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«Issued for Discussion DRG Studies Series Development Research Group (DRG) has been constituted in Reserve Bank of India in its Department of Economic ...»

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Issued for Discussion

DRG Studies Series

Development Research Group (DRG) has been constituted in Reserve Bank of India

in its Department of Economic and Policy Research. Its objective is to undertake

quick and effective policy-oriented research backed by strong analytical and

empirical basis, on subjects of current interest. The DRG studies are the outcome of

collaborative efforts between experts from outside Reserve Bank of India and the

pool of research talent within the Bank. These studies are released for wider circulation with a view to generating constructive discussion among the professional economists and policy makers.

Responsibility for the views expressed and for the accuracy of statements contained in the contributions rests with the author(s).

There is no objection to the material published herein being reproduced, provided an acknowledgement for the source is made.

DRG Studies are published in RBI web site only and no printed copies will be made available.

Director Development Research Group DRG Study

A Study of Corporate Bond Market in India:

Theoretical and Policy Implications By Sunder Raghavan Ashok Sahoo Angshuman Hait Saurabh Ghosh1 1 Prof. Sunder Raghavan is Professor of Finance, Embry-Riddle Aeronautical University. Shri Ashok Sahoo is Director, Financial Stability Unit, Shri Angshuman Hait and Dr. Saurabh Ghosh are Assistant Advisers in Department of Statistics and Information Management and Department of Economic and Policy Research, respectively, of the Reserve Bank of India. The views expressed in this Study are those of the authors and not of the Institution to which they belong.


We wish to thank Reserve Bank of India (RBI) for sponsoring this Study on the Corporate Bond Market in India: Theoretical and Policy Implications as part of the Development Research Group (DRG) Studies.

We want to extend our thanks to Shri B. M. Misra, Officer-in-charge, Department of Economic and Policy Research (DEPR) and other officials at RBI who provided valuable support and guidance throughout the process of this Study.

We are grateful especially to an anonymous referee and others who commented and provided feedback on the draft proposal, work-in progress and final seminar of this Study.

I personally wanted to acknowledge Embry-Riddle Aeronautical University for supporting me with a grant of sabbatical leave to work on the Study.

Finally, I wanted to thank all my graduate student assistants who helped me in the project. In particular, I would like to thank Daniel, Kruthika, Lionel, Harish, Luis and Giby who were involved in the project at one time or the other.

We are, however, responsible for the all the errors that still remain.

–  –  –

ABS Asset Backed Securities AFS Available for Sale AMFI Association of Mutual Funds in India BRIC Brazil, Russia, India and China BSE Bombay Stock Exchange CARE Credit Analysis and Research Ltd CCIL Clearing Corporation of India CDS Credit Default Swaps CFS Company Finances Statistics CRISIL Credit Rating and Information Services of India Ltd CFSR Committee for Financial Sector Reform in India CVM Brazilian Securities and Exchange Commission DvP Delivery versus Payment ETS Electronic Trading System FIMMDA Fixed Income Money Market and Derivatives Association of India FRB Floating Rate Bond GDP Gross Domestic Product GLS Generalised Least Square GoI Government of India HFT Held for Trade HTM Held to Maturity ICRA Indian Credit Rating Agency ICCL Indian Clearing Corporation Limited IMF International Monetary Fund IOSCO International Organisation of Security Commission ISMR Indian Securities Market Review ITC Investment Trust Companies JASDAQ Japan Association of Securities Dealers and Automated Quotation KCFG Korea Credit Guarantee Fund KSE Korea Stock Exchange MBS Mortgage Backed Securities NDRC National Development and Reform Commission NDS-OM Negotiated Dealing System - Order Matching NHB National Housing Bank NSCCL National Securities Clearing Corporation Ltd NSE National Stock Exchange OTC Over-the-Counter RBI Reserve Bank of India RTGS Real Time Gross Settlement SEBI Securities and Exchange Board of India SLR Statutory Liquidity Requirement TDS Tax Deducted at Source YTM Yield to Maturity RMBS Residential Mortgage Backed Securities

–  –  –

Executive Summary

Chapter 1: Introduction

Chapter 2: Lessons from Corporate Bond Market in Other Countries

2.1 Corporate Bond Market Development in Japan

2.1.1 History of development in the Japanese Corporate Bond Market

2.1.2 Lessons from the Japanese experience

2.2 Bond Market Development in South Korea

2.2.1 History of Corporate Bond Market Development in Korea

2.2.2 Experiment with Bond Guarantee Scheme

2.2.3 Corporate Bond Market Development after 1997 Financial Crisis

2.2.4 Improvement in Credit Ratings

2.2.5 Emergence of Asset Backed Securities

2.2.6 Lessons from Bond Market Developments in Korea

2.3 Corporate Bond Market Development in Brazil

2.3.1 History of Bond Market Development in Brazil

2.4 Corporate Bond Market Developments in Singapore and Malaysia

2.4.1 Malaysia’s Islamic Bond Market

2.4.2 Singapore’s Offshore-Based Issuers

Chapter 3: Development of Corporate Bond Market in India

3.1 Brief Survey of Theoretical Literature on Corporate Bond Market in India.............. 21

3.2 Capital Market Reforms

3.2.1 Development of Primary Market

3.2.2 Development of Secondary Market

3.3 Progress in Implementing Recommendations

3.3.1 Clarifying the Roles of Different Agencies

3.3.2 Reduction in Cost and Length of Issuance Process

3.3.3 Improving Transparency in Secondary Market Trades

3.3.4 Encouraging Participation of Retail Investors

3.3.5 Clearing and Settlement of Trades

v 3.3.6 Introduction of New Debt Instruments

Chapter 4: Effect of Implementation of Reforms on the Bond Market

4.1 Primary Market

4.2 Secondary Market

4.3 Corporate – Government Bonds Yield Spreads

4.4 Source of Funds for Companies

4.5 Efficiency of Bank Lending Rates

Chapter 5: Empirical Analysis of the Indian Corporate Bond Market

5.1 Regression Analysis

5.1.1 Development Stage of the Economy

5.1.2 Natural Openness

5.1.3 Size of the Banking System

5.1.4 Size of the Government Bond Market

5.1.5 Development of the Stock Market

5.1.6 Corruption Index

5.2 Regression Analysis of Sources of Funds

5.2.1 GDP at Constant Prices

5.2.2 Financial Dummy Variable

5.2.3 Time Trend

5.3 Results and Analysis

Chapter 6: Summary and Policy Prescriptions

6.1 Introduction

6.2 Policy Implications and Need for Future Reforms

6.2.1 Encouraging Retail Participation

6.2.2 Encouraging Foreign Investment Participation

6.2.3 Encouraging Institutional Participation

6.2.4 Streamlining Issuance Process

6.2.5 Creation of New Debt Instruments

6.2.6 Credit Enhancements………………………………………………………….….........47 References

–  –  –

1. A well-developed capital market consists of equity and bond market. A deep and liquid bond market with a significant role of the corporate bond market segment is considered to be important for an efficient capital market. A vibrant corporate bond market ensures that funds flow towards productive investments and market forces exert competitive pressures on lending to the private sector. While India boasts of a world-class equity market, its bond market is still relatively underdeveloped and is dominated by the Government bond market. The share of outstanding Government bonds in India was 39.5 per cent of Gross Domestic Product (GDP) as of 2010 and compares favorably with other Asian countries such as China (27.6 per cent) and South Korea (47.2 per cent). The share of corporate bond outstanding in India, however, was only 1.6 per cent of GDP in 2010 compared to Malaysia (27 per cent) and South Korea (37.8 per cent) in the comparable period.

2. In this Study, we trace the reforms which have been put in place in the last decade and consequent developments of the corporate bond market in India. It is observed that though there is scope for further improvements in certain areas, such as reforming the stamp duty, substantial developments have taken place in the corporate bond market in India owing to measures taken by Securities Exchange Board of India (SEBI), Reserve Bank of India (RBI) and the Government of India (GoI) in order to implement the recommendations of various committees on corporate bond market. A study of the impact of the reform process on the corporate bond market shows that resources mobilised from the primary and secondary corporate bond markets have continued to increase over the years. The corporate bonds outstanding amount has increased from $ 3.8 billion in 2005 to $ 25 billion in 2010 (0.5 per cent of GDP in 2005 to 1.6 per cent of GDP in 2010). Secondary market trades grew from ` 959 billion in 2007-2008 to ` 7,386 billion in 2012-13. The increase in the corporate bonds' outstanding amount, and as percentage share of GDP, indicated the gradual impact of the reform process in India.

3. One of the objectives of this Study is to analyse the experience of other emerging and developing economies (EDEs) at similar stage of development to capture lessons in relation to the development of Indian corporate bond market.

In this milieu, we looked at the development of bond markets in Japan, Korea, Singapore, Malaysia and Brazil. The Japanese experience suggested that bond market development should be planned and implemented on a long-term basis with a reasonable sequence and should go hand in hand with economic development and banking reforms. The Korean experience showed that Government policy reforms and development of a vibrant Government bond market was crucial for the development of the corporate bond market. Korean experiment and consequent failure with the Bond Guarantee scheme on the other hand had important implications for the development of the Indian corporate bond market. The development of the mutual fund industry in mobilising and channeling funds to the corporate bond market in Brazil and the growth of pension funds in supporting the bond market in Chile also had interesting implications for the development of the corporate bond market in India. The issue of Sukuk bonds in Malaysia indicated that India could find innovative ways to improve the retail investor market. Finally, there were important lessons to be learnt from the reforms put in place in Singapore to improve the foreign investment in local currency bonds.

4. Bond guarantees have not been successful in other countries such as Korea in developing the corporate bond market. The Reserve Bank in its circular (RBI/2008-09/79 DBOD.No.Dir.BC.18/13.03.00/2008-09 dated July 1, 2008) specifically discouraged banks from guaranteeing bonds or debt instruments of any kind as it could have significant systemic implications and impede the development of an efficient corporate bond market. Bond guarantees in the long run could distort the risk return trade-off and would hinder the bond market from developing and acting as an effective alternate channel for raising resources. Further, the South Korean experience suggested that a financial crisis could trigger a collapse of the guarantee system.

5. The retail investors’ presence in the corporate bond market in India, however, is still shallow despite the reforms put in place by SEBI to reduce the size of trading lots and the recent increase in foreign investor limits for the corporate bond market. India might explore innovative ways, such as the issue of Sukuk bonds in the case of Malaysia, to attract retail investors. Recently, European Governments and banks are increasingly turning to their citizens and customers by issuing patriotic bonds such as the “National Solidarity Bonds”. It is worth exploring such innovative ways to expand investors' base in the corporate bond market in India. Another method to broaden the investor base is through advancement of the fund management industry by strengthening mutual fund offerings. In India, though the mutual fund industry accounts for a major share of lending in the CBLO and market repo segments, there is scope for further improvement in the retail investors’ segment. Improvements in the retail investment sector of the mutual fund industry can help in enhancing the liquidity 2 in the corporate bond markets. Investor base can be further strengthened by encouraging foreign investment in local currency bonds. The GoI has closely monitored the developments in corporate bond market, revised the cap on foreign investment and the lock-in period from time to time to develop this market segment. Recently, the GoI reviewed and revised these limits and the lock-in period for investments. Previously, the lock in period of 3-year was perceived as a major hindrance in corporate bond market development in India..

6. India, like many other developing countries, suffers from “original sin” phenomenon as foreign investors are reluctant to invest in local currency bonds of developing countries due to the uncertainty and risk. Though foreign currency bonds can be issued under Infrastructure Debt Fund (IDF), the problem of original sin remains. In order to increase foreign investor participation, India can follow the success of Singapore by easing regulations relating to disclosure requirements and give tax incentives to encourage foreign investments in local currency bonds. The recent liberalisation in FII investment in long term corporate debt in the infrastructure sector by the GoI is a positive development and will help alleviate the original sin problem.

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