Ravi Krishnan Moneycontrol News
The Securities and Exchange Board of India’s (SEBI’s) discussion paper on a framework for large corporate borrowings smacks of regulatory overreach. The capital markets regulator has proposed that firms with long-term borrowings of at least Rs 100 crore and a credit rating of AA or above will have to compulsorily source 25 percent of their incremental debt financing from the bond market starting next financial year. Further, it has suggested that after a couple of years a monetary penalty be imposed if firms don’t achieve this target.
The broad objective of deepening the corporate bond market is laudable and necessary. In the current scenario, banks do not have the wherewithal to lend to industries and in the last few years have ended up taking poor decisions leading to the massive bad loan problem.
Bond markets will instil a sense of credit discipline. Errant borrowers will be punished by the market immediately. The insolvency and bankruptcy code, which places bondholders higher than even the government in the liquidation waterfall, is a great enabler for the growth of bond markets.
However, it is bad practice for the regulator to be dictating how firms should borrow. The regulator is impinging on what is essentially a commercial decision for companies. Why should companies be forced to borrow via bonds if their cost of funds is lower elsewhere? In a rising interest rate environment, typically, the costs of borrowing from the bond market is higher than, say, borrowing from banks.
A fundamental problem with the bond market in India is that the government crowds out the private sector. Both the Centre and the states borrow massively from the markets. If the corporate sector has to increase its presence, it is necessary that the Centre and states follow a path of fiscal consolidation. Else, the costs are largely going to be higher.
In the past two financial years, if there has been an increase in bonds’ share of fund flow to the commercial sector, it is partly owing to the fact that rates were lower in the bond market. This growth was not forced by any regulation, although the capital markets regulator and the Reserve Bank of India did ease some norms.
Forcing firms to mandatorily switch their borrowings is neither advisable nor sustainable without any thought given to who would buy this fresh supply. Remember, that almost nine-tenths of corporate bond issuances in India are already by AA and higher rated companies.
Regulation should be more about making it easier for borrower firms to issue debt paper and for investors to invest. Allowing tri-party repos in the corporate bond market, enabling foreign investors to buy corporate paper with a residual maturity of one year (compared to three years earlier) and allowing reissuance of bonds with the same maturity to boost liquidity are some of the measures which the regulators have got right.
Now, the government and regulators should take a step to shore up the investor base for such bonds. That would include measures like allowing more foreign investor participation, allowing insurance companies and pension funds to buy into the lower rated paper.
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