Thursday, April 9, 2015

Deepening the bond market: Policy changes are happening

Corporate Bond market is underdeveloped in India. A RBI report shows that India is at a very low position vis a vis some of the major Asian countries.

Source: RBI site
Let us understand why it has become a necessity to revive the bond market.

Long term and low cost

Large infrastructure projects require long term, low cost financing to become financially viable. Since these projects (ports, power plants etc.) have long gestation time, cash flow from operations would begin only after couple of years and would remain low until the utilization reaches higher levels. During this first 5-10 years, if the interest rates are higher, they will not be able to service their debt. In such a situation, a company which raised funds at 6-7% interest rates has better chances of success than those paying 12-14% interest rates.

Infra was hit hard

Banks cannot offer lower rates but the bond market is underdeveloped in India. So the infra companies had to borrow from banks to develop their projects. As the global economy slowed down, cash flow in these projects became leaner. That is what led to higher NPA situation India is facing now. Cash flow for many infra companies are lower than the interest costs, they do not have the money to service their loans, so they are restructuring loans and have lost the courage to take up new projects. When Banks do not get the money back, they can’t led it further, so the credit growth in India has come down as there is weak demand for loans and banks do not want to risk lending more money to defaulters. When nobody takes risks, economy shrinks.

Burning hands with foreign debt

Whoever went to overseas market and borrowed at lower rates but in dollar terms, did not gain either as Rupee depreciated a lot. (Let us assume a company borrowed few years ago when Rupee was at 50 a dollar, will need more money to repay their loan now as dollar is at 62 now). All the loan amount cannot hedged, even if it is hedged completely, the hedging costs will take away the benefit of low interest rates.

Reviving Bond Market seems to be the only solution

For all the financing problems India is facing, deepening the bond market seems to be the only solution. It reduces the risk concentration in banking system with higher NPA. Private companies need not depend on banks and can borrow at lower rates by issuing bonds. And they also need to efficiently manage their business, else the bond market would demand higher coupon rate. RBI in the recent past has announced several measures to deepen the bond market. It is pushing corporate to issue Rupee bonds in foreign markets. (Link: That takes out the risks arising from forex volatility. Hedging costs and benefits would be transferred to a third party. And it provides access to low cost capital. RBI also intends to open up Govt. treasury market to retail participants. (Link: Though how big that market is not yet known, it is a right step forward. Whether RBI likes it or not, it has to promote bond market. Will it affect credit growth in Banking? Probably, yes. And they may have to depend on retail customers more. But in a growing country, both bond market and banks will find avenues to grow.