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Dr.Velmurugan.PS, Dr.P.Natarajan
Historically, major sources of long term funding in India are Foreign Direct
Investment, External Commercial Borrowings and Banks. But these sources have their own
limitations and do not meet the funding requirements of the economy which struggles to
achieve higher growth rate. At present Indian economy is going through rough phase with
growth slowing down to decade lows of 4 to 4.5 percent. The prevailing interest rates are too
high and deter stability and growth of the economy. A feasible alternative source for India is
to concentrate on mobilising investment through debt instruments such as Corporate Bonds. A
well developed Corporate Bond market is much required for the economy to supplement bank
credit and the equity market in terms of providing long term capital for corporate, specifically
can help meeting India’s infrastructure financing requirement.
Commercial banks have and inherent asset-liability mismatch which makes it difficult
for them to meet the demand for long term project funding. Further, as India is facing
continuous current account deficit problems, overdependence on corporate bond will
aggravate the issue and prove to be a transmission line of global financial shocks to the Indian
economy. A full-fledged domestic Corporate Bond market can reduce the reliance of on
corporate sector in external debts, thereby reducing the exchange and liquidity risks
associated with external funding sources.
Government has formed a committee headed by RH. Patil and it submitted its report a
decade ago. Since then, substantial effort is made to develop Corporate Bond market. But the
result are not encouraging because still institution and an individual’s prefer collateralised
lending rather than unsecured debt instrument. Even if they prefer for unsecure debt, they
prefer higher rated bonds rather than riskier lower rated bonds. Even underwriters are
showing away from underwriting lower rated bonds, which keeps away SMEs from
approaching Corporate Bond Market. Actually, the Corporate Bond market in India is
dominated by high-rated papers but the presence of those papers is very few. According to
rating agency Crisil, as on September 2013, not even 5 percent of the companies it rated in
India carried the premier ‘AAA’ rating.

Electronic copy available at: https://ssrn.com/abstract=2977874

Though in the recent past Corporate Bond issuances in India has increased to
approximately R 3000 billion in 2013 especially in the post financial crisis period, Corporate
Bond accounts for only less than 5% of the total Indian Debt Market. Corporate Bond market
in India is dominated by bank and finance companies and relatively small amount of funds are
raised by manufacturing, infrastructure and other industries. India’s Bond market make up
0.009 percent of the global bond market. In short, India’s Bond Market is relatively
underdeveloped compared to other emerging markets and compared to its own equity
markets. Even the meagre share of debt that is raised through Bond market is denominated by
Government Bonds both in primary and secondary market trading. Turnover is Corporate
Bond market is only just 5% of the turnover of G-Sec market. It is really a challenge for the
Government and the regulator to initiate a shift of investors interest from G-sec’s to Corporate
Debt Market in India

G-sec. Corporate Bond Market

Public Sector Private Sector

On the other hand, there is very poor retail participation in India’s Bond Market which
is evident from the statistics that during the financial year 2013 out of Rs.3.88 Lakhs Crore of
bonds that were issue in India, more than 90% were privately placed. Recently SEBI has
constituted a 16 member committee namely ‘Corporate Bonds & Securitisation Advisory
Committee’ comprising members from SEBI, RBI and industry experts to suggest a road map
for developing Corporate Bond market in India. The committee is expected to advice SEBI
bond issues and removal of regulatory hurdles.

Need for a vibrant Corporate Bond market in India:

Estimates of Indian industry associations peg the total financing requirements of
India’s infrastructure development programs to US $ 1 trillion. Available Govt. Funding may

Electronic copy available at: https://ssrn.com/abstract=2977874

not be sufficient to meet the development. Alternatively, the traditional source for funding
such financial requirements in India is Bank funding. This has resulted in overdependence of
bank finance especially for infrastructure Projects. Given the limitations and inadequacies of
Govt. & Banks funding, there need to promote alternate some of funds for infrastructure
projects because India’s economic growth and development is dependent on the availability of
adequate capital to meet its funding requirements.
Private investment sources especially Corporate Bonds can play a greater note to full
this gap. As far as Indian corporate one concerned, at present, around 20 percent of their
external funding requirement is met from bank loans and advances. However, Bank sources
are unable to wholly meet the finance demand of corporate especially when it comes to longer
term credit facilities. A well developed Corporate Bond market will help shift the
concentration of credit risk away from the banking sector. Thereby it can (i) enhance financial
stability (ii) Diversify & distribute risks & (iii) enhance facility to withstand economic
Factors that hinder the growth of India’s Corporate Bond market:
 Jurisdiction on Indian Corporate Bond market investment lies with various regulators
viz., SEBI (Capital Markets), RBI (Banks), IRDA (Insurance funds), PFRDA (pension
funds). Because each regulator tries to safeguard the credibility of them domain, such
overlapping of jurisdiction on Corporate Bond market investments hinders the growth
of this market.
 Retail participation remains low due to lack of understanding and knowledge of bonds
as an asset class.
 Bond market is dominated by private placement. Only less than 49 investors, largely
institutional, tend to dominate the land scope of corporate debt privately placed. Public
issues are very less. Hence bonds available for trading in secondary market are
affected, resulting in poor pricing discovery process.
 Life insurance and pension funds are not showing interest investing in Corporate
 Stamp duty rates across the country are distorted and not standardized.
 High withholding taxes.
 Inadequate products for credit enhancement.

 Timeliness and quality of information disclosure is critical for increasing investor
confidence. But Indian Bond market is characterized by information asymmetry.
Investors (other than large institutional investors) have only limited information. But
as on date, secondary market transactions are now required to be reported to market
exchanges. Most banks, insurance companies and provident funds are complying.
 Lack of pricing benchmarks. Even in G-sec segment, bonds are traded at only select
 In case of default, there is inadequate legal framework for recoveries. The default rates
are higher in India compared to emerging countries. This causes reasonable risk
aversion to investors. As of now, non-banking investors cannot take recourse under
SARFAESI and Corporate Debt Restructuring (CDM) is applicable for only for banks
and financial institutions. This is keeping a major class of investors (mutual funds)
away from investing in Corporate Bond market.
 The Primary Corporate Bond market is dominated by financial institutions i.e., Non
Banking Financial Corporations. Corporate, especially those who do not have good
credit rating are finding it difficult to source funds from public bond issue.
 Regulatory restrictions such as prohibition of investing in ‘below investment grade’
securities for banks and insurance companies, affects investment in Corporate Bonds
by these institutions.
What should be done for the growth development of Corporate Bond Market?
For promoting Corporate Bond Market an effective, stable and alternative source of
funding, the following steps should be taken on pan Indian basis;
 Educating investors about the advantages of investing in debt instruments through
outreach programs by exchange and regulators. This will enhance activity in primary
and secondary retail segment of Corporate Bond market.
 To make available Exchange Listed Bonds and Public Issues, which is the thrust of
regulators worldwide, to make risks more transparent and encourage secondary market
 In case of issuer defaults, there is a lack of codified bankruptcy procedure. This has
hampered the timeliness of enforcement resulting in poor recovery value. In the case
of bankruptcy, the amount and speed of recovery remain as a major concern in the

minds of retail investors. Steps should be taken to strengthen bankruptcy recovery
procedures. In this case, the establishment of a ‘Resolution Corporation’ mooted in the
‘Financial Sector Legislative Reforms Commission’ (FSLRC) is a very important
recommendation which needs attention.
 Corporate entities should not be encouraged to adopt extensively risky projects based
on debt from Corporate Bonds.
 Steps should be taken to strengthen /develop Credit Default Swap and Interest Rate
Futures markets.
 To enhance transparency and strengthen the Corporate Bond market, market
participants need to have access to live pricing and trading markets along with ease of
transacting. This would help enhancing transparency and strengthen the markets.
Creation of such facilities in existing stock exchanges will facilitate retail
 Transparent market place can save as a catalyst for the development of corporate bond
market; creation of a comprehensive and centralized database with all data on the
individual issuances will improve information dissemination and bring market
 Market makers are essential to the development of any market as they assume the risk
of providing both ‘buy and sell’ quotes. Indian Corporate bond market does not have
market makers who could add value, depth and diversity to the market.
 There is need for coordinated effort to bring the regulatory powers, which is presently
scattered among different regulatory bodies, under one authority for the overall
development of financial market, especially Corporate Bond market.
 To avoid overdependence of corporate in banks, banks themselves should be advised
to motivate and redirect corporate to depend on Bonds for mobilizing their long term
fund requirements.
 To reduce the number of ‘buy and hold investors’ and to improve activity in the
secondary market, tax incentives should be offered on capital gains while selling
bonds in the market.

 Government, regulators and industry associations should initiative steps to educate and
encourage investors by arranging investor campaigns on a regular basis to awareness
among investor public.
 Though off late ‘tax free bond’ issuances attracted retail investors, their participation
in primary market and secondary market is almost nil. This is due to lack of
awareness, knowledge and understanding of bond as an asset class. Inadequate
information (or) information asymmetry pertaining to the issuer and instrument, keeps
retail investors away from Corporate Bond market.
 To ensure wider participation of investors, the participation of private placement has
to be restricted to a maximum of 49. This would facilitate better price discovery,
transparency and broader investor base.
 To facilitate better participation of Private Sector issuers to access longer tenor
funding for infrastructure projects, they should be allowed/encouraged to issue tax free
bonds. This will enhance public-private relationship.
Status of Government Securities (G-Sec) market in India: The Government Securities
(G-Sec) market in India is well-developed and backed by well-functioning depository
systems. Thanks to Reserve Bank of India, the G-Sec market has a standardized settlement
and trading system. It is vibrant and well developed with large investor base. But, as stated
earlier, Bond investment in India is dominated by Government securities. G-Secs gives a
reliable source of benchmark yield of risk (default) free securities, which is a pre-requisite for
a sound and vibrant Corporate Bond market. Because G-Secs are risk free, investors including
banks divert their funds towards G-Sec. Further, there is regulatory requirement which
requires mandatory investment in G-Secs by various financial institutions. This provision
hinders investment moving towards Corporate Bonds.
Status of Primary Market for Corporate Bonds in India:
The Corporate Bond primary market is fairly active and dominated by highly rated
(AAA/AA) instruments. During early stages, bond issues were by highly rated public sector
undertakings such as NTPC, SAIL, and by financial institutions such as NHAI, PFC (power
finance corporation) etc., Now–a-days large corporates such as Tata Group, L&T etc. are
actively participating in the primary market. Such vibrancy in the market was facilitated by
factors such as introduction of base-rate by banks which prohibited the erstwhile practice of

sub-prime lending rates, the possibility of issuing bonds at rates below bank’s base rates,
increase in ECB loans, tax free bond issues. In spite of these developments, issues with lesser
ratings, issues by MSMEs and issues by SME’s do not have major presence in the primary
Status of Secondary Market for Corporate Bonds in India:
At present the volume of trading Corporate Bonds in the secondary market is very
low. It suffers from important drawbacks of poor liquidity and poor transparency. Investors
who do long term investment in bonds through primary market just adopt the strategy of ‘buy
and hold’ as they are not willing to trade in the secondary market. But, ironically, Indian
Corporate Bond is dominated by such ‘high-end’ large investors viz., banks, pension funds,
insurance companies, high net-worth individuals, foreign NBFCs and private equities. Retail
investors and bonds of SMEs are almost absent in Indian Corporate Bond market. market is
robust only for highly rated bonds with AAA and AA rating, which constitutes around 98
percent of the traded volume. All these has resulted in poor price discovery mechanism in the
bond market. Hence, the Government and the regulators should develop policy measures to
make Debt Capital attractive for various types of investors especially retail investors.
Corporate Bond Market Vicious Cycle:

Low Level of Trading in

Secondary Market Affects Liquidating

Leads to Less Profitable This Affects Broad

Market intermediation basing participation

Result in high
Transaction costs

Status of institutional long term investors in Indian Corporate Bond Market:
After implementation of New Pension Scheme, pension funds had increased their
participation in Corporate Debt Holdings. But it is largely biased towards ‘Sovereign Debt’.
Similarly, insurance companies and mutual funds (ex: Infrastructure Project Special Purpose
Vehicles (SPUs)) participate in the bond market for meeting the requirements of their fixed
maturity plans. They have the practice of ‘Buy & Hold’ by which they the instrument till its
maturity period instead of using it for trading in the secondary market. Investment strategies
of pension funds, insurance companies and mutual funds are still dictated by rigid regulations.
This creates a negative effect on the liquidity of such bonds in the secondary market.
Status of Debt Derivatives Market in India:
The lack of development of associated derivative market like Credit Default Swap
(CDS) and Interest Rate Futures (IRF) is a major shortcoming in Indian Corporate Bond
market. A credit default swap (CDS) is a financial swap agreement that the seller of the CDS
will compensate the buyer in the event of a loan default or other credit event. The buyer of the
CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange,
receives a payoff if the loan defaults. In the event of default the buyer of the CDS receives
compensation (usually the face value of the loan), and the seller of the CDS takes possession
of the defaulted loan. An interest rate future (IRF) is a financial derivative futures contract
with an interest-bearing instrument such as Corporate Bond or Treasury-Bill or Treasury
Bond as the underlying asset. It is a particular type of interest rate derivative. Interest rate
futures are used to hedge against the risk of that interest rates will move in an adverse
direction, causing a cost to the company. For example, borrowers face the risk of interest rates
rising. Futures use the inverse relationship between interest rates and bond prices to hedge
against the risk of rising interest rates. A borrower will enter to sell a future today. Then if
interest rates rise in the future, the value of the future will fall (as it is linked to the underlying
asset, bond prices), and hence a profit can be made when closing out of the future (i.e. buying
the future).
Presence of financial derivative instruments such as CDS and IRF serve as tools to
hedge against market risk and credit risk in the underlying market. But in India, as for as the
underlying Corporate Bond market is concerned, there is poor liquidity and less chance for
price discovery. Hence, repeated attempts to build a strong CDS & IRF market by

Government and regulatory bodies has failed to pick-up. Similarly, Successful development
of IRF market will play a key role in further developing the emerging corporate debt market.
A Vibrant derivatives market where credit risk products get actively traded can distribute risks
much more efficiently throughout the economy. A ready market for hedging credit risks can
take a long way forward in meeting the objectives of developing a Corporate Bond market.
Recent initiatives by Government & Regulators:

Many progressive steps were taken by Government to deepen and wider participation
in the Corporate Bond Market so that it directly caters to the needs of real economy and the
financial sector. Viz.,
(i) Norms were liberalized for Insurance and Provident funds for investing in Lower
Rated Papers.
(ii) RBI, SEBI & IRDA have permitted the introduction of many new & promising
(iii) REPO’s in Corporate Bonds were introduced, which is a key step to improve
liquidity by using bonds as collateral; Moreover IRDA has permitted insurance
companies to participate in the repo market to enhance liquidity in the Corporate
Bond market.
(iv) Allowing foreign Investment in Corporate Bond up to USD 51 million.
(vi) Credit Default Swaps (CDS) were introduced, which is a tradable format for
credit enhancement, which would mitigate significant risk for Corporate Bond
issuance etc., Incidentally, IRDA has also permitted insurance companies to
become users of CDS. Even mutual funds have been permitted to participate in
CDS in corporate debt securities, as users.
(v) RBI has permitted banks to take limited membership in SEBI-approved stock
exchanges for the purpose of undertaking proprietary transactions in Corporate
Bond market.
(vi) FIIs were allowed to use their investment in Corporate Bonds and G-Sec as
collateral to meet their margin requirements.
(vii) Government has announced that stock exchanges will be allowed to introduce a
dedicated debt segment on the exchanges.

If we want to see India as a stronger economy with above 8 percent GDP growth per
year, then huge funds are required to push forward the growth rate of the economy. This is
possible only when reasonably good activity in the corporate bonds market is ensured.
Corporates will not differentiate between raising money through debt market and banks,
provided both the cost of borrowing and convenience of borrowing are low. Several novel
steps taken by the Government and the regulatory authorities doesn’t seem to help developing
the Corporate Bond Market due to underlying problems in transaction structures. Going by
the data provided by Economic Survey 2012-13, for the year 2012-13, public issue under
corporate debt category was Rs.4,974 crore as against Rs.35,611 crore in 2011-12. This shows
that, in-spite-of the economic function that Corporate Bond market is to play for a developing
country like India, its importance is less realised. Though deep and broad Corporate Bond
market is the objective of the policy makers and market participants but achieving this
objective needs much determination and coordinated effort by the stakeholders.