Is bond market welcoming back corporates? Wrong conclusion, say experts

The government bond yields have also fallen after the liquidity infusion exercise by the RBI | Representative Image
The spread between corporate bonds and equivalent maturity government bonds have come down substantially. Although this gives an impression that the bond market is welcoming back corporates, experts say it would be a wrong conclusion to reach.

The spread between the 10-year AAA-rated corporate and equivalent maturity government bonds have fallen to 108 basis points, from about 140 basis points in October end last year. 

The drop is even sharper for the five-year segment where the spread has contracted to 64 basis points, from about 110 basis points in the end of October.

This may give an impression that the rate transmission the Reserve Bank of India (RBI) hoped for may have happened in the corporate bond segment, too. That would also mean that Indian companies can raise bonds at a cheaper rate from the market.

But issuances in corporate bonds are actually falling, largely because non-banking financial companies (NBFC) are staying away from issuing fresh papers.

This is creating its own demand for every new issuance. And that may explain why corporate bond yields are also falling.

As prices of bonds rise, the yields fall and vice versa.

“Compression in spread between G-Sec and corporate bond is largely to do with favourable demand-supply dynamics and improvement in the interest rate outlook. However, in the case of risk premium or market liquidity, they haven’t improved considerably,” said Soumyajit Niyogi, associate director at India Ratings and Research.

At 6.80 per cent for a five-year maturity AAA-rated paper, Indian corporate bonds still offer one of the highest returns for a foreign investor. In case of public sector enterprises, the yield is about 15-basis points lower. Still, those are attractive yields for almost risk-free returns.

But foreigners are not major investors in these markets, even as the government has opened up more space for them in the Budget. 

Mutual funds, by far, are the largest buyers of corporate bonds. But they are not as active as before after the IL&FS crisis where AAA-rated bonds got downgraded to junk in a matter of few weeks. 

The lack of supply also makes the new issuances in the top-rated category costlier for investors.

The government bond yields have also fallen after the liquidity infusion exercise by the RBI. 

For example, the 10-year government bond yields have fallen from 6.80 per cent at the end of December to 6.35 per cent. 

Similarly, corporate bond yields have also fallen as general liquidity improved. The 10-year AAA-rated corporate bond yield, in the same period, has fallen from 7.86 per cent to 7.43 per cent.

But both yields need not move together, said Badrish Kulhalli, head of fixed income at HDFC Life Insurance.

“Both the yields don’t necessarily move in tandem. High spreads are often not an indication of dislocation, but it’s just normal leads and lags,” said Kulhalli.

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