« Should public resources be auctioned? On which parameter? |
Main
| The Rating Demons: Why they are the real demons and the case for nationalizing them before any possible nationalization of the banking system »
February 06, 2009
What ails India's Corporate Bond Market and a solution
The new issuance of bonds and debentures by non-Government Public Limited companies in India was at Rs 1,309 crores (US$ 270mn approx) in the whole of 2007-08. This same class of companies made an equity issuance of Rs 56,848 crores (US$ 11.7 bn) over the same period(Source Reserve Bank of India Annual Report 2008).
In the US, the largest concentration of corporate issuers is of those rated as 'A' followed by those rated 'BBB'. In India, the corporate bond market is largely concentrated in the 'AAA' issuers.
In the eurozone the outstanding floating rate long term bonds as a percentage of the total outstanding bonds issued by MFIs(Monetary financial institutions i.e. financial institutions forming the money-issuing sector of the euro area. They include the ECB, the NCBs of the euro area countries, and credit institutions and money market funds located in the euro area. MFIs is 'the biggest private sector
issuer category in the euro area') has been growing from 1999 to 2006.The outstanding floating rate long term bonds were around 40% of all outstanding long term bonds issued by MFIs while the corresponding number for fixed rate bonds was around 55% (Source: ECB's Euro Bonds and Derivatives Markets June 2007). In general, credit spreads are larger for fixed rate loans rather than floating rate loans.
In India there is no transparent+traded benchmark for floating rate borrowings.
In the context of refinancing fixed interest rate housing loans of banks the National Housing Bank gives itself the right "... to revise the rates on outstanding loans on completion of 3 years...". And banks pass on this risk of revision in fixed interest rate for housing loans to retail borrowers every three years.
In effect, fixed rate loans are floating rate loans with a three year reset. And that too without transparency in which the way the interest rate is reset.
The benchmark used for the existing sovereign bonds is the average of the last three(for some bonds its six) 364 Day TBill Auction implied cut-off yield rounded to two decimal places. These bonds have a half yearly coupon.This is a transparent benchmark as its based on a fortnightly aution(The calendar for TBill issuances released by the Reserve Bank of India indicates the fortnighlty schedule for 182 Day TBills).
The Reserve Bank of India has already proclaimed an intention to move to the average of last three 182 Day TBill Auction implied cut-off yields as it tenor corresponds better with a half yearly coupon(for the exisiting sovereign bonds the reset of the coupon is either half yearly or yearly, thought the coupon is half yearly).
In its Master Circular-Interest Rates & Advances dated 1st July 2008 The Reserve Bank of India informs and instructs banks that
'...In order to ensure
transparency, banks should use only external or market-based rupee benchmark interest rates for pricing of their floating rate loan products. The methodology of computing the floating rates should be objective, transparent and mutually acceptable to counter parties. Banks should not offer floating rate loans linked to their own internal benchmarks or any other derived rate based on the underlying. This methodology should be adopted for all new loans. In the case of existing loans of longer / fixed tenure, banks should reset the floating rates according to the above method at the time of review or renewal of loan accounts, after obtaining the consent of the concerned borrower/s."
In BIS' Developing Corporate Bond Markets in Asia the then General Manager of BIS asked
"...if the US market has a government bond benchmark yield curve that helps in the pricing of corporate debt, does that mean your market should have the same kind of yield curve? Let’s bear in mind that even the euro zone’s corporate bond market, which is about $7 trillion in size and which functions efficiently, relies for its benchmark yield curve not on a government curve, but on the euribor or euro-swaps curves."
V.K. Sharma & Chandan Sinha both from the Reserve Bank of India, but in their personal capacities say "...The government securities market is well developed, so that it can provide the benchmark yield curve for bond pricing."
A soverign benchmark like the TBill yield allows us to clinically separate the spread over the benchmark, as we can attribute this spread to the credit risk of the corporate issuing the bond. But, swap market trading volumes often dwarf sovereign bond trading volumes. This in general makes the swap curve more observable(from traded prices). Thus, by having a swap market which trades on a sovereign benchmark we can get the best of both world's: the benchmark sovereign rate for floating rate bonds that would also likely be easily observable when the swap market trades on this bechmark. So in a way India could attempt to get the better aspects of both the American and the European corporate bond markets.
We try to convert the only transparent benchmark for sovereign bonds i.e. TBill benchmark into a tradeable benchmark in the swap market(this will require interest by banks/FIs/other traders and hedgers). Simultaneously, we try to have all floating rate loans to be linked to the same benchmark(this may be enforced by regulations). This will build a virtuous cycle as it will allow banks which want to lend at a fixed rate(floating rate) to convert it into floating rate(fixed rate) by using the swap market. (Currently, only the Overnight Index Linked Swap(OIS)is liquid in India's Interest Rate Swap Market). This will create a conducive environment for issuances by non-AAA corporates. This will take a lot of stress on the demand for bank credit by corporates.The availability of a floating rate corporate bond market and swap market, will together allow pricing for the fixed rate corporate bond market to become much simpler.
The above, in my humble opinion is the key to growing a liquid corporate bond market that is able to meet corporate India's debt financing needs.
Posted by amgodbole at February 6, 2009 08:08 AM
Post a comment
