Why the Indian corporate bond market is so hot right now

Anuj: What makes this market so hot right now?

A: The foreign institutional investors (FIIs) interest in the country like India has been very good and initially they started with government securities but since g-sec limit was completely utilised till June or July, they have no option but to either wait for the government securities limit to be enhanced or start investing in the corporate bond.

[Also] they get slightly better yield in corporate bonds than government securities and they are as safe as the government securities because they (FIIs) have started investing in corporate bonds of top notch rated PSUs, which are not only giving them extra yield but they are stable and their credit quality is much better.

So, in the corporate bond market, from June-July onwards we see a about USD 1.5-2 billion inflows every month from FIIs. That has contracted the spreads between government securities and corporate bonds. It used to be about 70-80 basis points historically, they have now come down to 30-40 basis points.

The outlook about India has also changed in the investors’ mind with stable currency, growth coming back, stable government, investor-friendly policies, all that has prompted them to buy the corporate bonds little aggressively.

Ekta: What kind of spreads are FIIs, foreign portfolio investor (FPIs) getting on Indian corporate bonds and which are the corporate bonds that we are seeing them invest in?

A: We have seen a lot of FIIs especially buying the very frequently-issued corporate bonds like PFC, REC, IRFC and Power Grid Corporation and couple of banks like ICICI Bank or Axis Bank and HDFC Bank.

These all are available right now at a spread of 35-40 basis points over the government securities on annualised basis.

Ekta: Globally what is the spread difference that is making them more interested in Indian bonds as oppose to other international debt markets?

A: These FIIs are coming either from the European countries, US or the South Asian countries like Singapore, Hong Kong and all. The yields in other countries, especially on government-sponsored corporate bonds is not as high as it is in India. In India, these are available at a yield of 8.25-8.40 levels whereas globally these are traded at yield of 1.5-2 percent levels.

Ekta: Do you expect the limit that they have in the corporate bond markets for the FIIs to possibly get exhausted soon maybe even in this year?

A: The limits were at around 30-32 percent six months back and they are currently at around 74 percent. Up to a limit of 90 percent utilization, you don’t need to buy limits and go for bidding process; you can just straight away make investments and inform Securities and Exchange Board of India (Sebi).

But once you reach the limit utilisation level of 90 percent, you need to wait for the auctions and buy the limits and then make investments or wait for limit enhancement.

The way the flows are coming in, I expect limits to be utilised to a level of 90 percent over the next two to three months.

Ekta: What happens then after the utilisation is completed at 90 percent? Do you think there could be any sort of relaxation on the FII limit from the government or the Reserve Bank of India (RBI)?

A: It is very likely. We have seen that happening in the government securities especially when in the month of June-July there was limit exhaustion and there was need for more investments required by the FIIs.

However, what RBI has done is they have shifted a part of the limit, which was not utilised on the sovereign wealth fund and pension fund and the central bank quota [which was a separate USD 10 billion], it has reduced USD 5 billion from there and shifted to the normal quota and it was very quickly exhausted.

The market is expecting a kind of a limit enhancement in the government securities as well so we need to wait. Since the flow is taking place in corporate bonds I don’t see the need for enhancing the government bond limit [right now] but once the corporate bond limit gets utilized, there will be a quick enhancement in the corporate bond limit.

Anuj: If there was room to invest in both what would be more attractive right now from foreign investment point of view?

A: We have seen that historically. FIIs are more interested making investments in government securities. The reasons are that these are sovereign, very liquid and you can any day buy any amount. Whereas the corporate bond supply is as and when there is supply, you buy.

The secondary market [in corporate bonds] is not very liquid compared to government bonds. Historically, FIIs have preferred to buy government bonds but since government bonds were not available, they have started making investments in the corporate bond. Given a choice, they will prefer government securities.

Ekta: A quick word on the first half borrowing calendar that came out yesterday, Rs 3.6 lakh crore, that was in line with estimates?

A: It looks like it is more or less similar to what it has been every year, Rs 3.6 lakh crore borrowing out of close to Rs 6 lakh crore which is 60 percent -- it looks front loaded.

But when I carefully analysed it, it is not like that. Historically, they have been borrowed about 57-60 percent [in the first half]. Last year, the net borrowing was about 58 percent. [But this year] most redemptions are in the first half this year. So, if we see the net borrowing, we are borrowing about 49 percent compared to 58 percent last year.

The second half last year we borrowed about 42 percent. Against that, this year we will be borrowing 51 percent. So, it is not actually front loaded. It is more or less calibrated very well and there are a lot of redemptions in the first three to five years. So, this time they [government] have been constantly been reducing maturity between 5-9 percent and they are borrowing longer term.

They have introduced a 40 year g-sec for the first time and majority of the borrowings are in the 20-year segment onwards have increased by 2-3 percent. So, it looks like we are keen to borrow slightly longer term rather than facing the redemptions in the coming three or four years.