R Gandhi: Corporate debt market: what needs to be done - a
reaffirmation
Inaugural address by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the
"CARE Ratings Debt Market Summit - 2015", Mumbai, 23 March 2015.
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Assistance provided by Ms Anupam Sonal is gratefully acknowledged.
Good morning ladies and gentlemen!
2. I would like to thank CARE Ratings for taking this initiative of holding this Summit on
the corporate debt market. As I can see, the seminar is quite exhaustive in content and we
will be having some excellent speakers representing various segments of the industry and
hence it will be very interesting to hear their views. As a regulator, we in the Reserve Bank
do have our own approach to the development of any market, but to hear the market
participants is always important for us as it is only when we debate the issues that we can
come to a workable solution. I am sure that we will have a lot to pick up from these
deliberations that take place here today.
Corporate Bond Market in India - Current status
3. Indian Corporate Debt market has seen some growth in recent years, both in terms
of number of issues and amount. The outstanding issues which were at 12,155 as at end
March 2011 increased to 18,664 by end Dec 2014. During the same period, the amount
outstanding increased from ₹ 8,895 billion to ₹ 16,485 billion. While the types issued included
fixed rate bonds, floating rate bonds, structured notes and other types, the fixed rate bonds
were predominant both in number and value. Another characteristic of the issuances was
that almost all issuances were by financial sector entities. Yet another peculiar feature of our
Corporate Bond market is that private placements are the norm. The public issuances which
were ₹ 94.51 billion in 2010-11 increased to ₹ 423.83 billion in 2013-14, though it fell back
to ₹ 90.49 billion in the current year till Feb 2015. The private placements were
₹ 2187.85 billion in 2010-11, ₹ 2612.82 billion in 2011-12, ₹ 3614.62 billion in 2012-13,
₹ 2760.54 billion in 2013-14 and ₹ 2692.45 billion in the current year till Dec 2014. The
secondary market trading was ₹ 6053 billion in 2010-11, ₹ 5938 billion in 2011-12,
₹ 7386 billion in 2012-13, ₹ 9708 billion in 2013-14 and ₹ 10043 billion in the current year till
Feb 2015.
4. Though the above mentioned figures do indicate a healthy growth in number and
volume of corporate bond market activity, in comparison with government bonds market, the
corporate bond market is dwarfed. A comparative position of the governments bonds and
corporate bonds as on March 2013 as a proportion of GDP among the major Asian countries
in the Table (page 2), reflects India at a very low position vis a vis some of the major Asian
countries.
Indian Corporate Debt Market - An Enigma
5. Thus corporate debt market in India has been quite an enigma. We keep talking of
the issues that are in the way of its progress and the solutions that could address them. Yet,
there has been limited movement in this area despite several attempts and there is some
kind of gravity keeping us down. We had the R H Patil Committee Report on corporate bonds
and securitization of 2005 which has served as a reference point for all of us. However, the
progress in the growth of the corporate debt segment has not been too satisfactory and there
is evidently a pressing requirement to revisit this subject. There have been several
suggestions made - some have been implemented with mixed success.
6. Yet, as noted earlier, the debt market remains confined largely to financial
institutions, and corporates are not much in the picture. Even within this limited perimeter,
public issues are less frequent and the preference has been for private placement of debt
paper. This is the starting point of the puzzle which we need to analyze.
7. Another part of the puzzle relates to our own achievement. We did experience close
to double digit GDP growth in FY08 and our investment ratio was 38.1% in that year- with
financing issues not coming in the way. On the face of it one may tend to conclude
erroneously that there is no need to get too worried about the absence of development in
corporate debt market. After all, have we not got investment rate of 38.1%? The reason why
the problem does not appear to be magnified is because we are working at well below our
potential. We are not realizing that the paucity in long term resources can severely come in
the way of investment. Therefore, the question to be asked is as to for how long can we carry
on with this situation.
8. We do have fairly large numbers that are required for financing both industrial
growth of 8-10% in the next five years and funds required for infrastructure development.
Presently as industrial growth is in the phase of stagnation and infrastructure well below
satisfactory levels due to a varied set of factors around policy action, the demand for funds
has not really reached the expected levels. Evidently this should not give rise to
complacency and we should work in this period in building structures for growing our
corporate debt market.
Need to develop the Corporate Debt Market
9. The government has its own limitations when chipping in as the fiscal responsibility
targets leave little scope for finding funds. Though the commercial banks do cater to the
investment needs of corporate and infrastructure sectors, they are also reaching their own
limitations. We have gotten support from FDI and external borrowings, but they have their
own pace and size. External borrowings are a good way out when global interest rates are
low. But, the repercussions on our external debt are significant, and while we have been
permitting ECBs into various sectors, the external debt levels have been rising which has
servicing implications. Intuitively we can see that the capital market has to become
progressively more relevant in this process of garnering long term funds.
10. Economists contend that the absence of an adequately sized corporate debt market
leads to an oversized banking system in any economy. It also results in a large portion of the
lending market being excessively regulated, without being subjected to free market forces.
Such an imbalance is not desirable, because this becomes the perfect breeding ground for
crony capitalism, sloppy lending by banks and careless investments by corporates. Financing
of resources through corporate bonds rather than bank finance instills a greater sense of
credit discipline among the borrowers as the default events are captured immediately and
placed in the public domain. The disclosure requirements act as a big disincentive for default
or delayed payment. It has been observed that borrowers take the regulatory norm of
90 days period for a default to be recognised as a Non-Performing Asset as a leeway for
withholding the payment till the 89th day from the due date. On the other hand, even a single
day default by an issuer of corporate bond will be recognised as default in the market and the
information of default will be publicly available. Further, such information / risk will also be
reflected in external credit ratings and traded credit derivatives on a real time basis. Pricing
of credit also gets diluted in bank financing as credit facilities are extended not only on the
basis of credit worthiness of the borrower but also the relationship between the banks and
their borrowers. Financing through corporate bonds might remove such distortions to a large
extent as investors will demand higher coupon for issues with lower credit worthiness, while
borrowers with strong fundamentals and sound business get rewarded by lower cost of
financing. Thus there are many advantages of an efficient, well developed and liquid
corporate debt market.
11. The importance of a developed debt market viz., the corporate debt market for a
country like India, which has an huge and ever growing capital funding requirement is widely
acknowledged and although various measures on the regulatory and policy front have been
introduced in recent times, concerted efforts from all market participants is required to
develop and grow the largely untapped potential of the country's corporate debt markets.
Expert Committees
12. In India, progressively, a number of Committees and Groups were set up by RBI to
study the bank financing / funding patterns vis a vis the corporate funding requirements.
Prominent among them were the Tandon Committee, Chore Committee, etc. The
committees uniformly recommended that corporate reliance on bank finance for short term
recurring expenses need to be brought down. Chore Committee specifically recommended
the need for reducing the over-dependence of the medium and large borrowers - both in the
public and private sectors on bank finance.
13. More recently, a High Level Expert Committee on Corporate Bonds was set up
under the chairmanship of Shri R. H Patil which submitted its report in December 2005 and
made several recommendations including the need for rationalisation of stamp duty structure
and issuance costs, tax deducted at source, encouraging securitization, repos and CDS in
corporate bonds, enhancing issuer and investor base, simplifying issuance procedures, etc.
14. In the year 2009, the Committee for Financial Sector Reforms (CFSR) (Chairman:
Dr. Raghuram G. Rajan) also looked into the issues inhibiting the corporate debt market and
made several recommendations on similar lines. Some of the highlights were to bring all
trading related regulation within the purview of SEBI, improve coordination between various
concerned agencies where multiple regulators share concern, set up a working group on
financial sector reforms with Finance Minister as Chairman, the Committee, had
recommended the sequencing approach for corporate finance, which entails developing a
number of missing markets as well as complementary development of other sectors in the
economy for a healthy development of the corporate bond market.
Current issues
15. There are some key issues that the corporate debt market faces. They need be
tackled to facilitate improvement and growth of this segment. Foremost among these are as
follows:
a) The abysmal liquidity and the consequent lack of depth in the corporate debt
markets. The absence of a liquid corporate bond market acts as a deterrent to
investor participation. Trading in Indian bond markets are characterized by trading in
certain maturities and tendency of investors to 'buy and hold' instruments, both of
which inhibit liquidity. Here the role of institutional investors such as pension funds,
provident funds and insurance companies must be reassessed. They do need to
take some more initiative and be aggressive in actively managing their portfolios.
Their investment horizon should not be confined to AA and above only. This will add
a lot of buoyancy to the market.
b) Low investor base - The investor base in the corporate debt market is confined to
banks, insurance companies, PFs, pension funds and primary dealers. Retail
participation remains low due to absence of knowledge and understanding of bonds
as an asset class. It is imperative to consider innovative ways for expanding the
investor base. The fund management industry can contribute significantly in
attracting the retail investor to corporate debt.
c) Preference of public debt - The huge supply of government papers in the country is
one of the major impediments to growth of the corporate bond markets. Government
borrowing and thereby the supply of government papers are seen to grow unabated
year on year. We have seen that the government is progressively trying to rein in the
deficit at the absolute level which will put less pressure on the market. Also the
move of the Reserve Bank to gradually lower the SLR which can also be positive for
the corporate bond market.
d) Limited instruments and products - There is need for a wide array of instruments
and products to be available in the markets that would meet the diverse needs of its
participants. There is lack of these in the Indian context which in turn inhibits
development of these markets. CDS and IRFs have been some of the instrument
that have come in of late and it is expected that these will grow. Of late, there has
been some element of buoyancy in the IRF market which is a good sign.
Securitization of the corporate debt instruments would provide a big fillip to the
market as it would improve risk transference and diversification and provide liquidity
to the issuers.
e) Market Infrastructure also finds mention as a factor affecting corporate bond market
trading and thereby transparency and vibrancy in the market. Infrastructure facilities
such as screen based automated order matching, central clearing and settlement,
negotiated dealing system, etc. on the lines available to the government securities
market would certainly facilitate and encourage secondary market trading, enhance
market transparency and liquidity as well as develop scientific risk pricing. We need
to improve the credit rating mechanism for corporate bonds and encourage market
for lower grade ratings which inhibits the market.
f) Ease of issuances - Bond issuance is viewed as being costly and cumbersome
compared with bank lending. For it to be attractive to the issuers to approach the
corporate debt market, the ease and cost of issuance has to improve. The listing
and disclosure requirements and procedures have to be simple and less
complicated. The size, scale and tenure of issues must improve and need to be
made more attractive by encouraging public offers instead of the current preference
for private placements. It is expected that consolidation of bond issues through
reissuance/s would improve liquidity and encourage secondary market transactions.
However, care would need to be taken to prevent excessive batching of
redemptions and consequent liquidity stress.
g) Market making - The growth and development of any market is dependent on
market makers who can provide both buy and sell quotes. Although prevalent in the
government securities markets, they are lacking in the corporate bond segment.
Market makers not only assume risk, they add diversity to the markets. Therefore,
we need to develop a class of underwriters and market makers in corporate debt
bonds on the lines of Primary Dealers in the government securities market.
Policy Initiatives
16. What are we doing to tackle these issues affecting the corporate bond market?
Several measures are being undertaken at the policy level to address these. Some of the
recent initiatives by Government, the Reserve Bank, SEBI and other agencies in the direction
of developing the corporate debt market are as follows:
a) Trade reporting platform: For improving transparency, reporting platforms for OTC
trades in corporate bonds, Commercial Paper, Certificates of Deposits,
NonConvertible Debentures and securitized debt has been set up. Till recently, reporting
of trades in corporate bonds was done at three different places (FIMMDA's FTRAC,
reporting platform of NSE and BSE). Though multiple reporting platforms were
available, majority of trades were reported on FIMMDA platform and cleared through
one of the clearing houses of the stock exchanges. The reporting of secondary
market trades in corporate bonds and securitised debt by RBI regulated entities has
been shifted to stock exchanges with effect from April 1, 2014.
b) Pooling account: Clearing houses of the stock exchanges have been permitted to
have a pooling fund account with RBI to facilitate DvP-I based settlement of trades
in corporate bonds.
c) Repo in corporate bond: In 2010, repos in corporate bonds were permitted to
regulated and other RBI permitted entities. Guidelines were further relaxed in terms
of reduction of minimum haircut requirements and expanding the list of eligible
collateral by permitting short term instruments like CP, CD and NCDs of original
maturity less than 1 year. Scheduled Urban Cooperative Banks (UCBs) have also
been permitted to participate in the repo market subject to adherence to conditions
prescribed.
d) Credit Default Swaps (CDS) on corporate bonds: CDS on corporate bonds has been
permitted to facilitate hedging of credit risk associated with holding corporate bonds.
Based on market feedback, short term instruments like CP, CD & NCDs and
unlisted but rated corporate bonds have also been permitted as eligible reference
obligations.
e) Encouraging participation of banks and PDs in corporate bonds:
i. In July 2014, banks have been permitted to issue long-term bonds with a
minimum maturity of seven years to raise resources for lending to (a) long
term projects in infrastructure sub-sectors, and (b) affordable housing. These
bonds have been exempted from computation of net demand and time
liabilities (NDTL) as well as Adjusted Net Bank Credit (ANBC) and are
therefore not been subjected to CRR / SLR or priority sector lending
requirements.
ii. The Reserve Bank has issued the instructions asking banks to consider
raising Tier II capital through public issuance to retail investors.
iii. In order to encourage active participation of standalone PDs in corporate debt,
investment norms have been relaxed by allowing them to invest funds
borrowed from call money market subject to certain limits, enhancing
investment limit in Tier II bonds of other PDs / banks / FIs from 5% to 10% of
NOF and increasing the Inter Corporate Deposit (ICD) borrowing limit from
75% to 150% of NOF.
iv. Banks and standalone PDs have been allowed to become direct members of
stock exchanges for undertaking proprietary trades in corporate bonds.
v. Credit enhancement by banks - As per a recent policy announcement made, it
is proposed to permit banks to offer partial credit enhancement to corporate
bonds by way of providing funded and un-funded credit facilities for
infrastructure projects but not by way of guarantee. The final instructions are
expected to be issued shortly.
f) Foreign Portfolio Investors (FPIs):
i. Rationalisation of investment limits: FPI investment limits have been
rationalised, whereby existing limits and subdivisions have been merged in
two broad categories - government securities and corporate bonds. The
sublimits for FPIs in Government securities ($10 billion) and dated securities
($15 billion) and other categories have been merged to retain the overall cap
of $25 billion. In case of corporate bonds, the ceiling of $1 billion for qualified
foreign investors (QFIs), $25 billion for FPIs and $25 billion for FPIs in
longterm infra bonds, have been merged - retaining the overall cap for corporate
bonds at $51 billion.
ii. Rationalization of allocation of debt limits: Method for allocation of debt limits
in corporate bond market through auction has been changed. As per revised
scheme, FIIs can now invest in Corporate Debt without purchasing debt limits
till the overall investment reaches 90% after which the auction mechanism
would be initiated for allocation of the remaining limits. Consequent to the
changes, the restrictions on re-investment by FPIs, shall no longer apply in
respect of limits held / investments made by FIIs in the Corporate Debt
category, till the limits are available on tap.
iii. Withholding tax rate: The rate of withholding tax on interest payments on the
borrowings of Infrastructure Debt Funds (IDF), investments made by a
nonresident in rupee denominated long-term infrastructure bonds and interest on
FIIs' investment made in bonds issued by Indian companies and Government
securities have been reduced from 20 per cent to 5 per cent.
iv. New Foreign Portfolio Investor (FPI) Regulations: Recently, SEBI has notified
new FPI regulations to put in place an easier registration process and
operating framework for overseas entities seeking to invest in Indian capital
markets. The new regulations replace the existing SEBI regulations for FIIs
and the new class of investors, FPIs, would encompass all FIIs, their
subaccounts and QFIs.
v. The Budget for 2015-16 has proposed to extend the period of applicability of
reduced rate of tax at 5% in respect of income of foreign investors (FIIs and
QFIs) from corporate bonds and government securities, from 31.5.2015 to
30.06.2017.
g) Credit enhancement by IIFCL: It has been mentioned in the Union Budget 2013-14
that IIFCL will provide partial credit guarantee to enhance ratings of bond issues, enabling
channelization of long-term funds for infrastructure projects. IIFCL is presently undertaking
pilot transactions under its Credit Enhancement initiative.
h) Introduction of Rupee linked offshore bonds by International Finance Corporation
(IFC): With an objective to signal confidence in the Indian economy and encourage inflows of
USD in India, IFC was permitted to float a rupee linked bond overseas for an amount of
USD 1 billion. IFC received very good response and the limit has been fully utilized by IFC.
i) Domestic Issuance of bonds by IFC: Approval has also been given to IFC to issue
bonds in India worth ₹ 15000 crore for infrastructure financing. This will also facilitate
development of benchmark yield for long term corporate bonds.
Way forward
17. Going forward, we expect a special impetus to the growth of corporate debt market
in our guidance to the banks to issue long term bonds to support infrastructure and housing
projects. Further, in order to meet the capital requirements under the Basel III Framework,
banks will tap the market with their Additional Tier 1 bonds, besides Tier 2 bonds. These
developments can usher in emergence of quasi government yield curve, which can serve as
benchmark for corporate issuances. When the Basel 3 Framework relating to Large
Exposure norms take effect, and as banks reach their limits in supporting direct lending to
the corporate sector, corporates be nudged to resort to market borrowing. On top of this, the
expected robust economic growth will also compel the corporate sector to approach the
market. Keeping all these in perspective, we need to ready ourselves with the following
measures to usher in a vibrant corporate debt market:
a) regulatory and administrative reforms to institutionalize debt markets,
b) involvement of market-makers who can provide two-way bid-ask quotes,
c) enhancement of investor base,
d) increasing the efficiency of these markets through better reporting, settlement
and clearing platforms,
e) emphasis on the reduction of information asymmetry.
Conclusion
18. To conclude, the debt markets is undoubtedly a very essential segment of the country's
financial markets and vibrancy in these markets is imperative to meeting the massive funding
requirements of the country. I am confident that this Conference proceedings and
discussions will lead to specific suggestions for action and provide clarity on issues.
19. I thank you all of you for your time and attention.