Non-banking financial companies, that used to comprise at least 70 per cent of the issuance in the corporate bond market, are witnessing a credit freeze as investors shun bond issued by lower-rated firms. The investors are stunned by the defaults by AAA-rated firms that were downgraded to default rating in a matter of months. Mutual funds and insurance companies, major buyers of bonds in the markets, are shying away as a result. Ironically, investors in government bonds are also complaining of oversupply by the government. Kanungo’s caution, in this context, assumes significance.
The government securities outstanding in the market is about Rs 58 trillion, with another Rs 6 trillion in short-term treasury bills (that mature in less than a year). However, liquidity in most papers remains thin.
“Though the primary issuances have been quite seamless, only the 10-year benchmark security accounts for bulk of the trading volumes,” Kanungo said. Even as the bid-ask spread is “impressive” and among the best in emerging markets, liquidity “almost completely dries off in other off-benchmark securities, which does not reflect well on the market”.
The situation is not impressive in corporate bonds either. While in the five years between June 2014 and June 2019, the market size has grown from Rs 14.43 trillion to Rs 30.63 trillion, most of the issuances are private placements, and by financial firms. There are in excess of 24,000 instruments outstanding, reducing the average outstanding per instrument to a small figure, Kanungo said.
“The secondary market in corporate debt is so illiquid that we can very well say there is no such market. The rating transition of some corporate debt, particularly those issued by financial firms, has been phenomenal — from sound credit to junk,” said the deputy governor.
Besides, the evolution of the money market “continues to be stunted”, with most of the activity being concentrated in the overnight segment while a “robust term money market continues to elude us”. While treasury bills are still traded, short-term commercial papers and certificates of deposits issued by companies and banks is confined to primary issuances. “The interest rate derivatives market also continues to be lacklustre. There is reasonable liquidity in overnight interest swaps, but there is no appetite, and hence not much trading in other derivatives including interest rate futures.”
In particular, the credit default swap market, introduced in 2012 “is moribund”. “It is ironical that while some participants used to write little understood products like quanto swaps a decade and a half back, there is little effort to provide simple products like caps or collars on bonds today,” the deputy governor told the bond investors under the umbrella of Fixed Income Money Market and Derivatives Association and Primary Dealers Association of India.
The deputy governor cautioned that despite allowing the non-resident investors full access to the domestic interest rate derivatives market, “anecdotal evidence seems to suggest that an offshore market in this segment might be developing, much like the NDF market”.
Recently, a committee headed by former deputy governor Usha Thorat suggested that such offshore markets be brought onshore by giving them the same facility in GIFT City. Anything offshore is problematic for the regulator as the RBI has no control over these markets, but they set the mood for the domestic market.
To ensure a healthy domestic market in bonds, the deputy governor said it is important that wide participation in large volumes is ensured. Since banks are the single-largest set of entities followed by insurance companies, pension funds, and now alternative investment funds, they must take the lead. These firms, despite their huge balance sheets, are not very active either in markets or in innovation.
“There is perhaps a need to go beyond the comfort of 6-9-3 banking in search of unexploited market and unharvested returns,” the deputy governor said.
The RBI, on its part, would work towards enhancing the overall liquidity in government securities market in terms of availability of two-way quotes in less liquid maturities through targeted market making schemes.
“Further, measures towards activation of a securities lending and borrowing programme, inter-operability of depositories for smooth transfer of ownership in securities will receive our attention. We are also engaging the government for active consolidation of government debt through frequent buyback/switch operation,” Kanungo said.
Even though there has been a great deal of interest from foreign investors in local debt securities in recent times, there is a threat to stability in the interest rate market and some threat to stability in the forex market, even as local companies get saved from foreign currency exposure. “Be that as it may, greater access to foreign investors to the rupee debt market — cash as well as derivative — will gradually be considered,” the deputy governor said.
There is a need to bring stability in derivatives product, while other regulators too could help development of interest rate markets, by allowing, for example, short selling.