Budget 2013 - Tasteless for the Bonds Market

Bonds Market in India

A reasonably well-developed corporate bond market is very much required in any economy to supplement banking credit and the equity market and to facilitate the long-term funding requirement of corporate sector as well as infrastructure development in the country. Banks accounted for 14.4% of the financing of large firms in 2000-01, which went up to 17.8% in 2010-11. The bond market stagnated, with 3.5% in 2000-01 and 3.9% a decade later. Despite considerable interest in bond market development, the corporate bond market accounted for only 3.9% of the sources of funds of large Indian companies. Finally, foreign borrowing rose sharply, from roughly nothing in 2000-01 to 3.2% in 2010-11[1]

The finance minister while presenting his Union Budget for FY 2013-14 expects the fiscal deficit to be 4.8% of the gross domestic product in FY 2013-14, compared to 5.2% in the current fiscal year, but the gross borrowing programme for 2013-14 is estimated to be around Rs 6.29 lakh crore, 12% higher than Rs 5.6 lakh crore estimated for 2012-13. With 89% of the fiscal deficit budgeted to be funded by market borrowings, bond yields are expected to be higher. This affected the bond market of G-Sec securities as evident on the budget day. The bond market of 10-year G-Sec closed at 7.88% on the budget day as compared to its previous close of 7.80% on the previous day.

Growth comparison to other developing economies of our like and reasons for such lag in bond market development – this then requires us to list the challenges in India with regard to the corporate bond market.

a)  Key challenges in the corporate bond market

Though, the development of the corporate bond market has been an important area and has received greater policy attention in recent times, it is yet to take off in a significant manner. On worldwide scenario, bond financing is rather more populous than bank financing, but the picture that India presents is totally reverse. It can be said that the impeding growth of the corporate bond market is due to overhang of government bond market because of high fiscal deficit. The factors which can be attributed to such impede growth are:

i) Tight liquidity or trading in secondary market;

ii) Tax deductibility and stamp duty issues;

iii) Bankruptcy laws need to be streamlined to enable the growth of Corporate bond market

iv) Bond ratings also deter the growth which cannot be totally done away with.

The issue can be overcome by:

i)  Drawing up a roadmap for a structural shift from a bank-dominated financial system to a more diverse financial system where top-rated corporates access finance from capital markets,

ii) Strengthening of the legal framework for regulation of corporate debt by necessary amendments in rules/regulations,

iii) Relaxation of investment guidelines for pension, provident, and insurance funds to enable the participation of long term investors in the corporate bond market,

iv) Improving the market infrastructure for enabling liquidity, transparency in price discovery, and stimulating growth in trading volumes;

v) Relaxing tax and stamp duties norms to make the sector more attractive.

Introduction of new products and making nascent products such as covered bonds, municipal bonds, credit default swaps, credit enhancements, and securitization receipts may be considered more attractive for public issuance of bonds at reduced cost.

a) Steps taken during the year 2012-13 to develop the corporate bond market:

i)  To permit banks to take limited membership in SEBI-approved stock exchanges for the purpose of undertaking proprietary transactions in the corporate bond markets.

ii) To enhance liquidity in the corporate bond markets, the Insurance Regulatory and Development Authority (“IRDA”) has permitted insurance companies to participate in the repo market. The IRDA has also permitted insurance companies to become users of credit default swap (“CDS”).

iii) In consultation with the Technical Advisory Committee on Money, Foreign Exchange, and Government Securities Markets, it has been decided to reduce the minimum haircut requirement in corporate debt repo from the existing 10% /12% /15% to 7.5% /8.5% /10% for AAA/AA+/AA-rated corporate bonds, respectively.

iv)  Mutual Funds (“MFs”) have been permitted to participate in CDS in corporate debt securities, as users. MFs can participate as users in CDS for eligible securities as reference obligations, constituting from within the portfolio of only fixed maturity plans (“FMP”) schemes having tenor exceeding one year.

v)  Revised guidelines on CDS for corporate bonds by the RBI provide that in addition to listed corporate bonds, CDS shall also be permitted on unlisted but rated corporate bonds even for issues other than infrastructure companies.

vi) Users shall be allowed to unwind their CDS-bought position with the original protection seller at a mutually agreeable or Fixed Income Money Market and Derivatives Association of India (“FIMMDA”) price. If no agreement is reached, then unwinding has to be done with the original protection seller at FIMMDA price.

vii) CDS shall be permitted on securities with original maturity up to one year like CPs, certificates of deposit, and nonconvertible debentures with original maturity less than one year as reference/deliverable obligations.

viii) In November 2012, the limits for FII investment in G-Secs and corporate bonds (non-infra category) have been further enhanced by 5 billion each, taking the total limit prescribed for FII investment to US$ 25 billion in G-Secs and US$51 billion for corporate bonds (infra+non-infra).

ix) The government is incentivizing corporate bond markets for attracting retail and High Networth Individuals toward this segment for enabling issue of long term funds in cost effective manner.

b) Current trends/ issuances by corporates

Indian corporate bond market is relatively under-developed as compared to its G-sec (government securities) market. Until 2011, there has not been much development in the Indian bond market. Lot of new products were introduced to develop the market, however, barring interest rate swap, no other option has got much popularity. :p>

However, since 2010, lots of companies have come out with bond issues. The year 2012-13 evidenced the highest issues till date. Below we discuss the major terms of some significant issues which came during the said year:

An analysis of above stated issues of above companies shows that companies are offering an interest of 10%-12% on average basis on issues which have been assigned a stable rating from registered credit rating agencies. Corporates are using attractive features and options attached to such bonds to seek attention of more investors. Srei issued the NCDs giving put options to investor. India Infoline issued unsecured NCDs and thereby raised money as public deposits by complying with public deposit rules.

c) Budget 2013-14: Expectations, Proposals and Implication

In spite of several steps taken by regulators in this regard, bond market in India is still underdeveloped. An immediate relief could have been provided by this Union Budget by granting some relaxation in withholding tax on FII investment which would have lured more FII money in corporate bond market. Some expected demand-supply balance for government securities to be tilted marginally against the bond markets even with an optimistic 4.8% fiscal deficit. Corporates and financial institutions were expecting some tax concession for their long term borrowing projects.

The infra companies wanting to access the bond market to raise long term funds will be getting credit enhancement from India Infrastructure Finance Corporation Ltd (IIFCL) which will work together with Asian Development Bank.

The Budget seems to be promoting the FDI whereby FIIs shall be permitted to use their investments in corporate bonds as collaterals to meet their margin requirements. However, this is subject to SEBI Guidelines yet to be issued in this behalf. The recent increase in investment limit for FIIs in November, 2012 by 5 billion will attract more FII investment however no announcement on relaxing withholding tax in this regard may act as hindrance.

InIn the last two years, a number of institutions were allowed to issue tax free bonds. Such institutions have raised Rs. 30,000 crore in 2011-12 and are expected to raise about Rs. 25,000 crore in 2012-13. To make the sector more attractive and to provide opportunities, Mr. P. Chidambaram, the Finance Minister, has announced that infra bonds up to Rs 50,000 crores can be raised as tax free. In 2012-13, tax free bonds up to Rs 60,000 crores were allowed to be raised.

With a view to attract investment in long term infrastructure bonds in foreign currency, the rate of tax on interest paid to non-resident investors was reduced in 2012-13 from 20% to 5%. The same benefit shall continue for FY 2013-14 also.

Conclusion

The bond market’s immediate reaction to the Budget was negative as the market was expecting a lower government borrowing amount and some tax concessions for infra bonds. A vibrant bond market for the corporations can ease financing constraints both in terms of cost of funds as well as ease of access to funds. According to SEBI data, FIIs were gross buyers of debt worth Rs 2.06 lakh crore, while they sold bonds worth Rs 1.71 crore- a net inflow of Rs 34,988 crore or $6.65 billion[6] during 2011-12. The Union Budget will surely fuel the FII investment this year. However, interest rates should look to trend down in the FY 2013-14 but the fall will not be immediate and will be slow and steady.

[1] Source: http://finmin.nic.in/workingpaper/CorpBond_Market_India.pdf