India Inc. to bond more with the bond market…
From April 1st, 2019, companies with at least Rs 100 crore of debt on their books and the credit rating of ‘AA’ or above will have to tap the bond market for at least 25% of their incremental long term borrowing needs.
How significant is this development?
According to Crisil, nearly 444 companies satisfy the above criterion and 210 of them are already complying with the new set of rules.
We believe it’s just the beginning of what can potentially turn out to be a growth catalyst.
Why is a vibrant bond market a precursor to rapid economic growth?
Economic growth and corporate credit demand are interdependent.
Economic growth among large economies is often fueled by debt and the demand for incremental debt also depends on the economic progress of a nation, to a large extent.
Beyond a point, banks are unable to cater to the credit demand of corporates thus a vibrant bond market plays a vital role in any growing economy.
Are Indian bond markets ready to play catch up?
(Source: CARE Ratings, Crisil)
According to Crisil, the Indian corporate bond market is set to double in size between FY18 and FY23, from Rs 27 lakh crore to Rs 55-60 lakh crore.
If corporates are encouraged to tap bond markets to secure long term credit, it would help resolve some systemic issues as well.
As you’re aware, Asset Liability Mismatches (ALM) can create havoc. Recent NBFC fallouts are a poster child of what systemic problems can lead us to.
Indian banks and other financial institutions are backed primarily by a short-term deposit base against which financing long term projects and corporate capex plans often gives rise to ALM. And we’ve seen how that could cause systemic problems.
Heavy reliance on bank finance…
Global experience suggests that bankruptcy reforms foster the development of the corporate bond markets. Reforms go a long way in improving the acceptance levels of bonds among investors, thereby providing more depth to the corporate bond market. India passed the Insolvency and Bankruptcy Code (IBC) in 2016. Since then it has witnessed a constant improvement in the bank loan-bond ratio.
Corporate bonds to GDP ratio
Impact on debt markets…
Nudging large corporates to tap bond markets for their incremental borrowings may result in the deepening of the Indian bond market. Depending on the experience of the bond programme of ‘AA’ rated companies, the regulator might even consider getting ‘A’ rated companies in the purview of guidelines.
What would be the impact on companies?
Since bond markets are more efficient and transparent (as compared to banks) in reflecting the change in RBI’s policy stance, companies tend to benefit under a falling interest rate scenario and vice-a-versa.
Since bond defaults attract greater attention than NPAs, corporates might become more diligent in honouring their debt obligations.
What would be the impact on investors?
This move is aimed at increasing retail participation and offering institutional investors more options.
According to Crisil, a three-year average default rate in the AA-rated corporate bond space for every year over the last 10 years has been 0.2%. Although this is an encouraging number, retail investors might still prefer to take the mutual fund route, as they have been doing so far, to invest in corporate debt.
Points to remember:
- If you are an individual investor, you shouldn’t try to trade in bonds, especially long tenure bonds, unless you understand the nitty-gritties of bond markets. Instead, you should hold bonds until their maturity and try to earn interest income.
- Recent experiences suggest that one needs to go beyond credit ratings to analyse the default risk.
- If you want to invest in corporate bonds passively, you should invest in mutual funds.
PS: If you need any further guidance on investing in corporate bonds, write to us at email@example.com
Disclaimer: Ventura Securities Ltd has taken due care and caution in compilation of data for its web blog. Information has been obtained from different sources which it considers reliable. However, Ventura Securities Ltd does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Ventura Securities Ltd especially states that it has no financial liability whatsoever to any user on account of the use of information provided on its web blog. The information provided herein is just for the knowledge purpose and shouldn’t be construed as investment advice under any circumstances.