental cash reserve ratio (I-CRR). The funds that were impounded will be returned to banks in a phased manner ahead of the festival season, during which demand for cash rises.

Of the total I-CRR maintained, 25 per cent will be disbursed on September 9, another 25 per cent on September 23, and the remaining 50 per cent will be released on October 7.