Corporate bonds market is gaining traction on better returns
Nov 29 2012, 2022
The corporate bond market appears to have picked up, with issuers moving from traditional bank lines of credit directly to the private placements market. Subscribers to these bonds are necessarily banks, insurance companies — life and non-life — including the public sector behemoth Life Insurance Corporation of India, mutual funds and the pension funds. Foreign institutional investors too are in the bond market. In fact, capital markets regulator Securities Exchange Board of India has proposed to further hike their limit. But then, FIIs are also using the mutual funds route to buy corporate bonds, as returns are good right now. Well-rated bonds offer yields upward of 9 per cent. Those returns would further increase if the exchange rate appreciates during the holding period. The switch to emerging market debt is largely on account of high cash in the global banking system through the series of quantitative easing measures carried out by the Federal Reserve Board and the European Central Bank. The flood of dollars and euros in the global financial system has made FIIs a little more risk savvy. But the fact is that a few other countries have a better risk return combination. International credit default swap premiums for India is barely 250 basis points, while for Italy that is one notch higher on the investment rating scale, the premium is 270 basis points. The returns are higher in South America, though the risks of defaults are also equally high. The low risk perception of India is partly because unlike other countries, India has rarely borrowed directly from global financial markets. As a result, sovereign debt carries virtually no risk due to volatile exchange. Those risks have to be directly borne by investors or FIIs themselves. As for mutual funds and insurance companies, the shift to corporate debt is part fallout of the government's directive to cap bulk deposits with public sector banks at 15 per cent of aggregate deposits. Therefore, PSU bank demand for bulk deposits have shrunk. As a result, mutual funds and insurance companies that were the largest investors in certificates of deposits have shifted en masse to alternative sources of investment, including corporate debt. The rush, as a result, has kept corporate bond yields cool. Corporate bond spreads are just about 50 basis points over sovereign bond yields. For companies, the surge in demand has opened an alternative source of funds. Yet, most of the issues in the corporate bonds market are dominated by public sector enterprises or finance companies, including entities like HDFC and Nabard. Few of these issuers are also raising long-term funds. The preference instead is to stick to short-term issues in a period when interest rates are still seen to be high. But short-term issuances by some of the larger companies are also to meet working capital requirements. Accessing the markets is seen as a cost effective option against sourcing the same from banks. Right now, bank funds cost upwards of 11 per cent. Some have also used and continue to use the corporate bond markets to refinance their foreign currency borrowings. But long-term subscribers, particularly life insurance companies, are still bound by a plethora of internal and regulatory guidelines that restrict investments to companies that have a minimum credit rating of “double A” or high safety. That obviously means that infrastructure financiers are still confined to traditional sources of funding. Credit rating enhancers like India Infrastructure Finance Company (IIFCL) have modest capital to provide guarantees to all companies. Perhaps, the time has come to include other specialised financiers like Hudco, PFC and REC in providing guarantee support to infrastructure.