Tweaks and mandates: The wrong way to build a corporate debt market

Included in Finance Minister Arun Jaitley’s presentation of the Union Budget to Parliament last week was a package of statements and proposals aimed at increasing the depth of India’s corporate bond market. This is an important goal. Indian companies are over-dependent on borrowing from banks to finance investment, which has slowed down growth at times — such as now — when banks are reluctant to lend. Unfortunately, not all the measures the finance minister announced, in his effort to remedy this situation, can be welcomed. Mr Jaitley pointed out that corporate bonds rated BBB- or higher (according to the Standard and Poor’s metric, which corresponds to Baa3 or higher from Moody’s) are considered investment-grade. However, Indian norms typically require corporate bonds to have the rating AA or above in order to be acceptable investment-grade instruments.

Mr Jaitley urged the regulators to consider relaxing this requirement and to allow an A-grade rating to be the new cut-off for bonds to be considered investment-grade. This will clear the way for large institutional investors, such as the Employees’ Provident Fund Organisation, to invest in a larger set of corporate bonds than they currently do, which in turn will help deepen the bond market and free up bank capital. Already, in the face of banks’ general unwillingness to lend, companies have turned to the bond market in recent months and years, and it is now worth over Rs 4 trillion.

However, other aspects of the finance minister’s plan are not so palatable. For example, he suggested that it be mandated that a quarter of any company’s funding requirements be met from the bond market. It is unclear how this could be implemented. Certainly, a mandate requiring a particular minimum amount of borrowing from a particular source of capital seems both wrong-headed and difficult to implement. Companies with different requirements and expectations will seek to raise capital in different ways, through the mix of sources that fit their circumstances. A mandated minimum for their borrowing through bonds is an unwarranted and inexcusable interference in what should be a purely corporate decision. If the bond market is liquid, transparent, and deep, then companies themselves will choose to access it.

It is clear that while the aim of Mr Jaitley’s efforts is laudable, the focus and methods are misguided. The government should instead probe closer to home for reasons that a deep and liquid corporate bond market has not developed. Its own borrowing has been excessive, which means, for example, that banks have hundreds of billions of rupees worth of government securities on their balance sheets over and above statutory requirements. The total value of government paper available is perhaps 10 times more than that of corporate bonds. Nor has the government helped create a stable, low-risk benchmark for corporate bonds in the government bond market — that would require an independent public debt management office, the institution of which has been constantly postponed and is now being promised by the end of this calendar year. Financial sector reform and fiscal prudence are the only way to build a true corporate bond market — tweaks and mandates will not help.

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