Introduction

India’s equity market is well-developed, liquid, and robust. The resilience of the Indian market during the tumultuous past three years has surprised many experts worldwide. India is ranked fourth globally in terms of market capitalisation; as of 17 August 2023,^[1] the total market capitalisation of listed companies stood at INR 309 trillion, which is about 105 percent of GDP. The equity market in India has the best-in-class regulation compared to even the developed economies of the West.

The question that needs to be asked in this context is why India’s debt market continues to be underdeveloped. The country’s aspirations of becoming the third largest economy in the world by 2027 and a developed country by 2047 need to be backed by a liquid, deep, and well-functioning debt market. Private-sector investments cannot be leveraged without such a debt market. An underdeveloped bond market could disrupt India’s growth story.

An active bond market could fulfill multiple purposes. Besides providing borrowers with an alternative to bank credit, corporate bonds could lower the cost of long-term finance. Banks usually lack the ability to sponsor long-term projects because their liabilities are of a relatively shorter tenure. An efficient Indian corporate bond market with lower costs and faster issuances could provide a cost-effective source of long-term finance to Indian corporates. It could also provide institutional investors like insurance companies and provident and pension funds with the ‘preferred habitat’ for long-term financial assets, assisting them in aligning the tenures of their assets and liabilities.

From a macro-financial standpoint, a well-developed corporate bond market can diversify the risk of financial instability. Banks, which are situated at the core of India’s financial system, are critical to maintaining financial stability. As they supply liquidity services, credit, and payment systems to the economy, managing their risk assumes importance. To this end, a market-based source of finance, like the corporate bond market, could be effective in spreading risk across a broader class of investors, therefore contributing to overall financial stability.^[2] A sufficiently mature corporate bond market could assume the role of a spare tyre, mitigating financial shocks and maintaining financial stability.^[a] It is against this backdrop that the Indian government and regulators must facilitate corporate bond market development in the country.

For example, the infrastructure sector has a dire need for viable and sustainable financing options. The Government of India has identified a national infrastructure pipeline of projects that requires an investment of INR 111 trillion over a period of five years beginning 2019–20.^[3] Banks alone will be unable to finance these projects. The financing for infrastructure projects has an inherent asset-liability mismatch, which was the primary cause for banks accumulating massive non-performing assets (NPAs) in the past. While Indian banks currently have healthy balance sheets, they need to be careful not to repeat past mistakes.

Further, the government will be unable to sustain its sizeable annual budgetary capex allocations of the last few years over the long term. High fiscal deficit and rising debt burden are red flags for macroeconomic stability, especially when these are reinforced by concerns about inadequate public sector execution capacity, inefficiencies, and lack of financial re-engineering. Excessive government borrowings from the market can also crowd out the private sector from raising funds.

A possible solution is the National Bank for Financing Infrastructure and Development (NaBFID). However, NaBFID—established in 2021—is yet to gain traction. The experience of development financial institutions in India has been disappointing, with many functioning as unwieldy bureaucracies over time and thereby causing borrowers recurring grievances around time and cost overruns.^[4] Even from an optimistic lens, the contribution of NaBFID can at best be just the tip of the iceberg, owing to the limited size and scope of the institution in comparison to the large funding requirements of the infrastructure sector. Therefore, there is an urgent need to build a robust ecosystem to facilitate the growth of market-based debt raising.

The Indian Corporate Bond Market

The government, the Reserve Bank of India (RBI), and the Securities and Exchange Board of India (SEBI) have been considering prioritising the development of the corporate bond market for a few decades now, with some progress being made in recent years. Since 2012, there has been a steady growth in resources mobilised through corporate bonds (Figure 1).

Fig. 1: Corporate Bonds Outstanding (in INR crore)

Source: SEBI^[5]

Yearly issuances have increased from INR 3.8 lakh crore to INR 6 lakh crore from 2012 to 2022 (Figure 2).

Fig. 2: Corporate Bond Issuances (in INR crore)

Source: SEBI^[6]

The increasing size of the corporate bond market has coincided with the diversifying of issuers, which now include new types of entities like real estate investment trusts (REITs) and infrastructure investment trusts (InvITs). SEBI’s listing of municipal debt securities regulations has sanctioned the market-based funding of infrastructure projects. There are also early signals of the development of a market for distressed corporate debt securities, including debt securities issued as part of corporate insolvency processes.^[7]

Other facets of India’s corporate bond market attest to its resilience. A mature government securities market forms the basis for the development of other rate markets, like the corporate bond market. Corporate bonds are typically priced off the sovereign yield curve, and resilient markets feature stable credit spreads over benchmark government security yields A comparison of the yields of five-year government securities and AAA-rated bonds of the same duration indicates that the latter have indeed been priced off the former in India for over a decade (Figure 3).

Fig. 3: 5Y G-Sec and 5Y AAA Bond Yield Over Time (2010–22)

Source: Bloomberg

 Trends in credit spread movements are also reassuring, with spreads widening during periods of stress or volatility, both domestic and external.

Another encouraging feature has been the Indian corporate bond market’s capacity for innovation and adaptation. When there were concerns surrounding the creditworthiness of businesses during disruptions caused by the COVID-19 lockdowns, bonds with conditional credit risk premium were introduced, which were designed to align the interests of issuers who wanted to lock-in to the prevailing low-interest rates with investors’ concerns surrounding credit quality. Similarly, while Indian corporate bonds are largely issued as fixed coupons, more floating rate bonds were issued in CY2021, with coupons linked to the money market and government securities, driven by investors hedging against potential increases in domestic interest rates.

There are certain core issues that need to be addressed immediately. In the bank-dominated Indian economy, the corporate bond market stands at 18 percent of GDP—far lower than those of developed countries of the West; for example, it stands at 120 percent in the United States.^[8]

Yet, the modest growth of bond market volume in India is not the only issue. At present, the market largely comprises high-end bonds, with 97 percent of corporate bond issuances concentrated in the top 3 rating categories (AAA, AA+, and AA).^[9] Issuers who are unable to get these ratings cannot access the bond market. This would explain why most of the issuers are either non-banking financial corporations (NBFCs) or public sector undertakings (PSUs). Manufacturing firms accessing the bond market is a rarity, and the situation is worse in infrastructure projects. Despite being best suited for market-based financing due to their long gestation period, these projects are unable to raise funds through bonds, primarily due to their typically low BBB ratings in the initial phase of their lifecycle.

Another important metric to gauge corporate bond market depth is the development of secondary bond markets. In India, although secondary bond market trading volume has increased since 2010, it has been underwhelming compared to the growing market size of the country (Figure 4).

Fig. 4: Secondary Market Trading in Indian Corporate Bonds (2010-2022)

*Data for FY2022–23 is up to June 2022
Source: SEBI^[10]

Recent Regulatory Interventions

The Indian corporate bond market has the distinction of being regulated by two regulators—SEBI and RBI. Some recent regulatory changes have improved the ease of doing business, helped increase transparency in the primary market, and enhanced liquidity in the secondary market. For example, listed companies issuing bonds through private placement are being nudged to use the Electronic Debt Bidding Platform for issuance and gradually reduce the threshold amount beyond which the platform must mandatorily be used. Additionally, the Request for Quote mechanism is an initiative undertaken by SEBI to facilitate the price discovery of bonds. The initiative began with the regulatory mandate to mutual funds to undertake at least 10 percent of their trades on this platform. There has been some progress, with other market participants joining the platform.

Two significant initiatives by SEBI, which are likely to bring in liquidity and improve confidence in the market, are the setting up of a limited purpose clearing corporation (LPCC) for facilitating trading in corporate bond repos on the exchange platform, with the LPCC acting as the central counter party; and the setting up of a corporate debt market development fund (CDMDF) as a backstop facility for buying bonds in a distress market situation. An active repo market improves liquidity in the underlying securities. The link between the repo market and trading in underlying security is most evident in the government security (G-Sec) market. A well-developed repo market in corporate bonds would facilitate improved liquidity in the underlying debt securities; the ability of debt holders to monetise debt securities without selling the underlying; and meeting the temporary funding requirement and securities mismatch. Considering that mutual funds are the most active participants in corporate bond trading and are likely to benefit from the repo market, asset management companies (AMCs) with debt assets under management have been roped in to capitalise the LPCC. As issuers would benefit from increased liquidity by raising bonds with reduced yields, they have been mandated to contribute to the core settlement guarantee fund of the LPCC.

The CDMDF has been envisaged as an entity that is on standby to quickly respond to market stress situations—as happened during the COVID-19 period—with a view to bring liquidity and stability to the corporate debt market; address risk aversion during times of stress, especially for securities rated below AAA; and build the confidence of market participants in the secondary market. The specified debt mutual fund schemes and AMCs would contribute to the corpus of the CDMDF. The fund would be eligible to take credit based on a guarantee of ten times the corpus backed by the sovereign. The CDMDF’s resources would be utilised to purchase corporate debt securities from specified debt mutual fund schemes during times of market dislocation.

The LPCC has a corpus of INR 150 crore, with each mutual fund house contributing to this corpus in proportion of their debt assets, and the Association of Mutual Funds in India (AMFI) calculating fund house contributions on the basis of the average assets under management (AUM) of the funds. The work on the LPCC was initiated in 2019–20 and on the CDMDF in 2020–21.  These facilities were eventually launched in July 2023. While LPCC is operational, it is bound to take time to be established. The CDMDF is yet to be capitalised. Both institutions require hand-holding from the regulator, and their implementation needs to be closely monitored in order to quickly address any teething troubles.

The Way Forward

The government has on several occasions promised setting up a credible credit enhancement mechanism that would be especially beneficial for financing infrastructure projects. The development of markets for credit default swaps (CDSs) and interest rate derivatives are other items that have been on the radar of the regulators, although there has been limited tangible progress so far. One of the most desirable and feasible reforms would be the unification of the bond market, i.e., the unification of the regulatory regime for G-Secs and corporate bonds for both issuance and trading. This would simplify the processes for investors, traders, and other stakeholders.

G-Secs have an overwhelming presence in the debt market in India; as of June 2022, the outstanding G-secs were around INR 85 trillion compared to outstanding corporate bonds, which amounted to INR 40 trillion.^[11] The pricing of corporate bonds is intrinsically dependent on the presence of a continuous yield curve in G-Secs. The G-Sec market and the corporate bond market are currently separated and follow different regulatory regimes. Unifying these markets would enable the seamless transmission of pricing information from G-Secs to corporate bonds. Having the same regulatory regime for the trade, clearance, and settlement of corporate bonds and G-Secs will result in economies of scale and scope, leading to greater competition, efficiency, and liquidity in markets.

To increase retail participation in G-Secs, in November 2021, the RBI released a scheme for direct retail participation in G-Secs through its own depository system and trading platform. This online electronic platform aims to simplify the process of retail participation, both in G-Sec issuance and trading, on the RBI’s Negotiated Dealing System – Order Matching (NDS-OM) platform. However, the RBI’s scheme may not be able to encourage retail participation, as it results in an artificial segmentation of investors in different types of securities.

As with any other form of security, to achieve ease of doing business and with a view to facilitate greater investor participation, G-Secs should be issued and traded through the stock exchange mechanism. Retail investors’ interest in bonds has been on the rise since SEBI started regulating online bond trading platforms in 2022. These platforms also facilitate trading in G-Sec, but only on stock exchange platforms. However, most of the G-Sec trading volume is concentrated in NDS-OM and settlement through Clearing Corporation of India Ltd. (CCIL), under RBI’s regulatory oversight.

The government should issue G-Secs in demat so that demat holders (currently, more than 120 million and expanding) can easily invest in G-Secs. G-Sec-based exchange-traded funds (ETFs) should also be developed to increase retail participation. The lessons learnt could help develop ETFs for corporate bonds, which could also be instrumental in increasing retail participation.

In the absence of capital account convertibility, RBI occasionally sets the limits for foreign portfolio investor (FPI) investments in corporate bonds and issues operational guidelines. At present, the overall upper limit for FPI investment in corporate bonds amounts to INR 6.68 trillion. Additionally, two routes—the simple route and the voluntary retention route—are prescribed for investment. The latter route keeps FPIs invested for a longer period to discourage the influx of hot money into the bond market. However, the guidelines under the voluntary retention scheme, including the concept of a ‘committed portfolio size’, are complex; the cap of 50 percent of each allotment for an individual FPI has especially been widely questioned.

The utilisation of the FPI investment limit in Indian corporate bonds is at its lowest in ten years, and FPIs have shown little appetite for investing in corporate bonds in India (Figure 5). The rising interest rates in the West, especially in the US, has also dissuaded FPIs from investing in the Indian bond market. Nevertheless, there is a need to re-evaluate the present regulatory regime.

Fig. 5: FPI Investment Limit Utilised (FY2014-FY2023)

Source: Moneycontrol^[12]

The inclusion of India’s sovereign bonds in JP Morgan’s emerging market index in September this year is a welcome development.^[13] The matter had been under consultation for a while. In March 2020, RBI released a circular introducing a ‘fully accessible route’ to enable foreign investors to invest in specified government securities without any ceiling, which has been instrumental to making the inclusion possible. With the inclusion, 23 government bonds valued at a total of US$330 billion became eligible for inclusion in global indices.^[14] India’s weight in the JP Morgan emerging market index is slated to increase to 10 percent over ten months beginning July 2024.^[15] At the end of this period, there is likely to be an influx of US$24 billion into India’s government-bond market. This will have a positive impact on the government bonds’ yields and create domestic borrowing space for corporate bonds. However, the actual FPI inflows can only be gauged after the bonds’ inclusion in the index. Additionally, the global financial situation is uncertain. This skepticism arises from the fact that the actual net purchases of Indian government bonds by the FPIs have amounted to just US$3.8 billion in the first eight months of this year.

The inclusion in the index will mean an increased coupling of domestic markets with global markets. This will increase volatility in the domestic markets, and there could be sizeable capital outflows due to exogenous factors putting pressure on the exchange rate. The domestic policies in terms of fiscal deficit management and inflation control will have to be more responsive and responsible. This may result in a good fiscal disciplining outcome. The government should also simultaneously facilitate increased domestic retail investor participation in G-Secs, which could counter the volatility arising out of exogenous factors or possible irresponsible behaviour by foreign investors.

Developing the bond market in India is vital, requiring a considerable amount of policy intervention from the government and regulators. A deep and liquid bond market is necessary for the country’s growth aspirations. Therefore, the discussion must be kept alive to push for an early and satisfactory resolution of unresolved issues.

---

Aditya Bhan is a Fellow at ORF.

Ajay Tyagi is Distinguished Fellow at ORF.

---

Endnotes

^[a] The “spare tyre” analogy originated in a 1999 speech by Alan Greenspan, Chairman, Federal Reserve (1999), in relation to alternate sources of finance to bank credit.

^[1] “All India Market Capitalization,” BSE.

^[2] RBI, RBI Bulletin: Corporate Bond Market in India – Challenges and Prospects, by T. Rabi Sankar, Mumbai, 2022.

^[3] Ministry of Finance, Government of India.

^[4] Tomojit Basu, Factsheet – Emerging Development Finance Institutions (DFIs) & India, New Delhi, OXFAM India, 2018.

^[5] Outstanding Corporate bonds – From Sep 2020 Quarter, SEBI.

^[6] Outstanding Corporate bonds – From Sep 2020 Quarter

^[7] T. Rabi Sankar, Corporate Bond Markets in India – Challenges and prospects, Basel, Bank of International Settlements, 2022.

^[8] “Corporate bond outstanding soars four-fold to Rs 40 lakh crore in a decade,” The Economic Times, August 24, 2022.

^[9] “SEBI looking at standardisation in corporate bond market,” The Hindu Business Line, August 3, 2023.

^[10] Corporate Bonds Archives, SEBI.

^[11] “Corporate bond outstanding soars four-fold to Rs 40.2 lakh crore in a decade,” CNBC TV18, August 24, 2022.

^[12] Manish M. Suvarna, “FPI utilization of investment limit in corporate bonds lowest in 10 years, shows data,” Moneycontrol, June 1, 2023.

^[13] “JP Morgan To Include Indian Government Bonds In Emerging Market Debt Index,” Outlook, 22 September, 2023.

^[14] “JP Morgan To Include Indian Government Bonds In Emerging Market Debt Index”

^[15] “JP Morgan To Include Indian Government Bonds In Emerging Market Debt Index”

• Indian Economy
• Economics and Finance
• Economic Reforms
• Financial Markets
• India

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.