Many benefits of moving to a bond market

India has historically been a bank-finance driven economy, with the banking system’s assets significantly higher than other sources of financing, such as insurance, mutual funds, pension & provident funds etc. Going forward, the funding requirement for the infrastructure sector alone is estimated at over USD 1 trillion as per the Twelfth Five Year plan from 2012 to 2017. With a current non-food credit portfolio of around USD 1.1 trillion, the domestic banking system will clearly be unable to meet this demand.

The problems get accentuated in the current economic environment, where public sector banks that account for around 70 percent of the banking system assets and liabilities, are facing acute challenges on profitability and capitalization levels on the back of asset quality issues. Banks’ reported NPAs are likely to rise for some more quarters, given the typical lag in recognition. However, given the system’s focus on delinquent assets, the pace of NPA build-up would moderate going forward. Nevertheless, credit costs are likely to remain high, weighing upon banks’ profitability and preventing a sizable decline in domestic bank lending rates in the next 12-18 months, despite the expectation of further modest rate cuts. Moreover, system-wide credit growth is estimated to be restricted to below 12-14 percent for the next few years.

As a result, commercial paper and debentures are likely to remain relatively attractive, at least for better-rated entities. However, the eventual revival in the investment cycle would result in a broad-based pickup in corporates’ funding requirements, including less-highly rated entities. Meeting their credit needs would emerge as a challenge, unless the corporate bond market develops rapidly, diversifying the risk across market participants other than banks.

One of the other main benefits of moving to the bond market is that it instills greater financial discipline in the issuers, given that investors tend to be far less forgiving than banks. Additionally, while the bank loan market is relatively opaque, the bond market demands better disclosures and transparency levels from the issuers.  Broadening of the investor base also aids in improving the liquidity in the underlying markets, which acts as a feeder to entice more investors.

The Indian bond market continued to face challenges on many counts involving issuers, investors and market structures. Acknowledging the importance and necessity of a vibrant bond market, the government in collaboration with the various regulators have been taking steps over the years to develop this market. Consequently, the market has deepened in relation to the past, although it continues to fall short of expectations. The recent measures announced by the RBI wherein it accepted many of the recommendations of the Khan Committee report should encourage greater activity levels in the bond markets. In a break from the past, this time the RBI has announced measures on many areas affecting issuers and investors that is under its purview to support the bond markets. The plan to encourage large borrowers to raise part of their requirements from the debt capital markets and restrict large exposures by banks are amongst the most strategic and important directives to be implemented over the medium term. While the investor risk appetite is the key, this measure will push entities to move to the bond market sooner than later. A similar support from other regulators and the Government on the areas actionable by them would augur well for the bond markets.

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Karthik Srinivasan

Senior VP and co-head of financial sector ratings|ICRA

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Technology will have to be leveraged to improve the bond markets in the country. We have already witnessed remarkable improvement in the equity trading volumes and also on the G-Sec market after the introduction of the anonymous electronic trading platforms. A speedier implementation of DVP III along with the electronic trading platform over the short to medium term would remain important as it can improve the liquidity and also get more investors. Further, the Indian market provides limited options to hedge one’s position in the debt markets. While there are avenues such as Interest Rate Swaps Interest rate futures and Credit default swaps, barring interest rate swaps, the volumes in other products have been low. The above coupled with further rationalization of transaction costs can help aid trading volumes.