The decade-old struggle to breathe life into the moribund corporate bond market in India continues. The policy, apparently being considered by the Union finance ministry, to allow banks to offer bank guarantees for domestic debt issues, seems eminently sensible in theory. Bank guarantees help improve the risk profile of a company and enable it to access the market at cheaper rates. However, this is not the first time that the government has tried to kick-start the corporate debt market. The aggregate limit for foreign investors, to take an example, was raised by $5 billion to $10 billion in November. Yet, if the track record of these earlier initiatives is anything to go by, there appears to be little reason to be too optimistic about the efficacy of another attempt to expand this market.
What ails the Indian corporate bond market? Why does it refuse so resolutely to rise from its sick-bed? At a fundamental level, the absence of a well-defined, risk-free yield curve that typically underpins all debt issues is perhaps the biggest constraint. Central government bonds define this “risk-free” rate. The irony is that while the large fiscal deficit ensures a large supply of sovereign paper and large trading volumes, they are confined to select tenors and “on the run” bonds. For other tenors and papers, volumes are pitiably small and thus a representative yield curve with adequate volumes at each tenor has failed to evolve. Why? For one, there has been little effort to dovetail the government’s borrowing programme to the objective of building a comprehensive yield curve. RBI has preferred not to extinguish illiquid bonds and re-issue the more liquid ones to consolidate the yield curve. The government, on the other hand, has used its position as monopoly-issuer to offer bonds only for the tenors that it has found attractive. These have not necessarily been the ones that would help deepen the market. Besides, the lack of a diverse investor base has also held this market back. Insurance and pension funds usually provide the bulk of the demand for long-term debt raised for things like infrastructure projects. Yet insurance companies or provident funds are restricted to investing only in debt that is of the highest investment grade. (For insurance companies only debt instruments rated AA and above are eligible for investment under the “Infrastructure and Social Sector”).
Some dilution of these norms is imperative if indeed the government is serious about this market. Banks could also potentially be big players in this market. However the heavy draft through the statutory liquidity ratio (SLR) that forces banks to hold 24 per cent of their deposits in central government debt. Unless this changes (AAA corporate bonds could be given SLR status), banks simply do not have the kind of spare cash they need to make significant investments in corporate paper. In short, the institutional changes needed to foster a healthy corporate debt market are significant. Yet the policy approach to this market has been piecemeal and timid. Unless the government and the central bank are prepared for a serious overhaul of India’s debt market as a whole, relatively minor steps like allowing bank guarantees are likely to have only minimal impact.
