What’s Cooking In The Indian Bond Market?
In recent years, India has grabbed all kinds of positive headlines.
The country is famous for consistent economic growth in the high single digits, and it’s become a key target for expansion by international banks, corporates and investors.
But it wasn’t always this way. Back in the 90s, Indian debt issuance was dominated by fiscal restrictions, with automatic monetisation of fiscal deficits and interest rates that were tightly controlled to reduce borrowing costs. This (along with other factors) meant the domestic government bond market has been slow to develop in India.
In 2003 all that changed. The Fiscal Responsibility And Budget Management Act brought sweeping changes in market infrastructure that have made it easier for public and private entities to issue debt.
India is now home to a dizzying array of fixed-income instruments. These include government securities (known as “G-Secs”) and T-Bills, State Development Loans issued by Indian states, Corporate Bonds, Public Sector Unit bonds issued by SSAs and bonds issued by financials. Other securities issued and traded include Masala bonds (INR-denominated bonds issued offshore and only legalised recently), Securitised Debt Instruments, Municipal Bonds issued by Urban Local Bodies for financing specific infrastructure projects and Gold Sovereign Bonds designed to bring liquidity to India’s large gold holdings in private hands. Green Bonds have also been issued since 2016, and a handful of transactions have hit the screens.
In recent years India’s two key regulatory bodies, SEBI and RBI, have taken steps to address blockages impeding the development of the bond market. The result has been rapid growth in both debt and derivatives products. In fact, the domestic bond market has grown from around USD 1.0tn at the end of 2012 to approximately USD 1.5tn by March 2017, with government securities accounting for around 70% of all issuance. The sovereign yield curve now extends out to 40 years and offers a robust reference for pricing of other fixed-income and derivative products. The market is broad and deep enough to support large benchmark issuance and respectable secondary volume with low bid-ask spreads. Progress has also been made when it comes to market microstructure. The Reserve Bank of India has worked hard to drive efficiency through the development of issuance, trading, clearing and settlement infrastructure.
Whilst the public market has exploded, the corporate sector has been slower off the mark. Up until now, corporate insurance has been negligible due to the complex regulatory framework.
That is changing, with the financial authorities in India recognizing the importance of the bond market (and a well functioning market for derivatives) as a funding channel for the real economy. Indeed, recognising that action must be taken to reduce pressure on the banking system and nudge corporates towards the bond market, SEBI recently proposed that large corporations should raise 25% of their borrowings from the corporate bond market.
Bank balance sheets remain weak, which is suppressing lending and creating greater reliance on bond markets for funding. Traditionally this activity has been dominated by private placements rather than benchmark issuance, but this will no doubt change in the years ahead as the market infrastructure becomes more supportive, secondary liquidity improves and corporates increasingly turn to bonds to fuel growth.
All this is really positive, But there are several challenges yet to be met. Tamal Bandyopadhyay has outlined these in this excellent thought piece. He emphasises that public issuers continue to crowd out corporates, dominating the portfolio of domestic and foreign investors seeking exposure to India, and that this seems unlikely to change unless government finances improve and it borrows less. Noting that the market is dominated by AAA issuers to such an extent that A-rated transactions accounts for just 2% of total issuances, Tamal draws our attention to challenges for issuers lower down on the credit spectrum, with investor regulations discouraging investment in private corporate bonds rated lower than AA.
He also suggests some solutions. These include reforming regulations to allow investments in A-rated paper, which can be small and increased gradually. Corporate bond repos can improve funding costs and increase trading and liquidity in AA and A paper. And tax incentives for foreign investors in lower-rated corporate paper would help focus attention.
Financial markets in India have benefited from the Indian authorities’ willingness to make bond markets more attractive for issuers and investors. What is needed now is a cohesive vision for the future that acknowledges the symbiosis of public and private markets. The result will be strong growth for the wider financial economy in India, with positive knock-on effects for the entire country.