Monday, 24 September 2018

Teething troubles

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India’s domestic bond market has struggled to keep up with the exponential growth of rupee lending, but there are signs that issuers and investors are warming to the idea.

The growth in infrastructure-related financing has been a boon to India’s domestic lenders, but the rupee bond market has offered limited opportunities. Regulators have been trying to introduce changes to help deepen the corporate bond markets, but much more needs to be done.

The first key issue to address is on the demand side: Indian companies view the bond markets as only a secondary option over the loan markets. Only if this attitude is changed will the market really develop.

“Indian corporates are quite willing to access the domestic bond market and are quite active from time-to-time. However, historically, given the strong liquidity position and credit appetite of Indian banks, the rupee loan market has been more efficient from a pricing perspective,” said Raju Shukla, managing director and country head for India at Barclays Capital. “Also, non-bank investor appetite for all but the best rated issuers (AAA/AA+) has been limited, and banks prefer to lend in loan form rather than invest in corporate bonds because of mark-to-market considerations (applicable to bonds, but not to loans) and the higher pricing available on loans.”

According to Thomson Reuters data, the Indian rupee bond markets have grown steadily over the last three years. In 2009 rupee bond volumes reached Rs1.7trn from 459 deals, up 13% from the Rs1.5trn from 604 issues in 2008. This year is keeping up that run rate: the markets had recorded volumes of Rs1.4trn from 360 issues as of the end of August.

Many, however, feel that more reforms are needed. Under current legislation, for example, foreign institutional investors - cumulatively - can invest only US$500m in the corporate debt market in India and that too is restricted to the secondary market.

Shukla believes a rationalisation of the withholding tax rules for debt securities will encourage FIIs to invest in Indian corporate bonds and will bring in greater liquidity to the market.

“Payments of interest/redemption premium to FII investors are also subject to a 20% withholding tax. In reality, most FIIs benefit from various double taxation treaties, and will have a lower tax payment, thus requiring them to apply for tax refunds,” he said.

Moreover, many of India’s biggest institutional investors, such as insurance and pension funds, are state-owned, and face restrictions in investing in bonds issued by privately-held entities. In addition to this, the secondary markets are quite illiquid as most often bonds are kept on the books till maturity rather marked-to-market under the bond portfolio.

There are signs, however, that issuers and investors are now recognising the importance of the bond markets.

For instance, in May two Malaysian companies raised Rs5bn (US$105m) from issuing five-year bonds backed by receivables from two toll roads. This uniquely structured bond issues refinanced the loans taken by Emas Expressway and Mapex Infrastructure for the construction of the toll roads.

Indian treasury managers have also found some opportunity to lock in funding ahead of anticipated rate hikes. In May again, engineering and construction major Larsen & Toubro raised Rs8bn from three different bond issues that included some unusual features.

The first of those issues was a Rs3bn 10-year partly-paid unsecured bond - a structure last seen on a domestic bond over a decade ago.

Under the terms of the issue, investors chip in with only 10% of their commitments on day one and pay the remaining 90% after a year. The deal carried a coupon of 8.75% in the first year before stepping up to 9.15%.

This deal was followed up with a similar transaction - a 10-year Rs3bn deal, but this time with a coupon of 8.65% in the first year, which steps up to 8.95%.

The structure allowed L&T to lock in funding in a rising interest rate environment, while lessening the negative carry by paying a lower interest rate until it received the cash.

Deals are also getting longer. For instance, a 25-year tranche of the three-part Rs15.55bn bond issue of Indian Railway Finance Corp in May paved the way for more long-dated paper. “There is interest in the market to develop a yield curve for 25-year paper,” remarked a New Delhi based bond trader.

Reforms have been a regular feature of the market, with recent changes including the tightening of short-term bond rules to boost investor confidence by making it harder for weak companies to sell bonds.

Challenges remain, but India’s regulators are aware of the need to develop the country’s bond market. The bank loan market may be booming, but a country with such big infrastructure financing plans cannot afford to ignore any market that may be able to share that burden.

Manju Dalal

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