India needs to develop a debt

market
The structure of the financial system in the country is required to reflect the
development of the real economy. India has developed as a rich-poor
country and our financial system is required to have the sophistication of
developed markets coupled with base banking to meet the needs of small
businesses, farmers, individuals, etc. Pending the development of debt
markets, the banking system is being asked to fulfill the job of debt markets
and the government's financial inclusion agenda, which is a tall order. In
addition, we have developments in regulations, which would compound the
issue further.
India will need huge amounts of funds for its development. As the
government grapples with the imperatives of bringing public finances
under control and of improving execution efficiency, the role of the private
sector in this domain is likely to keep growing. The Twelfth Five Year Plan
put in place by the government envisages $1 trillion worth of infrastructure
investments over the period 2012-2017. Of this, $500 billion or 50% is
expected to come from the private sectora significant jump from the
average private sector participation rate of 25-30% during the Eleventh
Five Year Plan period. Of the $500 billion worth of private sector
investment towards infrastructure, $350 billion is projected to be funded
through debt.
Where does the private sector raise this debt from? Infrastructure projects
are long-gestation projects that require long-term funding. This would
typically be the domain of the capital markets. Will the domestic private
bond market be able to deliver these funds? That seems unlikely. At a mere
5% of GDP, the market for non-government bonds in India remains
underdeveloped despite more than a decade of effort. This compares with a
corporate bond market size of 16% of GDP for China and 19% for Brazil.
Could this change? Given the experience of the past decade, it would be
optimistic to expect a dramatic turnaround in the debt market's fortunes
going forward. The reasons for the stagnation in the bond market are
known. Here's a quick recap of what has held back the development of a
debt market.
Recent Developments in Corporate Bond Market in
India
by Smriti Chand Economics
Recent Developments in the Corporate Bond Market in India are given below:
The most important recent development on the corporate bond market is the
migration away from physical certificates into dematerialised holdings at the
depository. This process began in 2000, but got major support from RBIs
regulations:
corporate bond market
i. From October 31, 2001 onwards banks, FIs, PDs and SDs were required to make
fresh investments in bonds and debenture only in dematerialised form.
ii. By June, 2002, these entities will be required to dematerialise all outstanding
holdings of corporate debt securities.
This led to a sharp rise in the stock and settlement of dematerialised corporate
debt securities at National Securities Depository Limited (NSDL). The corporate
bond market is highly non-transparent; hence these trends should be treated as
being indicative only. The credit spread for the AAA bond has risen steadily from I
June, 2001 onwards, except for a slight fall in recent months, the credit spread for
AA and A bonds has risen sharply in recent months, suggesting a sharp increase in
the credit risk of second-tier firms.
The corporate with higher ratings raised capital at lower rates of below nine
percent. The amount raised during the period April-January, 2003 is as Rs. 33,509
crore, 26 percent higher than Rs. 26,956 crore raised during the same period last
year.
In January 2001, companies raised Rs. 2,690 crore through debt papers as
compared with Rs. 3, 670 crore raised in the previous month. It was also lower
than the average Rs. 3,424 crore raised per month during April-December 2001.
All the amounts were raised through private placement. Interest rates offered on
corporate bonds declined during January 2002 the range of interest rates was 7.5
per cent to 10 per cent.
There is a sharp rise in the stock of dematerialised corporate bonds, from Rs.
7,960 crore in March 2001 to Rs. 59,735 crore in December, 2001. Similarly, the
volume of transactions settled in dematerialised form rose from Rs. 813 crore in
May 2001 to Rs. 9,499 crore in December 2001.
These values are expected to continue to grow till June 2002, by which time RBI-
regulated entities have to completely eliminate physical bond certificates. On the
equity market, NSDL holds Rs. 3,16,040 core of securities. This is 5.3 times larger
than the stock of corporate debt held by NSDL.
NSDL settled Rs. 12,051 crore of equity transactions in December 2001. This was
only 1.27 times larger than the settlement done on corporate debt securities.
Contrary to the common notion that corporate debt in India is extremely difficult
to trade, a significant volume of such transactions are taking place.
It has also been observed in recent years that the vast majority of corporate debt
paper has been issued on a private placement basis leading to lack of
transparency and liquidity in the corporate debt market. It was therefore; felt that
regulatory action was needed to be taken by both SEBI and RBI to regulate this
market in order to induce greater public issuance of corporate debt.
SEBI issued guidelines on September 30, 2003 stipulating the conditions to be
complied with in respect of private placement of debt. These conditions governed
issuance, listing and trading of privately placed debt securities. The Reserve Bank
also issued corresponding guidelines putting prudential limits on banks relating to
subscription to privately placed corporate debt.
Subscription beyond these limits would have to be public issues of corporate debt
that is then more transparent, and whose market price would potentially be
clearer at any time. Subsequently, market participants made representations and
suggestions and sought clarifications on various provisions of the circular from
SEBI.
There was a general feeling in the market that the guidelines were too stringent.
Based on the feedback received from market participants and banks, RBI also
modified (on December 10, 2003) the prudential guidelines for banks non-SLR
investments.
Besides, SEBI was advised to take steps to address the issues of (i) a simplified
listing procedure for listed companies and (ii) to spell out an appropriate listing
procedure for unlisted companies. SEBI issued a circular on December 22, 2003 to
all the stock exchanges incorporating the above suggestions.
With the development of an elongated and smooth yield curve and aided by
abundant liquidity in the system, the stage is set for growth in infrastructure
financing. It is needless to highlight the importance of infrastructure financing if
the stated objective of attaining the developed country status for India is to be
achieved.
Therefore, the developments in the debt markets should percolate down to this
sector as well. On its part, RBI has been actively encouraging the government and
the market participants to work more on the issue and ensure credit
enhancement to the sector.
In the recently held 13th State Finance Secretaries Conference, a decision was
taken to set up a Working Group to study the issue of credit enhancement to the
infrastructure financing in states.
The private sector infrastructure agencies could also be active in the long term
financing, but for this to work, the credit enhancement has to pick up. While in
1995-96, there were large numbers of issuers, today there is a substantial pool of
potential investors, who need to be tapped for this credit enhancement to
materialise for the infrastructure area. At the same time, a bond insurance
mechanism can potentially be developed for ensuring credit enhancement and
investor | safety.
There have been enough indications that infrastructure needs would go up, which
would contribute to an efficient functioning of corporate debt market. The crucial
issues involved in developing the corporate debt market are the ways and means
of elongation of maturity of corporate debt paper, improving the liquidity in
secondary market, improving institutional mechanics etc.
While the G-Sec markets were now fairly well- developed, the corporate debt
markets needed to go a long way so that India can have a well-integrsited
financial market. An integrated financial market is necessary for efficient
transmission of monetary policy, keeping in view the fact that it is now operated
on indirect instruments.
Fortunately, the foundations for developing an efficient corporate debt market
have already been laid as the necessary infrastructure and institutions that have
been created for the G-Sec market are already available.
The regulators have also taken the first initiative in this regard with SEBI
announcing its guidelines on trading and listing requirements for corporate debt
and the RBI asking banks to invest only in listed and rated corporate paper on a
private placement basis.
The economy being on a high growth path would create higher demand for funds,
especially in infrastructure development. Corporate looking to raising funds from
the capital markets would also require them to raise the balancing debt.
With term lending from financial institutions on the decline, corporate funding
needs, especially of the infrastructure segment, would necessarily have to be met
by the bond market.
With these motivating factors for development of corporate debt market and a
large pool of well-informed urban population with 35 cities having 10 million
populations, there is a huge potential in this market for new issuers and investors.
However, we need innovations in credit enhancement with the active
participation of brokerage houses, retail investors etc.
However, while the development of corporate debt market was an opportunity,
the experience of developing the G-Sec market has shown that it is a long drawn
out and arduous effort which requires cooperative and collaborative efforts from
not only the regulators but also from the market participants and self regulatory
organisations.
The players both issuers and investors in the corporate debt market would be
varied. It was therefore important for the regulators to focus attention on
protecting investors interest by developing processes of clearing and settlement
that would ensure a risk free environment. This calls for effective regulation and
innovative approaches as well.
One of these innovations could be conversion of loan market in to bond market of
banks. Since the cash flows being similar and loans outstanding are significant,
these loans could be securitised and bonds could be issued against them. This
would lead to high credit quality and reduction in overall risks.
To facilitate the growth of corporate debt market, the Reserve Bank is actively
considering introduction of repos in corporate bonds, to be settled through CCIL.
Participation of corporate in repo market is also being considered positively.
Further, the securitisation market has been growing at a rapid pace, particularly
after the SEBI/RBI introduced regulations on the private placement in debt
market.
To encourage the growth of this market, the Reserve Bank excluded investments
in Asset Backed Securities (ABS)/ Mortgage Backed Securities (MBS) from the 10
percent ceiling on the investment of banks in unlisted non-SLR securities.
However, several issues relating to regulation, listing and improvement of
liquidity need to be addressed. Most MBS/ABS is issued by Special Purpose
Vehicles (SPVs) in the form of trusts which are not regulated. ABS/MBS issued by
trusts cannot be listed, although these are rated. Only the securities issued by the
companies can be listed.
On the other hand, there is legal ambiguity on the status of the listing of
ABS/MBS. Exchanges reportedly sought SEBIs clarification on the issue and it is
learnt that SEBI preferred an unambiguous enabling provision in the SCRA that
these mortgage backed securities can be listed.

TOWARDS DEVELOPMENT OF CORPORATE DEBT
MARKETININDIA*

1. Perhaps, importance of debt market could rather be better
gauged from a statement made by Mr.Greenspan, earlier
ChairmanofFederalReserve.HethoughtthattheAsiancrisis
would have been less severe ifEast Asiahad a functional
capital market in general and a bond market, in particular. He
thought that existence of a deep and liquid corporate debt
market could make emerging economies less vulnerable;
especiallytovolatilecapitalflows.

2. For, areasonably well developed bond market could
supplementthebankingsysteminmeetingtherequirementsof
thecorporatesectorforlongtermcapitalinvestmentandasset
creation. It could provide a stable source of finance; especially
whentheequitymarketisvolatileandresourcerequirementsof
the corporate entities are large. In the case ofIndia,
development of a corporate bond market has become even
more crucial especially, in view of the decline and
disappearance of development financial institutions and the
need for raising large amount of resources for infrastructure
developmentinthecountryduringthenextcoupleofyears.


3. During the recent years, the expansion of corporate bond
market in the Asian region has been receiving much more
attention than before. The progress made, however varies
widely across countries. Both,MalaysiaandSouth Koreahave
made reasonable progress in this respect followed
byThailandin regard to the developingAsia. Yet going by
theUSor European standards the progress has been tardy;
ratherinsignificant considering the actual requirements of the
region, as of now. BothChinaandIndiahave surprisingly
laggedbehindindevelopingcorporatebondmarkets.

4.Thereisaplethoraoffactorsresponsiblefortheslowgrowth
ofcorporatebondmarketintheAsianregion.Theseare:

There are only a few corporate entities in the region
whichare capable of meeting investor requirementsin
terms of transparency and governance standards. This
has resulted in a yawning gap between demand for and
supply of corporate bonds inAsiacausing outflow of
capitalinsearchofgreenerpasturesforsafetyandhigher
returns.

Publicofferingofbondsbeingexpensive,timeconsuming
and procedure oriented, corporates have been finding it
easier to either borrow from banks or make a private
placementoftheirbonds.

Corporatebondmarkethasbeenaninstitutionalmarket.
It involves over the counter bulk trading thus making
tradingactivityrlesstransparent.

Non availability of bankruptcy laws to ensure investor
protection in the Asian markets has also contributed
towardsslowdevelopmentofthecorporatebondmarket.

Corporategovernanceanddisclosurestandardsavailable
in these countries do not provide enough confidence to
investors to go in for investments in bonds, as unlike
banks, bond investors will bewidely dispersed and
thereforewillhavelessbargainingpower.

Building the infrastructure required for a well developed
bond market is subject to significant time and resource
costs. In fact, most developing Asian economies neither
have the resources, nor the skills and the required
technology to embark on an infrastructure development
programmewithaviewtorevampingtheirbondmarkets.

5.InIndia,developmentofcorporatedebtmarkethasbeenone
areawhichismostdeliberateduponanddiscussedabout.And
yetitremainstheleastdevelopedofallsegmentsofthemarket
for reasons known to the market participants. It has also been
the least regulated till recently and to some extent even today.
Reforms of the financial markets seem to have bypassed this
segmentofthemarket,altogether.

6. Yet,India,has been anexception in regard to many of the
shortcomings observed in respect of most Asian
countries.Indiahas a legal framework in place to provide for
regulatory oversight and investor protection. It has a fairly
developed financial sector segment of the market which is
reasonably free of controls. It also has quite a few corporate
entities who could take advantage of the bond markets for its
requirement of financial resources. It hasthe required
infrastructureinplaceandhastwoworldclassstockexchanges
for trading, clearing and settlement systems. The country also
can boast of reasonably well functioning depositories and a
crediblesystemofexperiencedcreditratingagencies.Overand
above, It hasthe required skilled manpower coupled with
availabilityofthebesttechnology.

7.Againstthisbackground,afreshattemptisnowbeingmade
by the Government to create a vibrant dynamic and deep
corporatedebtmarketinthiscountry.Abeginningtowardssuch
an attempt has already been made with the High Level
Committee on Corporate Bonds and Securitization, set up by
theGovernmentofIndia,whichhasspeltoutmeasuresneeded
torealizethedreamofdevelopingsuchamarketinthiscountry.

8.Subsequent to the announcement of the Finance Minister
accepting the recommendations of the Committee SEBIs
internal group worked out a road map for implementation ofa
plan for the development of a corporate bond market inIndia.
An internal Group of RBI has also recently come out with its
views onthesubject.I understandthatInJune last,the World
Banktooorganizedaseminarwhereintherelevantissueswere
discussedbythemarketparticipants,threadbare.

9. SEBIs internal committee has given some thought to an
envisaged set up to make a beginning in the corporate debt
market.Asanintegralpartofitseffortstopromoteanefficient,
orderlyandfairfinancialmarketithassuggestedsettingupofa
trade reporting platform for corporate debt to start with and an
exchange for bond trading, clearing and settlement.
Globalization being the watch word for success, perhaps we
need to think ahead andforge ahead in this area providing
even a hubfortrading,clearing andsettlement of Asianbonds
.Let us for a while think of ourselves as the rock stars of an
Asianbondmarketoftomorrow.Sinceweneednotreinventthe
wheel,thefactthatIndiaisyettodevelopadomesticcorporate
bondmarketshouldnotdeterusfromachievingthisgoal.


10.Somestepstowardsachievingthisobjectivecouldbe:

Setting up a corporate bond trade reporting system to
ensure real time dissemination of information on bond
trading;

Settingupanexchangeexclusivelyforbondtradingwith
appropriate arrangements for clearing and settlement as
soon as the trade reporting system stabilizes and
generates the required information on bond trading for
dissemination;

Taking appropriate measuresto widen and deepen the
bond market. This could include enhancing the investor
base,introducingaclassofmarketmakers,sortingoutof
taxationissuesetc.

Evolvingaselfregulatoryorganizationonthelinesofthe
National Association of Securities Dealers in theUSto
help ease the burden of SEBI in regulating the bond
marketcouldbeanintegralpartoftheplan.

Establishing optional platforms to provide facilities for
onlinepublic offerings in different ways to investors
andsettingup a scheme of repurchase agreements in
corporate bonds to enhance liquidity of bonds could be
addedfeaturesoftheproject.

11.Oncethedomesticsegmentoftheexchangefullystabilizes,
an international segment of the exchange could be opened for
listing of Asian bonds to facilitate Asian issuers of corporate
bonds to undertake their trading activities. This will be in tune
with the decision to explore the idea of setting up an
international financial centre in Mumbai, on the one hand and
the move towards capital account convertibility on the other.
Such a move would enable Asian countries which have
amassedabout$2.73trillionofforeignexchangereserveshave
avenuesforinvestmentwithintheregion.