Time to reshape the bond market for India’s infrastructure financing needs

The allure of new-age bonds, particularly infrastructure bonds, inherently lies in their risk-to-reward proposition

The current size of the National Infrastructure Pipeline stands at a staggering Rs 111 lakh crore, a figure that dwarfs the capacity of government capital expenditure alone to meet. The arithmetic is straightforward: traditional funding mechanisms are inadequate for the scale of India's ambitious infrastructure vision. This is where a reimagined bond market comes in, acting as a conduit between India's infrastructure needs and investors searching for reliable returns.

The news of India's inclusion in JP Morgan's Government Bond Index (GBI-EM) has been music to the ears of policymakers and investors alike. In June 2024, 23 Indian government bonds worth $33 billion will debut on this index. This landmark event will serve as a springboard for the government to undertake bold reforms to channel investments into the infrastructure sector. The GBI-EM’s inclusion will channel foreign funds into Indian government bonds and free up domestic capital to be redirected towards infrastructure bonds. This reallocation creates financial liquidity essential for infrastructural projects. The macroeconomic shifts, driven by key policy reforms, have opened a window for the government. But to truly harness the promise of the bond market, India needs imaginative reforms to enhance liquidity and expand the investor base.

Ripe for Diversification

Historically, the Indian bond market has predominantly meant government bonds. While these instruments have been crucial for India's fiscal stability, the bond market is ripe for diversification with corporate bonds, municipal bonds, and, notably, infrastructure bonds. Given infrastructure's role in India’s growth story, these bonds could serve as a conduit, connecting India's infrastructure needs with investors' search for reliable returns.

In the Union Budget for 2023-24, a notable change was the tax revision on debt mutual funds, aligning the tax treatment across all investible debt instruments like bonds, market-linked debentures and bank fixed deposits. This modification addresses a significant systemic issue — the stunted growth of the corporate bond market due to tax disparities. The assets under management (AUM) in debt mutual funds primarily consisted of sovereign/quasi-sovereign/AAA-rated securities having minimal exposure to interest-rate fluctuations and almost no credit risk. With debt funds no longer mere vehicles for converting interest income to capital gains, the stage is set for invigorating the corporate bond ecosystem.

Collaborative Approach Required

But for instruments like infrastructure bonds to thrive, especially given the risks associated with mega projects, a collaborative approach to risk management between the government and the private sector is vital. The allure of new-age bonds, particularly infrastructure bonds, inherently lies in their risk-to-reward proposition. The government can offer a tiered guarantee mechanism on interest repayments based on strategic importance, project risk and duration. Instead of the government financing the entire pipeline, deploying a dedicated risk fund to attract private capital would be a much more efficient use of the limited resources of the government. This structured risk-sharing model can provide investors with a safety net while ensuring risk is distributed prudently across stakeholders. Such an initiative could initiate a virtuous cycle, bringing in a fresh wave of institutional and individual capital.

A shift in understanding and managing risk through a comprehensive risk-sharing model involving both government and private stakeholders can turn the perceived risk from being a deterrent to an attraction for investments. Additionally, robust third-party assessments and credit rating mechanisms can further illuminate the risk-return profile of various bond offerings. Incorporating transparency within this framework can further enhance its resilience and attractiveness, by providing investors with a clearer understanding of the risk and return associated with various bond offerings. This would allow pension funds, provident funds and insurance companies with investment restrictions to look beyond AAA ratings and diversify into relatively riskier asset classes offering higher returns.

Encourage Retail Participation

Retail investors are another segment waiting to be tapped. India boasts over 120 million demat accounts, showcasing enthusiastic retail participation in equities that often surpass foreign and domestic institutions. But retail ownership in bonds remains confined to risk-averse instruments like bank FDs, with investor awareness and access to bond markets woefully low even compared to Asian counterparts. A developed bond market cannot operate in silos. It requires collective efforts, harmonising the expertise of the Reserve Bank of India, the Securities and Exchange Board of India and other key market entities. A collaborative approach could significantly enhance the efficacy of these efforts. To broaden the investor base, regulators must facilitate access by partnering with established entities. Integration with the infrastructure of NSE and BSE and leveraging these exchanges' expansive customer networks can pave the way for user-friendly electronic platforms and simplified bond products suited for first-time investors.

The government can also initiate targeted financial education programmes that explain bond investing and its benefits compared to traditional fixed-income options. A vibrant bond market needs a well-informed and diversified investor base.

The building blocks and boundless investor appetite for a vibrant Indian bond market exist. It is time for imaginative reforms, stakeholder collaboration and measures that can unlock the power of bonds to fuel India's infrastructure dreams. The opportunity to reshape the bond market to meet India's infrastructural aspirations is here and now. With the right reforms, risk-management frameworks and investor-friendly policies, India can harness the promise of the bond market to deliver the infrastructure that will define the nation's future.

Chirag Dudani is Assistant Consultant at the Economic Advisory Council to the Prime Minister. Views are personal, and do not represent the stand of this publication.