Developing Corporate Bond Market in India
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Content
- About Bonds
- Present status of corporate bond market in India
- Need for developing corporate bond market
- Reasons for underdeveloped bond market in India
- Way Forward
About Bonds:
- A bond is a debt instrument signifying a loan extended by an investor to a borrower, usually a corporation or government entity.
- Governments and corporations frequently utilize bonds as a means of borrowing funds for various purposes.
- Governments, at all levels, use bonds to finance infrastructure projects like roads, schools, dams, and to address sudden expenses related to emergency such as pandemic, wars, etc.
- Similarly, Large organizations often require amounts beyond what typical banks can provide, leading them to issue bonds and borrow from both institutional and retail investors.
Present status of corporate bond market in India:
- India’s corporate debt to GDP ratio was 17%, contrasting with 123% in the US and 19% in China.
- A larger proportion of Indian firms rely on banks as their primary source of working capital compared to many other developed nations.
- The underdeveloped nature of the corporate bond market in India is evident from these trends.
Need for developing corporate bond market:
- Meet investment needs: Economic Survey 2018-19 has highlighted that India needs to shift gears from consumption-driven economy to investment-led economy wherein private sector investment has to become key driver.
- Reduce pressure on government and banks: In India, given the absence of a well-functioning corporate bond market, the burden of financing infrastructure projects such as roads, ports, and airports are more on banks and the government.
- Asset-Liability mismatch: Banks use short-term deposits (3-5 years maturity period) to fund long term infrastructure projects with long gestation period leading to asset-liability mismatch.
- Reduce foreign currency exposures: Corporate bond market enables firms to borrow for longer maturity periods in local currency to meet their investment needs and avoid foreign currency exposures.
- Provide long term financial assets: An active corporate bond market could provide institutional investors such as insurance companies and provident and pension funds with quality long term financial assets.
- Diversified Funding Sources: Developing the corporate bond market in India provides companies with an alternative and diversified funding source beyond traditional bank loans.
- Lower Financing Costs: A well-functioning bond market can potentially lead to lower borrowing costs for companies, making capital more accessible at competitive rates.
- Infrastructure Development Support: A thriving bond market facilitates funding for large-scale infrastructure projects, aligning with the country’s developmental goals.
- Global Competitiveness: A well-established bond market enhances India’s global competitiveness by providing a sophisticated financial infrastructure attractive to international investors.
- Risk Management: Corporate bonds offer effective risk management tools, allowing companies to hedge against interest rate fluctuations and other financial risks.
Reasons for underdeveloped bond market in India:
- Narrow investor base: Demand for corporate bonds as an investment is mostly confined to
institutional investors with retail investors accounting for only 3% of outstanding issuances. - Dominance of government securities: Central and state government securities constituted almost half of the total investment in the bond market.
- Constraints on foreign investors: Investment limit for FPIs in corporate bonds has been enhanced along with a reduction in the withholding tax. However, FPIs are not fully utilising enhanced limits due to limited liquidity in the market.
- Absence of longer maturity bonds: Corporate bond market is basically dominated by bonds with average maturity period of 2-5 years. This market has not been able to cater the long-term investors such as pension and insurance fund companies through issuance of long-term maturity bonds.
- Lack of risk management market: Absence of interest rate/ credit derivatives which can efficiently transfer the risks arising out of interest rate movements.
- Taxation Structure: Stamp duties on corporate bonds across various states have not been standardised.
Way Forward:
Several reports by expert committees on development of corporate bond markets in India such as R. H. Patil Committee (2005), High Powered Committee on Making Mumbai an International Financial Centre in 2007 (Percy Mistry Committee), H.R Khan Committee on Corporate Bond Market. Important recommendations:
- Easing the process of bond issuance: To incentivise corporates to raise a part of their requirements through bonds, time and cost for public issuance and disclosure and listing requirements should be reduced and made simpler.
- Enhancing Investor Base:
- the scope of investment by provident/pension/ gratuity funds and insurance companies in corporate bonds should be enhanced.
- Retail investors should be encouraged to participate in the market through stock exchanges. Such investors should also be encouraged to participate in the corporate bond market through mutual funds.
- Investment in corporate bonds should be considered as part of total bank credit while
computing credit deposit ratio by banks.
- Bonds Primary Issuance Database: A centralised database of all bonds issued by corporates; made available free of cost to all the investors.
- Municipal bond market: Municipal bonds may be given some fiscal support in the form of bond insurance so that municipalities are encouraged to issue such bonds.