WHAT ARE CORPORATE BONDS

Corporate bonds are a form of debt security sold to investors by corporations that want to raise finance for their operations. Repayment is made in full principal or interest earned over some time.

In simple terms, if you purchase this type of bond, you are loaning the amount to the corporation for its operation. These bonds are different from stocks. They are legal contracts that bind the corporation to repay the borrowed money to you with interest at fixed intervals. Usually, corporate bonds offer a higher rate of interest than government bonds[1].

WHY DO COMPANIES SELL BONDS

The main reason for selling bonds is to raise money. There are several avenues and ways for companies to raise money. They can raise money by selling equity (initial public offering if the first time or rights issue if the company is already listed), go to the bank for loans or raise money through the issue of bonds. The bond is a loan that the bondholder makes to the bond issuer. The bond issuer owes holders a debt and is obliged to repay the principal at a specific date and interest periodically. Because of this interest component that does not change throughout the bond’s life (we refer to fixed-rate bonds); this is also why bonds are also known as fixed income securities.

Lending companies purchase bonds to add stability to their portfolio. Bonds are generally regarded to be of lower risk than equities and investors in bond funds will generally be less exposed to volatility[2].

BENEFITS OF A DEVELOPED CORPORATE BOND MARKET IN INDIA

After having understood what exactly are Corporate Bonds, it is worthwhile to understand and evaluate the benefits of it for its development in India. It has several upsides to it, which shall be put to focus sequentially.

To begin with, corporate bonds would work towards de-stressing banks of the latter’s prospective NPAs. It has been observed over time that companies have relied on opaque bank financing of big-ticket long-gestation projects. It results in the untoward build-up of huge non-performing assets (NPAs) negatively affecting banking. Another aspect which gives an edge to the companies over banks in redeeming the money lent to the borrower company lies in the fact that the level of due-diligence into the repayment capacity of the borrower, is higher in case of companies than in case of banks. Shifting to corporate bonds as the go to option for financing projects of various companies shall thus ensure safety of the money of depositors in banks[3].

In India, given the absence of a well-functioning corporate bond market, the burden of financing infrastructure projects such as roads, ports, and airports is more on banks and the general government. This, in turn, puts lenders such as the banks under pressure as reflected in the ballooning of bad loans. For instance, in banks, such investments create an asset-liability mismatch. In other words, they are buying into long-term assets, such as a highway, with short term liabilities, that is deposits of three- to five-year maturities. Eventually, this not only results in inefficient resource allocation but also weakens the bank balance sheets.[4]

The real problem in Indian context is the loans to large businesses can have huge ramifications on the economy. Large companies accounted to Rs. 65.47 Trillion (58%) of the total Bank Credit till March 2016 when the NPAs (Non-Performing assets or Bad Loans) stood at roughly the Rs. 6 Trillion mark. By this estimate if 10% of the loans to the large-scale companies were to become NPAs, then the lending banks will soon be out of business.  That’s a huge setback to the economy and would sabotage it. [5]

An efficient corporate bond market would help companies to raise capital in the primary market and help investors to trade in and out of risks in the secondary market. A fully functioning corporate bond market would have the following advantages:

A liquid and transparent corporate bond market will make more information available to investors to judge individual credit risk, thus leading to better demarcation between good-quality and poor-quality investments, based on the financials of the available companies to invest in via issue of corporate bonds. Investors can continue to lend to deserving businesses while businesses are incentivised to keep the quality of the balance sheet high via tax rebates and concessions in CSR norms.

Wider investor base: A well-developed corporate bond market allows a wider investor base to access the market, with each investor holding a smaller proportion of the total risk. The diversity of investors implies less risk of capital erosion as the number of investors/lenders are numerous unlike the present scenario where much of the corporate finance is provided for by the banks as lenders, and in case the borrowing company defaults on payment, the load of non-redemption does not fall on just one lender alone as it does in case of taking a loan from the bank to raise finances by the borrowing company.

Multiplicity of Investment Options: At present, apart from equity and several deposit schemes in banks, and other financial companies, an opportunity to invest in corporate bonds ensures widening of investment options. This option could ensure good returns especially in times where equities fail to deliver promising returns in times of economic distress. In addition, it furthers the said cause by developing the economy of the nation.[6]

Growth and development of the corporate bond market would also foster economic development.  In countries with a developed bond market, the contribution of corporate bonds to the GDP is much more than that in India. For instance, in the US, the corporate bond market accounts for about 120% of GDP, with investors investing across the spectrum, including in junk bonds. The figure for India is 16% of GDP.[7]

COMPARISON OF THE CORPORATE BOND MARKET OF INDIA WITH THAT OF OTHER COUNTRIES

In 2012, the size of the Indian bond market was approximately equivalent to 27% of the Chinese bond market and 69% of the Korean bond market. As far as the percentage of the corporate bond market to GDP is concerned, the same is denoted by the table given below[8].

Table 1: Corporate Debt Market Penetration (as per cent of GDP)-June 2018
Countries Corporate Bonds to GDP Ratio
US 123.47
China 18.86
Japan 14.57
South Korea 74.30
Singapore 34.02
Malaysia 44.50
India 17.16
Brazil* 99.05
Turkey** 142.06

The table above clearly represents as to how the corporate bond market of India lacks to match up to GDP, and hence, acts as a serious impediment in the economic growth of the country.

CHALLENGES AND WAYS TO OVERCOME

Lack of high rated companies and transparency issues

There are only a few corporate entities in the region which are capable of meeting investor requirements in terms of transparency and governance standards. This has resulted in a yawning gap between demand for and supply of corporate bonds in Asia causing outflow of capital in search of greener pastures for safety and higher returns. Corporate governance and disclosure standards available in these countries do not provide enough confidence to investors to go in for investments in bonds, as unlike banks, bond investors will be widely dispersed and therefore will have less bargaining power.[9]

Crisil also points out that AAA-rated companies in India make up a meagre 0.85% of the rated universe of 32,500 companies, the lowest among the emerging markets.[10]

This is an extremely unfavorable market scenario for an investor, thus there is an urgent need for more companies in India to become a part of the AAA rated universe soon.

Absence of Corporate Bond Indices

As against equity, there is no bond index which enables real time monitoring of the corporate bond market in India. Such an index/indices shall foster transparency to the rates at which bonds are issued to the lenders, thereby increasing investor/lender confidence in the genuineness of the bonds they are putting their money into. Having an index is extremely useful in the development of any security as an investment option, as can be inferred from the development that the equity market has had in India over the past few decades. From being an underdeveloped equity market until the 1980’s, India emerged as the best performing equity market in the world, in 2020.[11]

A large contribution to this tremendous growth shown by India has to be credited to the equity indices, which helped India to gauge its progress and rewire its strategy whenever the equity market took a beating.

Absence of a Dedicated Regulatory Body

At present, the government bond market is regulated by the Reserve Bank of India (RBI) and the corporate bond market is regulated by the Securities and Exchange Board of India (SEBI). However, SEBI is already overworked in being the watchdog of the equity market In India, where an equity scam surfaces up in every few days. SEBI being the watchdog of the already developed equity market in India, cannot be expected to work with full efficiency towards the development and moreover, the regulation of the underdeveloped Corporate Bond Market in India.

RECOMMENDATIONS

Creation of Corporate Bond Indices: A bond index should be created to measure the performance of corporate bonds issued in the country. Single or multiple indices can be created and bonds of similar maturity or rating can be grouped together to allow investors to gauge the performance of bonds. These indices should also be made investible so that investors can invest in a basket of bonds.

Measures for attracting retail investors: Regulators and policymakers, especially SEBI have consistently focused on ensuring retail participation in equity markets and have achieved a fair amount of success in the same. Similar measures need to be implemented to draw retail investors to corporate bond markets. This is bound to be a time-consuming process; adapting whole markets for retail participation is not possible overnight. Meanwhile, it will also be beneficial to explore the possibility of carving out a specialized retail bond market[12]

In addition, evolving a self-regulatory organization on the lines of the National Association of Securities Dealers in the US to help ease the burden of SEBI in regulating the bond market could be an integral part of the plan.[13]

CONCLUSION

Taking cognizance of the present scenario of the corporate bond market in India, it is plagued with a number of shortcomings as has been pointed above. However, the future appears to be kinder to India than the past has been, with India being considered for being the new manufacturing hub of the world, as the ease of doing business in India has been steadily improved with time because of the pro-business stance shown by India in the recent years, be it the Insolvency and Bankruptcy Code, 2016 or tax advantages to companies. Owing to the said facts, there lies a huge upside potential for companies and businesses to thrive in India, and concomitantly the corporate bond market should also emerge as a favoured investment option in India, and the recommendations suggested above in this article if put to implementation shall hasten up the process.

Note:- 

[1] Corporate Bond Fund, Available at:  https://www.angelbroking.com/corporate-bonds (last visited on Nov 20, 2020)

[2]  How Bonds Work, Available at: https://cafemutual.com/news/industry/1097-how-bonds-work (last visited on Nov 20, 2020)

[3]  Fire Up the Bond Market, Available at: https://economictimes.indiatimes.com/blogs/figuringitout/fire-up-the-bond-market/ (last visited on Nov 23, 2020)

[4] Explained: Why a Corporate Bond Market, Available at: https://indianexpress.com/article/explained/why-a-corporate-bond-market-union-budget-2019-nirmala-sitharaman-5823094/ (last visited on Nov 24, 2020)

[6] Corporate bond market as a driver of economic growth, Available at: https://www.business-standard.com/article/news-ians/corporate-bond-market-as-a-driver-of-economic-growth-comment-special-to-ians-117101300260_1.html (last visited on Nov 23, 2020)

[7] Wanted, market for junk bonds in India, Available at: https://economictimes.indiatimes.com/blogs/et-editorials/wanted-market-for-junk-bonds-in-india/ (last visited on Nov 24, 2020)

[8] India’s Corporate Bond Market: Issues in Market Microstructure, Available at:  https://www.rbi.org.in/Scripts/BS_ViewBulletin.aspx?Id=17995 (last visited on Nov 24, 2020)

[9] TOWARDS DEVELOPMENT OF CORPORATE DEBT MARKET IN INDIA, Available at: https://www.sebi.gov.in/sebi_data/docfiles/2973_t.html (last visited on Nov 25, 2020)

[10] Wanted, market for junk bonds in India, Available at: https://economictimes.indiatimes.com/blogs/et-editorials/wanted-market-for-junk-bonds-in-india/ (last visited on Nov 25, 2020)

[11] India emerges as the best performing equity market in the world, Available at: https://economictimes.indiatimes.com/markets/stocks/news/india-emerges-as-the-best-performing-equity-market-in-the-world/articleshow/76553046.cms?from=mdr (last visited on Nov 26, 2020)

[12]CORPORATE BOND MARKETS IN INDIA: A STUDY AND POLICY RECOMMENDATIONS, Available at: https://tejas.iimb.ac.in/articles/Corporate%20Bond%20Markets%20in%20India_Tejas_August2014.pdf (last visited on Nov 26, 2020)

[13]TOWARDS DEVELOPMENT OF CORPORATE DEBT MARKET IN INDIA, Available at: https://www.sebi.gov.in/sebi_data/docfiles/2973_t.html (last visited on Nov 27. 2020)

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