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The time has come for corporate bond market

There has been a flurry of regulatory activity covering the primary (new issues) market recently. Unlike in the past when new issues invariably meant equity issues, this time the term covers the corporate bond market as well.

On December 3, the Securities and Exchange Board of India announced significant relaxations in its rules and procedures governing new corporate bond issues. These have significance for the growth of the corporate bond market in India. Under the new relaxation, SEBI will permit issuers of bonds to go to the market with their public and rights issues after obtaining a rating from just one rating agency. Hitherto, two separate ratings were required. Moreover, such a rating need not be of investment grade only. A rating below investment grade bonds will now be allowed. There has been further relaxation making issuance of debt instruments and the structuring of derivatives more flexible.

Less than a week earlier, on November29, the capital market regulator amended its guidelines relating to the primary market in equities.

Listed companies which satisfy certain regulatory guidelines can now issue additional capital on a fast track basis. Also, many categories of investors can apply for Indian Depository Receipts (IDRs) while companies can offer shares at a discounted price to retail investors in a public issue.

In India, it is the equity segment of the capital market that engages everyone’s attention, which included till recently even the regulator. For all practical purposes, the primary market has come to be synonymous with the primary equity market.

All this is understandable in a context where the corporate bond market, relative to the equity or government securities market, is small and continues to languish.

Why is a comprehensive corporate bond market essential? The overall growth of the Indian financial sector in recent years has of course been quite impressive. But a more vibrant corporate bond market will complement the already well developed and active equity and gilts markets. At present the corporate bond market remains a poor cousin. Most of the financial sector reforms including technology absorption can easily be extended to transform the bond market but attempts so far made have been in fits and starts. Some market watchers point to the absence of proactive regulation of the type that has led the sweeping changes in the equity and government securities markets. There may be some substance to the comment that bond market regulation has fallen between the two stools of the Reserve Bank of India and SEBI but too much need not be made of it.

The primary reason could well be the relative unfamiliarity of users of the bond market _ the corporates as well investors _ with its workings. But no one questions the need for a developed bond market in India. Financing of large projects, especially those in the infrastructure areas, will get a boost.

Until the early 1990s, medium term finance was the preserve of all India development financial institutions such as the IDBI, ICICI, IFCI, LIC and GIC. State level financial institutions and commercial banks chipped in with the balance of term loans. With the conversion of the all India financial institutions into commercial banks there is a huge vacuum in the development finance area that has been waiting to be filled. Commercial banks as a rule cannot fund long gestation projects. Their horizon is often restricted by the maximum duration of deposits they receive, namely, three years. A corporate bond market with substantial depth can fill the role but for a number of reasons this has not yet evolved.

As far back as 2005, a high level expert committee headed by R. H. Patil made a number of recommendations to strengthen both the primary and secondary segments of the bond market.

One important recommendation was to compulsorily list all privately placed debt issues. That would lead to more secondary market trades in debt instruments. Rating agencies will have a more visible role in the debt segment of the capital market. Ordinary investors can choose the appropriate instrument depending upon their risk appetite.

There are other advantages flowing from a full fledged corporate bond market. From the perspective of developing countries, a liquid corporate bond market can play a critical role in supporting economic development as it supplements the banking system. It can nurture credit culture and encourage market discipline.

The Government and the RBI will have another important avenue — besides the government securities market — to monitor interest rates in the country.

It has been found that developed countries have much more efficient bond markets than developing countries. In the former, the banking system complements the bond market which also provides a degree of protection against systemic shocks.

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