Buried near the end of the Reserve Bank of India governor’s opening statement at Tuesday’s post-policy press conference was a line that caught my attention.
The immediate focus may have been the RBI’s decision to keep rates on hold, or Governor Raghuram Rajan’s irritation at the banks’ failure to pass on lower rates to their customers. But in his final policy statement before his tenure ends on September 4, he also confirmed that the central bank will unveil a set of measures on August 25 to improve the functioning of markets, especially the corporate bond market.
The measures will draw on suggestions contained in the recent report penned by HR Khan (whose term as deputy governor ended last month). As a proportion of GDP, India’s corporate bond market is not only small but actually not very corporate: it’s broadly restricted to relatively short-term (2-5 year tenor) very highly-rated issues sold by financial institutions and public-sector borrowers to a pool of institutional investors with narrowly defined mandates.
However, as tighter bank capital requirements kick in, it is clear that debt capital markets will need to take up the slack, particularly around SME funding and long-term infrastructure financing. Khan hopes an active corporate bond market will provide a fillip to the local municipal bond market; particularly important in the context of the 100 Smart Cities challenge. Yet efforts to build a viable bond market in India have to-date been unsuccessful, despite a series of policy initiatives.
For a start, the government is inherently conflicted because it needs the banks to finance its own deficit, creating a crowding-out effect. Then there are caps on the quantum and maturity profile of rupee bonds that can be held by foreign investors; the market lacks a benchmark yield curve or a widely followed bond index family; the sound bankruptcy regime that Khan says is a pre-requisite for deep bond markets is in the works but currently still lacking, as are functioning CDS and credit repo markets or retail participation.
The tax rules are unclear; the notion of corporate bond market-making is alien; the corporate debt securitisation market is moribund. Khan also makes reference to an underdeveloped bond-currency derivatives nexus that acts as a block on progress. That’s quite a lot of negatives.
The issue in India is not that elements for a successful bond market don’t exist. They do. It’s just that no-one uses them.
The list of recent initiatives shows that regulators are clearly aware of the problem. There’s the emergence of online private placement platforms on the stock exchanges (BSE-BOND and NSE-EBP); allowing banks and primary dealers to become exchange members to boost trading activity; the relaxation of restrictions on foreign investor activity (around unlisted and pass-through debt); an increase in foreign portolio investment limits on corporate debt (for maturities beyond three years). None of those, however, have made much of a dent.
The same goes for the credit-enhancement scheme for infrastructure; partial credit enhancement by banks vis-à-vis corporate bonds; the issuance of long-term bonds by banks for infrastructure and affordable housing; or improvements to the market architecture (around post-trade transparency and settlement).
There’s also a bit of a “damned-if-you-do-damned-if-you-don’t” issue at play: the government might like the idea in principle of forcing large companies to switch from bank loans to bonds and commercial paper by introducing caps on the proportion of bank finance in the overall mix. But beyond the fact that such artificial caps will never work, the government is at the same time concerned that a lot of Indian companies are highly leveraged and wouldn’t necessarily make good bond candidates.
Khan has spoken widely about his thoughts – and frustrations – around the lack of progress towards a functioning, thriving corporate bond market in India. On the basis that there have been so many false dawns on this subject (note that Khan himself referred in a speech last October to the “deep-rooted, inertial nature of underlying factors”) it would be easy to dismiss the proposed new measures before the ink is dry. But let’s at least wait and see.
“For more than 10 years now, development of corporate bond markets in India has been the focus of all stakeholders but the arduous pursuit of the Holy Grail has not delivered desired results,” Khan said at a Federation of Indian Chambers of Commerce and Industry event last year. Relying predominantly on the banking system to support the development of the corporate bond market, directly or indirectly (witness some of the initiatives listed above) “militates against the very idea of the bond market de-risking the bank sector”, he added. And he’s right.
“Activating the corporate bond market will require a number of regulatory measures to address both the macro issues as well as the market micro-structure issues. While creating an efficient market infrastructure will create conditions for issuers and investors, the structural issues can be addressed over the longer term as the market evolves and the financial system gets more integrated with international markets.”
So expect some of the bottlenecks and restrictions to be relaxed on August 25. But in so many respects the issue in India is not that elements for a successful bond market don’t exist. They do. It’s just that no-one uses them. It’s partly a cultural issue.
I, for one, am not expecting dramatic changes to result from whatever RBI announces in a couple of weeks. Nor, I infer, is Khan: “we must be careful that our pursuit of perfect bond markets does not end up as an endless chimerical chase. Bond markets are part of a broader ecosystem and it would be best if these markets evolve organically,” he said at the FICCI event.
ANOTHER NEWS ITEM worthy of mention in the context both of India and the ongoing thematic debate about regulatory capital is the block on the small but storied Kerala-based Dhanlaxmi Bank on paying the coupon on its Upper Tier 2 Series I bonds.
The RBI instructed the bank to postpone the payment to later years because its capital adequacy ratio of 7.51% at the end of March was below RBI’s regulatory floor of 9-5/8%, allowable under the terms of the issue and subject to prior regulatory approval.
The bank, which reported a Rs2.09bn (US$31.3m) loss for year ended March 2016 owing to an uptick in bad-loan provisions and pension benefits, is apparently in the final throes of securing a Rs1.2bn infusion of equity via preferential allotment of shares to three existing shareholders (the board approved an infusion of up to Rs2bn).
Foreign portfolio investors, a collection of hedge funds and asset managers, own just over 20% of the bank; foreign individuals or NRIs, own just over 15%.Indian observers widely expect the bank to be subject to a takeover bid in the near term.
