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Are Stars Aligning for Growth of Corporate Bond Market in India?Pawan Agrawal

Chief Analytical Officer, CRISIL Ratings


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• Role of bond markets is growing in funding India’s corporate sector

– Its share (including CPs) in incremental funding doubles from 5 years ago

• Six stars that could align together in the near to medium term

– Conducive macroeconomic milieu, both domestic and global

– Large and increasing investment needs to fund infrastructure

– Constraints in banking sector will limit its ability to provide core funding, unlike in the past

– Favourable regulatory steps aimed at broadening bond markets

– Ongoing progress in innovation in structures, vehicles, and instruments

– Emerging legal framework on bankruptcy

• Further supportive steps by policy makers & regulators still needed to

– Provide greater flexibility and tools to attract more investors

– Expand the issuer base accessing the bond market

– Encourage greater innovation and its scale-up

– Strengthen institutional framework and bond market infrastructure

Key messages

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d.Growing role of bond

market in funding India’s corporate sector

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Bond issuances and issuers grow at a healthy pace over 10 years

4

0.79 0.921.15

1.741.90 1.92

2.51

3.52

2.71

4.33

4.80

0

150

300

450

600

750

0.00

1.00

2.00

3.00

4.00

5.00

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16*

Rs. la

kh

cro

re

Issuances (LHS) No of Issuers (RHS)

Bond issuances grow at compounded annual growth rate of 20% over the past decade

Source: Prime Database; (*) CRISIL estimates


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4.9

7.7 7.3

11.5

16.3

0.9 1.1 1.1

1.9

2.6

-

0.5

1.0

1.5

2.0

2.5

3.0

-

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

Mar-12* Mar-13 Mar-14 Mar-15 Mar-16

Rs

. lak

h c

rore

Rs

. la

kh

cro

re

Issuances during the year (LHS) Amount outstanding (RHS)

Commercial paper issuances have also kept pace

5

Issuance of commercial papers trebles in last five years

Source: RBI; (*) Issuances for 2011-12 are from June 2011 to Mar 2012


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Bond markets provide one-fifth of outstanding funding to the corporate sector

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Source: RBI; SEBI; Ministry of Finance

71.8% 69.7% 69.5% 66.8% 65.5%

9.4% 10.7% 11.1% 12.1% 12.1%

18.7% 19.6% 19.3% 21.1% 22.4%

0%

20%

40%

60%

80%

100%

Mar-12 Mar-13 Mar-14 Mar-15 Mar-16Bank Credit External commercial borrowings Corporate bonds and commercial papers

101.661.0 71.3 81.4 92.0

Represents total outstanding stock in Rs. lakh crore


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Share of bond markets in incremental annual funding was higher in recent two years

7

Source: RBI; SEBI; Ministry of Finance

101.661.0 71.3 81.4 92.0

Represents total incremental funding in Rs. lakh crore

64.6%56.9%

68.6%

45.7%52.8%

17.7%

18.1%

14.1%

19.5%12.3%

17.7%25.0%

17.3%

34.8% 34.9%

0%

20%

40%

60%

80%

100%

Mar-12 Mar-13 Mar-14 Mar-15 Mar-16Bank Credit External commercial borrowings Corporate bonds and commercial papers

9.69.8 10.3 10.1 10.6


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Six stars that could align over next few years

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• Robust and stable macro fundamentals are critical for bond market

• Low and stable inflation regime likely in India

– Adoption of a flexible inflation targeting framework

– Creation of Monetary Policy Committee

– These measures make monetary policy transparent and will fetch durable inflation gains

– Sustained low inflation should also elongate a low interest rate cycle

• Improving fiscal position of Government of India

– Path of fiscal rectitude should reduce ‘Crowding out’ of corporate bonds

– To be partly offset (in near term) by higher issuances under ‘Uday’, and from PSUs

• Addressing structural constraints in interest rate transmission

– Recent revision in rates on small savings schemes, and linking them to market

benchmarks (G-Sec yields) on a quarterly basis

• Currency stability

– Stable currency should enhance FPI participation in the domestic corporate bond market

Conducive macroeconomic milieu

9


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Large funding needs for infrastructure sector, estimated at Rs.43 lakh crore over 5 years till 2020

10

13.3

9.0

6.4

5.1

4.7

3.4 0.4 0.4

42.8

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

Power Roads Railways Irrigation Urban Infra Telecom Airports Ports Total

Rs.

lakh

cro

re

Sectoral break-up of infra investments: Nearly a quarter to be funded by bond markets

Source: CRISIL Research analysis


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• Public sector banks need equity of Rs.1.7 lakh crore by Mar 19, a tall order

– Sharp fall in profitability has diminished capital generation from internal accruals

– Weak performance has impaired ability to raise capital from external sources

– The capital need can turn out to be higher, should the credit growth be stronger

• Public sector banks will have high provisioning pressure

– To limit their ability to offer competitive interest rates

• These constraints could drive corporates towards the bond markets

– Malaysian experience offers a similar case study

Constraints in banking sector will limit its ability to provide core funding

11

Capital needs

(Rs. lakh crore)

Credit

Growth

(2015-19)

Tier I

Capital

Tier II

capitalTotal

Capital

raised in

2015-16

Public sector banks 9% 1.7 0.9 2.6 0.4

Private sector

banks21% 0.3 0.5 0.8 0.1

Total capital 12% 2.0 1.4 3.4 0.5

CRISIL Ratings analysis


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• Draft framework for enhancing credit supply for large borrowers through market

– This RBI framework proposes higher risk weights and standard asset provisions for banking

exposures to ‘Specified large borrowers’ beyond a defined limit

– Can be a critical enabler to diversify bond market’s issuer base

• Basel III liquidity guidelines

– Corporate bonds & CPs can comprise up to 40% of ‘High Quality Liquid Assets’ (HQLA), as

against current level of ~10%. This should encourage banks to invest more in bonds and CPs

– HQLA includes only non-financial sector corporate bonds, which should help in diversification

• Guidelines issued for municipal and green bonds

– Should expand the issuer base

• Partial credit enhancements by banks

– Should enable issuers and projects with moderate creditworthiness to access bond markets

• Limiting unhedged foreign currency (FC) exposures by corporates

– Higher capital requirements for banks towards any unhedged FC exposures by borrowers

– Increases the cost of ECBs and improves parity with rupee corporate bonds

Favourable regulatory steps to broaden bond markets

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• New structures can attract more issuers to the bond market

– Securitisation of power transmission utility business (Bond issue of East North Interconnection

Co. Ltd. rated CRISIL AAA(so)/ Stable)

• New vehicles can address structural constraints

– Government proposes to set-up a bond guarantee fund to provide credit enhancements

– TReDS, REITs, and InvITs are a step closer to reality

– New Development Bank (BRICS Bank) can play a supportive role

– 3 NBFC-IDFs have crossed combined asset size of Rs.5,000 crore by of Mar 16

• New instruments can expand avenues for investors

– Hybrids for insurance sector (Hybrid debt of ICICI Lombard General Insurance Co. Ltd. rated

CRISIL AAA/Stable, the first in the insurance sector)

• Global examples of innovative instruments should be evaluated

– Covered bonds, where a large global market exists, can be introduced in India (Outstanding

covered bonds stood at Euro 2.5 trillion at the end of 2014)

– Project bond credit enhancement (PBCE) by European Investment Bank (EIB)

Ongoing innovation can help develop bond markets

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• Predictable recovery process enhances confidence of bond market investors

• Countries with better enforced creditor rights have larger domestic currency,

than foreign currency, bond markets: Burger & Warnock study, 2006, IMF

New bankruptcy code can strengthen creditor rights …

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Countries with strong bankruptcy resolution mechanisms have better recoveries

CountryRecovery rate

(%)

Time

(Years)

Distance to

frontier *

Corporate

bonds/ GDP

ratio

Brazil 22.4 4 53 42%

Russia 41.7 2 58 20%

India 25.7 4.3 33 17%

China 36.2 1.7 55 46%

Japan 92.9 0.6 94 68%

UK 88.6 1 82 114%

US 80.4 1.5 90 115%

Source: World Bank’s ‘Doing business report’; BIS; SEBI; (*) Higher score on ‘Distance to frontier’ indicates stronger

insolvency mechanisms


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… and can lead to deepening of bond markets

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Corporate bond to GDP ratio nearly doubles 5 years after bankruptcy reforms

CountryYear of reforming the

bankruptcy laws

5 year average

(Pre-reforms)

5 year average

(Post-reforms)

Brazil 2005 12.7% 26.3%

Russia 2009 8.1% 13.1%

India 2016 17.9% Effect to be seen

China 2007 18.8% 33.4%

UK 2002 68.4% 106.8%

Source: Bureau of International Settlements (BIS)

0%

10%

20%

30%

40%

50%

-5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10

Corporate bond to GDP ratio

Brazil (Bankruptcy reforms in 2005) China (Bankruptcy reforms in 2007)

Bond markets tend to expand after bankruptcy reforms


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Further supportive steps still needed

16Classification: INTERNAL


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• Provide greater flexibility and tools to attract more investors

– Enhance liquidity in secondary markets by encouraging repo of corporate bonds

– Nudge investors to move towards bonds from G-Secs, by developing CDS protection

• Attract more issuers to access the bond market

– Reduce dependence on financial sector by mandating large corporates to raise a minimum proportion of their funding through bonds and CPs

• Encourage innovation by credit enhancement mechanism

– Set-up a bond guarantee fund at the earliest

• Strengthen institutional and market infrastructure

– Develop a reliable benchmark yield curve and a credit event reporting mechanism

– Encourage offshore rupee bond market

• Introduce legislative framework and ensure enabling environment

– Explore legislation for covered bonds, a critical ingredient for its success

– Implement bankruptcy code at the earliest

– Maintain stability in inflation metrics

Key areas for attention of regulators & policy makers for future growth in bond markets

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Thank you

Pawan Agrawal

Chief Analytical Officer

T: +91 22 3342 3301

[email protected]

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Secondary market trading and repo in corporate bonds remains low

Low trading in corporate bonds is consistent with other global markets

Daily trading/ Amount of bonds outstanding

G-Secs Corp bonds

USA 3.3% 0.9%

China 0.7% 0.3%

India 0.8% 0.2%

But, absence of developed repo in corporate bonds remains a constraint

Corporate repo volume/ Amount of bonds outstanding

USA India

FY13 10.3% 0.06%

FY14 10.5% 0.13%

FY15 11.2% 0.12%

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• Allocation to G-Secs is higher than corporate bonds for insurance

companies, banks, and EPFO

• Investments in corporate bonds much below permissible levels

• Given the ample supply of G-Secs over the medium term, this preference is

unlikely to reverse on its own

Investors prefer government securities over corporate bonds

20

Investor

Investments in (Rs. lakh crore)Proportion of portfolio

allocationInvestment

allowed in

corporate

bondsCorporat

e bondsG-Sec Others Total G-Sec

Corporate

bonds

Life insurance 4.2 8.1 11.1 23.4 35% 18% Up to 50%

Banks 2.6 25.5 1.7 29.8 86% 9% -

EPFO 2.0 2.7 1.6 6.3 43% 32% 35% - 45%

MFs 2.5 1.0 8.5 11.9 8% 21% -

FPIs 1.8 1.5 20.7 24.0 6% 8%Up to Rs.2.4

lakh crore

Corporate 1.4 1.1 7.8 10.3 11% 14% -

Total 14.5 39.9 51.4 105.7 38% 14%


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70%76%

68% 70% 73% 70%

8%

13%

15% 14% 9%8%

22%11%

17% 16% 18% 22%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

FY11 FY12 FY13 FY14 FY15 FY16*

Financial sector PSUs Private (Non financial) sector

High dependence on financial sector continues for the bond market

21

Trend in bond issuances: Financial sector accounts for 2/3rd of issuances

Source: Prime Database; CRISIL estimates


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Towards a rupee offshore bond market: Learning from China’s example• RMB offshore bond market has expanded, since it began in 2007 in Hong Kong

• Government of China has played an enabling role to develop this market

– Key part of Chinese government strategy to internationalize RMB

– Ministry of Finance, banks, and public enterprises of China are among leading issuers in offshore market

• Learnings from this success can be incorporated for development of ‘Masala bonds’

Outstanding Dimsum bonds (Million RMB): Size has grown five fold in 5 years

Source: Hong Kong Monetary Authority

22

0

100

200

300

400

Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Oct-15

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