Kick-starting corporate bond markets

A modern economy cannot run on love and fresh air. It runs on modern practices,” said the finance minister, P Chidambaram, speaking in Hyderabad earlier this month.

He was bang on, except that in one major area — the corporate bond market — there’s little sign of modern practices being introduced. This, despite the fact that it’s close to a year since the Patil committee set out a detailed roadmap on what needs to be done to energise the market.

It’s also close to 10 years since the East Asian crisis that saw Asian governments resolve to develop their corporate bond markets as a cushion to deal with volatile capital outflows. But with the exception of Japan, none of the others, including India, has made much progress.

Indeed India today ranks last among the BRIC economies, Brazil, Russia, India and China, with outstanding corporate debt of little over $2 billion compared to Brazil’s close to $4 billion, Russia’s $10 billion and China’s $12 billion, according to IMF estimates (2004).

This is surprising since both government as well as financial market players have often expressed their eagerness to see a well-functioning corporate debt market in place. So what gives? Why have we not been able to make any progress? More important, is there any way of putting the pieces in place?

The main problem, as a finance ministry official speaking at the just concluded World Economic Forum confessed, is that there are just too many obstacles — political, legal and policy-related — to the emergence of a vibrant corporate bond market.

To begin with, there are 78 laws, starting from the definition of a corporate bond, that need to be amended. Unfortunately, given the glacial pace at which legislative changes happen in our country, none of that is going to happen overnight.

Some changes can, of course, be incorporated in the new Companies Bill. But there are other changes that would not only need amendments to various Acts but would also require a supporting institutional machinery to be put in place.

For instance, holders of corporate bonds are not sure they will be able to enforce their rights in case of default by bond issuers. So unless there is a complete overhaul of the role and responsibility of debenture trustees and of bankruptcy law and procedures, it is unlikely they will be attracted to the market.

Yet given our huge infrastructure deficit — it is estimated India will need $320 billion for infrastructure projects over the Eleventh Plan period — we desperately need to bring our moribund bond market to life.

The reason is three-fold: the inability of government to invest on this scale; the demise of development financial institutions that provided long-term money in the past; and the inability of banks to extend term finance beyond a point, since the bulk of their funds is of much shorter duration. Consequently, the bulk of infrastructure financing will have to be through corporate bond issues.

The government, therefore, has two choices. Either it can wait till it gets all the necessary legislation in place before it does anything. Or, as with much else in the Indian context, it can plunge in.

Do whatever is possible immediately and then keep tweaking the system as the situation evolves. This is what it has done in a number of areas, notably value-added tax (VAT), where we pushed ahead with a far from perfect VAT and yet have not fared too poorly as a consequence.

The process is definitely messy and is fraught with frequent policy contradictions. But it is better than waiting endlessly for everything to become picture perfect before taking the first step. More so given the Indian predilection to debate issues endlessly.

So, what are the immediate changes that can give a boost to the market? As the first step, the government needs to encourage more players and simultaneously, take steps to improve liquidity and transparency so that secondary market transactions become easier.

In the equity market, automated nationwide real-time trading and settlement, depositories and an active regulator transformed the Indian equity markets. If the same can be replicated in the case of corporate bonds, there is no reason why the bond market cannot be transformed.

Fortunately, there some signs of movement on the ground. The finance ministry has got Cabinet approval to remove the legal ambiguities over asset-backed securitisation. This will enable special purpose vehicles to issue asset-backed securities for trading and will partially address the issue of poor volumes on the supply side, apart from improving the quality of paper.

The RBI could contribute by relaxing its existing guidelines on securitising debts. It could also incentivise corporates to issue bonds rather than resort to cash credit facilities by advising banks to offer a lower rate of interest on bonds.

On the demand side, pending pension and insurance sector reform that would bring in more players seeking long-term paper, investment guidelines for existing superannuation funds could be relaxed in line with those for employees PF. It could also raise the FII limit for investment in corporate bonds.

The issue of states levying varying stamp duties, making trading cumbersome, could be addressed by Sebi mandating that all bond issues as well as subsequent trading should be in demat form, as with equities. Section 8A of the Indian Stamp Act 1899 already has an enabling provision to this effect. TDS (tax deducted at source), another irritant, could be done away with as has been done for government securities.

Sebi can help with easier listing requirements, shelf prospectuses and less stringent disclosure requirements for already listed entities so that the edge that private placements have over public issues vanishes. It can ask exchanges to create a centralised database.

True, some niggling turf battles between Sebi and the RBI remain. But these are essentially over derivatives and can be addressed later. K Kamaraj, the Congress president through the ’60s and ’70s had a stock answer to sticky problems: parkalam (let’s see). It held him in good stead and might do likewise for compatriot, P Chidambaram. So let’s start with a cash market and see!