The recent approval by SEBI to reduce the face value of privately placed debt securities can boost demand for corporate bonds, but the impacts of this policy need close monitoring.
At its 205th board meeting, the Securities and Exchange Board of India (SEBI) made several amendments to the SEBI regulations (2021). The most significant change is the approval of a reduction in the face value of privately placed debt securities to INR 10,000. Initially, the minimum face value was fixed at INR 10 lakh, which was reduced to INR 1 lakh in October 2022. The gradual decline in the minimum face value can be seen as a move to increase retail investors’ participation in the corporate debt market, increasing liquidity and lowering the cost of capital for businesses. India’s underdeveloped debt market has much to do with this intervention and its implications.
Corporate bonds denote interest-paying debt instruments issued by private or public corporations incorporated in the country. Companies can issue bonds through public or private placement—the former referred to as listed bonds can be purchased through both primary and secondary markets. In 2023-24, the public placement of corporate bonds stands at only around INR 19,000 crore against the private placement of around INR 838,000 crore. The colossal difference in the volume of public and private placement poses critical problems of transparency, price discovery, and market efficiency.
Corporate bonds denote interest-paying debt instruments issued by private or public corporations incorporated in the country. Companies can issue bonds through public or private placement—the former referred to as listed bonds can be purchased through both primary and secondary markets.
Public placement requires companies to issue a prospectus, which can give a rough idea about the cash flow-generating parameters of the business, allowing greater transparency and more accurate price setting. The overwhelming dominance of private placement stems from its time- and cost-effectiveness and low compliance requirements. However, private placements are largely targeted towards institutional investors, given the advantage of raising a larger corpus from a smaller set of creditors. On the other side of the market, retail investors are deterred from entering the corporate bond market due to higher face values (entry costs), informational asymmetry, and the absence of a secondary market (limited liquidity). The widening demand and supply gap makes the functioning of markets increasingly difficult, calling for regulatory interventions.
While India lags behind other Asian emerging market economies when its corporate bond market size is seen in proportion to GDP, a Bank for Internal Settlements (BIS) survey has shown both advanced and emerging markets face similar problems in terms of secondary market liquidity. Thus, the Indian corporate bond market does not face a unique problem in generating liquidity. However, deepening the bond market is imperative, as India plans to capitalise on its growing demand and emerging entrepreneurial ethos to drive economic growth. Both these developments require strong credit markets and mobilisation of funds to fuel the economic machinery.
While India lags behind other Asian emerging market economies when its corporate bond market size is seen in proportion to GDP, a Bank for Internal Settlements (BIS) survey has shown both advanced and emerging markets face similar problems in terms of secondary market liquidity.
Increasing consumer demand, augmented by credit expansion due to a structural shift in savings preferences of the average Indian towards physical assets, has widened bank exposure. Simultaneous expansion of firms to match consumer demand might result in a credit shortage in the economy. Moreover, the term mismatch between bank assets and corporations’ project maturities, makes the corporate bond market a more suitable source for business financing. As consumer credit increases, the corporate bond market can swerve the leverage risks away from Indian banks and ensure greater financial stability.
Infusing greater liquidity into the corporate bond market will also provide another avenue for retail investors to diversify their portfolios. With the addition of 120 million retail investors in the last five years, the Indian stock market is rallying around its all-time high, reflecting consumer confidence and the shift towards less conventional investment instruments. This is a key window to employ policies incentivising retail investors to enter the corporate bond market; avoiding any speculative booms in the stock market or excessive equity dilution for existing stakeholders. Further, investors can safeguard their investments by hedging their equity portfolio against secured bond returns, facilitating a more risk-free investment environment in the economy. Thus, greater corporate bond market participation will assuage risks and enhance growth via three channels—increased bank stability, stock market moderation, and cheaper corporate financing.
The earlier reduction in the denomination from 10 lakh to 1 lakh saw non-institutional participation rise to 4 percent in July-September, 2023, against the usual average of 1 percent. Thus, this reduction in the ticket size to INR 10,000 aims to boost liquidity through increased non-institutional purchase of bonds through online bond platforms (OBPs). Leveraging the enormous size of private placements can effectively increase retail participation through OBPs, facilitating a more liquid secondary market and promoting corporate bonds as a viable short-term investment.
Over time, the deepening of the corporate bond market through private placements can have a spillover effect on public issues, raising the aggregate volume of outstanding bond issues. A larger bond market can significantly lower the cost of borrowing for firms, increasing profitability and encouraging new entrants. However, the bond market is dominated by firms with high credit ratings, making debt financing inaccessible to smaller firms (with lower credit ratings). This is due to the prevalence of institutional investors having lower risk preference, given their long-run obligations. Large-scale participation of retail investors with higher risk appetite can encourage the inclusion of lower-rated bonds and ameliorate the economy-wide cost of capital. The concomitant introduction of complementary repo and derivative markets can multiply the expansionary effects.
Over time, the deepening of the corporate bond market through private placements can have a spillover effect on public issues, raising the aggregate volume of outstanding bond issues. A larger bond market can significantly lower the cost of borrowing for firms, increasing profitability and encouraging new entrants.
From a macroeconomic standpoint, this move can significantly raise the effective demand for corporate bonds, till there is an expansion in the market size. This entails a reduction in interest rates as bond prices shoot up. Given the current steady trajectory of inflation, there might be a potential downward shift in the natural rate of interest allowing the Reserve Bank of India to take a more dovish stance. However, the impacts and magnitude of any macroeconomic policy can only be gauged in hindsight—foregrounding the need for continuous monitoring and regulation.
Arya Roy Bardhan is a Research Assistant at the Observer Research Foundation.
The views expressed above belong to the author(s). ORF research and analyses now available on Telegram! Click here to access our curated content — blogs, longforms and interviews.
Arya Roy Bardhan is a Research Assistant at the Centre for New Economic Diplomacy, Observer Research Foundation. His research interests lie in the fields of ...
Read More +
PREV
