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Investing India: Developed Stock Market, Early Days For Corporate Bonds in India!

Feb 23, 2018 10:26 AM 4 min read

Editor’s comment: The Finance Minister in his Budget Speech this year pushed for a deepening of the corporate bond market in India. In order to harmonise Indian regulations with international precedents as well as to open liquidity into riskier capital, the FM is pushing regulators to consider anything below A as ‘non-investment grade’ vs. AA and higher bonds only, as is the convention at present. Reclassifying lower rated bonds as ‘investment grade’ would enable institutional investors i.e. pension funds, insurance companies and mutual funds to tap this end of the market. The Securities and Exchange Board of India (SEBI) is likely to push corporates to allocate 25% of their funding requirements towards capital markets. However, developing a deep and functioning corporate bond market will require broader tax reforms as well to enhance the their attractiveness as an asset class.


In light of the Finance Minster's Budget Speech pushing for a deeper proliferation of the corporate bond market in India, the Securities and Exchange Board of India (SEBI) might look to ask corporates to finance as much as one-fourth of their funding needs from the corporate bond market. We think the impetus on developing the corporate bond market in India is commendable and one that needs focus. These greatly assist in lowering credit costs across the economy, create financing for mid-sized businesses and create robust capital markets, all of which leads to economic growth. However, developing a deep and functioning corporate bond market will require India to build on some of the current reforms and undertake more reforms. Market infrastructure and dynamics must be created to facilitate the market.


The Insolvency and Bankruptcy Code 2016 (IBC) needs to be built on and we need to show that the system can resolve cases expediently. A robust corporate conflict resolution mechanism will go a long way in building investor confidence in the product. Investors will look at corporate bonds as an attractive asset class if they are confident that conflicts can be resolved quickly and fairly. While corporate bond markets benefit all issuers, the greatest benefit is usually for issuers who have a relatively lower credit rating. The growth of the corporate bond market in the US was extremely beneficial for non-investment grade companies. Investor confidence in efficient resolution mechanisms is even more important if investors were to invest in corporate bonds issued by non-investment grade companies.


Current regulations do not allow large institutions such as LIC Pension Fund to invest in corporate bonds that are not investment grade. This is the right policy currently. However, if India could create an extremely efficient bankruptcy resolution mechanism, then such a mechanism would make a strong case for large public pension funds and insurance companies to start investing in corporate bonds slightly below investment grade. Such a move would significantly improve market liquidity in corporate bonds. Hence it is important that the government ensures that efficient financial resolution mechanisms are built in India.


Corporate bonds as an asset class must be attractive to an issuer. The issuing company will weigh the advantages of issuing corporate bonds versus other avenues of raising capital. First and foremost, it is important that stamp duties in issuance of corporate bonds are removed to really let the market flourish. To develop a market for a specific asset class reducing transaction costs is extremely important. Reducing transaction costs and hence making a frictionless financial system will go a long way in creating the right environment for a deep and well-functioning corporate Indian bond market.


From an investor’s perspective, the government must look at tax attractiveness of the bonds. One key aspect of the corporate bond market that would really add value is being able to encourage a long dated corporate bond market with issuance beyond 7 years. This would reduce the burden on public sector banks (PSBs) to lend for longer terms, something PSBs with short dated liabilities are not able to do. One way to encourage long dated corporate bond issuance and investment is to have a graded tax structure that reduces the tax burden for the investor the longer the duration of the corporate bond. This will reward investors for lending to companies using longer dated tenure. One variant would be a sliding scale of taxes for corporate bonds, such that the longer the lending the lower the tax liability. Such mechanisms will help build a deep and well-functioning corporate bond market.


The discussions around strengthening the corporate bond market in India have been going on for over a decade. We have taken some steps towards achieving the aforementioned aim. Now is the time to expedite the process on two fronts - regulations and tax attractiveness of assets. It is important to realize that such markets evolve over decades and many budget speeches. Incentivizing market forces for a solution is the ideal way to achieve efficient and credible markets that add both financial and social value.


Originally Published in Financial Express