The Indian Corporate Debt Market: Prescription for Revival

Tamal Datta Chaudhuri*

The paper evaluates the state of the corporate bond market in India and tries to understand the reasons for its subdued state. It shows that, unlike the government securities market, there is no incentive for either the buyers or the sellers of corporate debt securities to participate in this market. The paper then goes on to design a framework for reviving this market and making it active.

Introduction
Development of the bond market in India, and in particular, the corporate bond market, has attracted the attention of policymakers, regulators, bankers, financial intermediaries, Foreign Institutional Investors (FIIs), arrangers and also academicians. The reasons differ from player to player and depend on the objective function of each. In order to appreciate the arguments, one needs to assess the state of this market and the following tables provide data on the magnitudes involved. Table 1 gives a comparative picture of the Indian stock market and the bond market in terms of primary issues. Clearly, the stock market has dominated the total primary issues both in number and also in amount raised. As against Rs. 30,753 cr raised through 115 primary issues in 2006-07, the bond market saw only 3 issues amounting to Rs. 847 cr. Whereas if we look at debenture issues by way of private placement as given in Table 2, the numbers are significantly large. In 2006-07, the private corporate sector raised Rs. 84,387 cr through 1,539 issues. The numbers relating to primary issues and private placement of debentures are just not comparable. This implies that corporates find it cheaper and easier to privately place debentures with banks and institutions rather than go for a public issue. If the issue size is small then it is cheaper to privately place debentures. Besides, public issue of debentures requires credit rating as per Securities and Exchange Board of India (SEBI) guidelines, which is both time consuming and expensive.

The paper is based on a presentation made by the author in ISB, Hyderabad on December 8, 2007.

* Chief General Manager, Industrial Investment Bank of India Ltd. (IIBI) and Adjunct Faculty, The Icfai Business School (IBS), Kolkata, India. E-mail: tamal5302@yahoo.com
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Table 1: Number and Amount of Primary Issues of Corporate Debentures

(in Rs. cr) Year 2003-04 2004-05 2005-06 2006-07 Ordinary Shares 35 51 128 115 Amount 2,471 11,452 20,899 30,753 Debentures 3 3 2 3 Amount 1,251 1,627 245 847

Source: Handbook of Financial Statistics of the Indian Economy, RBI, 2007.

Table 2: Private Placement of Debentures to Financial and Non-Financial Institutions

(in Rs. cr) Year 2003-04 2004-05 2005-06 2006-07 Private Sector 640 717 946 1,539 Amount 18,759.9 35,794.2 41,189.6 84,387.1 Public Sector 234 193 169 139 Amount 45,140.7 47,611.3 56,283.7 61,183.7 Total 874 910 1,115 1,678 Amount 63,900.6 83,405.5 96,473.3 1,45,570.8

Source: Handbook of Financial Statistics of the Indian Economy, RBI, 2007.

On the whole, the corporates in India also rely very little on debentures for resources and resort to internal generation and bank loans as shown in Table 3. Thus, from the supply side, privately placed debentures and preference for loans has kept the corporate debt market in India, insignificant and narrow.
Table 3: Sources of Funds of Indian Corporates
1985-86 to 1989-90 1. Internal Sources 2. External Sources of which: a) Equity Capital 31.9 68.1 7.2 37.9 11.0 13.6 8.7 22.8 100 1990-91 to 1994-95 29.9 70.1 18.8 32.7 7.1 8.2 10.3 18.4 100 1995-96 to 1999-2000 37.1 62.9 13.0 35.9 5.6 12.3 9.0 13.7 100 2000-01 to 2004-05 60.7 39.3 9.9 11.5 1.3 18.4 1.8 17.3 100

b) Borrowings of which: (i) Debentures (ii) From Banks (iii) From FIIs c) Trade Dues and Other Current Liabilities Total

Source: Handbook of Financial Statistics of the Indian Economy, RBI, 2007.

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On the other hand, if we look at the size of the government securities market, the numbers are significantly larger than the corporate bond market and this is shown in Tables 4 and 5.
Table 4: Turnover of Debt Securities
(in Rs. cr) Year 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 (April-Feb) Government Bonds 5,72,145 12,11,945 13,78,158 16,83,711 11,60,632 8,81,652 9,71,414 Corporate Bonds 14,486 19,586 35,876 41,760 37,312 24,602 12,099

Table 5: Government Securities Outstanding (in Rs. cr)

Year Dec-2000 Dec-2001 Dec-2002 Dec-2003 Dec-2004 Dec-2005 Dec-2006 Dec-2007 Amount 1,15,733 94,461 1,16,117 1,42,528 1,79,715 2,22,724 3,08,000 3,72,004

Source: Business Beacon, CMIE.

Source: Business Beacon, CMIE.

This is also validated by Table 6, which gives an inter-country comparison of the size of the corporate bond market and the government securities market. For India, as at the end of 2004, the size of the corporate bond market as percentage of GDP was as low as 3.3% as compared
Table 6: Size of Domestic Corporate Debt Market as Percentage of GDP
Country US Korea Japan Malaysia Hong Kong New Zealand Australia Singapore Thailand China India Indonesia Philippines Corporate Bond Outstanding 128.8 49.3 41.7 38.8 35.8 27.8 27.1 18.6 18.3 10.6 3.3 2.4 0.2
Source: BIS (2006).

Government Bond Outstanding 42.5 23.7 117.2 36.1 5.0 19.9 13.8 27.6 18.5 18.0 29.9 15.2 21.8

Domestic Credit 89.0 104.2 146.9 113.9 148.9 245.5 185.4 70.1 84.9 154.4 60.2 42.6 49.8

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to 10.6% of China, 41.7% of Japan and 27.1% of Australia. However, the figures of government bonds outstanding for India are larger than many other economies. Moving away from the supply side of debentures to the demand side, Table 7 provides some idea about the composition of gross financial savings of the household sector in India. A clear preference is observed for bank deposits as compared to capital market instruments. Besides Provident Fund (PF) and insurance, household savings moves largely to bank deposits, rather than the capital market.
Table 7: Share of Various Instruments in Gross Financial Savings of the Household Sector in India
Bank and Non-Bank Deposits 48.6 45.0 39.6 43.4 40.9 Insurance, PF, Total Debt 31.3 25.9 25.5 30.5 29.0 Units of UTI 0.5 2.2 6.6 0.9 0.8 Claims on Government 4.2 11.1 8.1 10.8 18.8

(in %)
Shares and Debentures 1.5 3.9 9.4 4.7 3.2

Period

Currency

1970-71 to 1979-80 1980-81 to 1989-90 1990-91 to 1994-95 1995-96 to 1999-2000 2000-01 to 2005-06

13.9 11.9 10.8 9.7 8.9

Source: Handbook of Financial Statistics of the Indian Economy, RBI, 2007.

The public at large in India does not participate in the capital market. Even if we look at Mutual Funds (MFs), as per data provided by RBI, MF investors constitute a mere 1.6% of the population. Out of 321 million individual wage earners between the ages of 18 to 59, only 5.3 million invest in mutual funds. Further, 90% of savers have no clue of what a mutual fund is or how to access the markets through the Systematic Investment Plan route. In spite of its rapid growth in the last few years, Assets Under Management (AUM) by Indian MFs is only 10% of GDP as compared to 74% in the US, 100% in Australia and 45% in Brazil. AUM by MFs in India is only 14% of total bank deposits. This also establishes the preference of the households for bank deposits. From the above discussion, the following observations can be made: Indian corporates raise fewer funds by way of primary issues from the bond market than the share market. The Indian corporate bond market is significantly smaller in size than the government securities market. The Indian corporate bond market is smaller in size than other developed and emerging economies. Indian corporates raise more funds from the market by way of private placement than primary issues.
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Indian corporates rely more on bank loans and internal generation than bonds for funds. Indian households prefer bank deposits to capital market instrument to park their savings.

Reasons for Development of the Indian Corporate Debt Market

The data presented above suggest that there are demand side constraints and also supply side constraints for development of the corporate bond market in India. Households looking for fixed income prefer bank deposits. Further, the households see upside in the stock market, but do not see any upside in the bond market. According to them, if a fixed rate of return is the issue, bank deposits are way superior, as they do not have default risk. Corporates on the other hand prefer bank loans to debentures. If they issue debentures, they privately place them with bank and institutions, rather than making a public issue. Thus, both the arms of the market are missing. Given this state of the Indian bond market, we now turn to why the development of a debt market, and in particular a corporate debt market, is important for India. The reasons discussed in the literature are as under: A developed bond market makes it possible to generate a well-defined yield curve over all maturities and serves as a benchmark for pricing of loans and debentures. A deep and mature bond market leads to market-driven rates of interest and allows the corporates to minimize their cost of borrowings. Such a market provides greater transparency to households in terms of the rates of interest they can receive from their debt holdings. A vibrant bond market provides viable alternative to the stock market for retail investors in the event of a stock market crash. By offering fine rates, it reduces foreign borrowings by corporates and thus reduces currency risk, and A developed bond market provides an alternative to bank loans in the event of a banking crisis.

The reason why Reserve Bank of India (RBI) has taken various steps for development of the Indian bond market, is related to its role in designing the monetary policy and its responsibility for maintaining price stability, interest rate stability and also exchange rate stability. RBIs concern is two foldhow to keep the borrowing costs of the government of India at a minimum, and also how to keep the money supply within limits. From time to time, as the fiscal deficit has to be monetized, RBI has to keep a tab on the money supply. To the extent the government borrows from the market, the RBI makes all attempt to see that the process is efficient and thus, the primary dealers come into existence. Policy measures are taken to ensure that the market for government securities has depth such that the cost of
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borrowings of the government falls. This reduces the extent to which the deficit needs to be monetized. Thus, the objective of RBI in developing the bond market is macroeconomic in nature and it is not driven by the needs of the corporate sector. However, it partially helps the private sector for pricing their borrowings. What needs to be realized at this stage is that, the government, unlike the corporate sector cannot take loans from financial intermediaries, and besides tax revenue and internal generations, the ways that their expenses can be met are through issue of government securities or through printing of money. So, as long as the government spends more than it earns, the government securities market will naturally exist, and the RBI will try to see that this market functions efficiently. This however does not in anyway guarantee the development of the corporate bond market. The reason why financial intermediaries want development of the corporate bond market is because this could boost their non-interest income. They want greater FII participation in the government securities market to be able to generate greater trading income. They suggest removing distortions in the market in terms of rationalization of stamp duties across states and easing regulatory norms. But these measures cannot boost the corporate bond market.

A Design for Reviving the Indian Corporate Debt Market

The above discussion suggests that the constraints towards development of the Indian corporate bond market do not lie in the systems and processes or in stamp duty rates. It is also not dependent on the state of the government securities market. It has not developed because there is no logic behind its development, either from the supply side or from the demand side. Now an attempt is made to design a sequence of events, which can lead to the development of this corporate bond market. It is our belief that this design may work in activating the Indian corporate bond market. The systems and procedures will follow the requirements of the market. In the first stage, it is suggested that the commercial banks issue Fixed Deposit Receipts (FDRs) against Fixed Deposits (FDs) of households. Since households prefer to hold FDs, it would not be a problem for the banks to issue FDRs against FDs. These FDRs would have a coupon rate and tenure as that of the FDs. It is proposed that these FDRs be issued in demat form and listed on the stock exchanges. There would be Depository Participant (DP) accounts in which these FDRs would be credited and there would also be a clearing corporation. Households would hold FDRs, which would get liquidated after the end of the term and interest would be paid as per the terms of the FDRs. For the bank issuing FDRs, there is no additional cost, as the liability side would only show the FDs. With changes in the market rate of interest, the values of these FDRs would change and this would get reflected in the stock exchanges. If the rate of interest falls, then the value of the FDRs would rise and this is where the households would see the upside in these debt like instruments. Since, the issuers of these FDRs are the commercial banks and they are issued against the FDs, no credit rating would be required. Further, any household would be able to buy the FDRs in the secondary market without actually having to open a FD with a bank. Mutual funds could develop
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schemes with FDRs of various banks in its portfolio. It is possible that, with time, the market may provide different returns for different banks for the same tenure and same coupon, FDR. A new set of bond players would emerge who would do broking and they would provide depth to this market. The point is that households would get to taste the upside of the bond market and a genuine demand for debt papers may arise. Today, there is very little interest in Money Market Mutual Funds (MMMFs) in spite of the fact that mutual funds are fully involved and the regulations are clear. With FDRs and the culture that would follow, MMMFs may see a lot of interest. In the second stage, it is suggested that the commercial banks get into the securitization mode actively. It should become a part of the banking culture that assets should not be held in the books for long and that by holding on to assets, the bank gets exposed to the business cycle of the product and the chance of the account turning Non-Performing Assets (NPA) rises. Thus, banks should be issuing paper once a loan has been created, and a secondary market for securitized paper should emerge. If this happens and when the corporates see their loans getting traded in the market, pricing of their loans become much finer. Further, with the bond culture emerging among market players, including households and mutual funds, in the third stage, corporates would thus start issuing debt paper. As credit rating is a backward looking concept and any AAA corporate can turn AA or BBB, new forms of disclosures would need to be thought about, which could make the choice of the retail market participants easy. The corporate bonds would be competing with the FDRs for household savings. The design suggested above is presented in Figure 1.
Figure 1: Design of Indian Corporate Debt Market

Households

Secondary Market for FDRs

Market Makers, DPs and the Clearing Corporations

FDs Commercial Banks

FDRs MFs

Financial Institutions Including PFs and Trusts

Loans Corporates Securitized Paper

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The reader may recall that we had mentioned that the corporate bond market has not developed in India as both the arms of the market are missing. The suggested design and diagram cover only stages one and two in the development process, and a way is suggested to bring about a cultural change in the perception of debt instruments. Once this happens, in the third stage, the corporates can issue bonds in the retail market. As households would be familiar with investment in debt instruments and they would have tasted some upside, the corporate can find success with retail participation in debt instruments. Such instrument would have takers. This would lead to a desirable outcome in the sense that households could think of maximizing fixed asset income and be proactive in holding a portfolio. Further, an easy comparison with the stock market and stock market returns would emerge.

Conclusion
The paper argues as to why the corporate debt market in India has not developed. For a market to develop and mature, both the supply and demand arms have to be present. In India, both the arms are missing and thus there is no incentive for this market to develop. No such culture is also present, as there is for the stock market. Given the current state, this paper presents a design for developing this market and points out that a cultural process has to be initiated whereby the households have to understand that bond holdings also have an upside, besides the fixed coupon that they receive. This would have to be through FDRs. Commercial banks would need to get active in securitization and this market has to emerge in a big way. Then only can we expect to get buyers and sellers in the market, and the stamp duty issues and rating issues would be automatically taken care of.
Acknowledgment: Research assistance from Chandan Ghosh is gratefully acknowledged. The opinions expressed in the paper are those of the authors and do not reflect those of IIBI or IBS Kolkata.

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6. Raju M T, Upasana Bhutni and Anubhuti Sahay (2004), Corporate Debt Market in India: Key Issues and Policy Recommendations, SEBI Working Paper Series No. 9. 7. Rakesh Mohan (2006), Recent Trends in the Indian Debt Market and Current Initiatives, Fourth India Debt Market Conference, Organized by Citi Group and Fitch Rating India on January 31. 8. Reddy Y V (2002), Issues and Challenges in the Development of the Debt Market in India, BIS Papers No. 16. 9. Reddy Y V (2007), Developing Debt Markets in India: Review and Prospects, Meeting of Central Bank Governors of Asia, Latin America and the Caribbean, Washington, USA.
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