The Indian bond market has remained an undertapped avenue for infrastructure financing. The lack of liquidity for lower-rated corporate bonds, a narrow investor base and onerous exit routes inherent in corporate papers have stunted the growth of the country’s corporate bond market vis-à-vis its developed counterparts. The public and private issuance of bonds in India picked up after 2014 due to a decline in interest rates, which made the instrument a preferred medium of investment. After peaking in 2017, bond issuance declined in 2018, due to a rise in bond yields, from Rs 6,700 billion in 2017 to Rs 6,100 billion in 2018. The majority of these bonds were privately placed, while a meagre 2 per cent were issued publicly in 2018. Though the corporate bond market has shown some growth, albeit slow, in the past two-three years on the back of structural and cyclical factors, much remains to be done to increase its appeal to investors. The country’s green bond market, on the other hand, has seen a lot of activity, a deviation from the underdeveloped corporate debt market. The public sector has played a pioneering role in the Indian green bond market. With regard to municipal bonds, more recently, there has been some activity with issuances from Pune, Hyderabad and Indore.
Issuances in the infrastructure space
There has been an increase in bond issuances in the infrastructure sector in the past three years. Both the amount raised as well as the value weighted average tenure of bonds saw an improvement in the first nine months of 2017-18, as compared to the first nine months of 2016-17. The value weighted average tenure of infrastructure sector bonds was much higher than the overall private sector tenure of five-six years.
A sector-wise analysis shows that most of the bond issues were in the power and road sectors. The telecom sector constituted a small share of the total value of bonds issued in the infrastructure space. The power sector saw the maximum issuances for renewable and power transmission projects while refinancing of completed road projects drove issuances in the road sector.
A few notable bond issuances include the Rs 15 billion non-convertible debenture (NCD) programme of Kudgi Transmission Limited in July 2017 with a tenure of up to 23 years. Another major issue was the Rs 16.63 billion NCD issue by Jharkhand Road Projects Implementation Company Limited in May 2017 maturing in 12 years.
The bond market has seen a number of regulatory developments in the past 12-15 months. To deepen the corporate bond market, in November 2018, the Securities and Exchange Board of India issued a framework which requires a large corporate to meet 25 per cent of its borrowing requirements through corporate bonds. In the same month, the Reserve Bank of India permitted banks to provide partial credit enhancement (PCE) to bonds issued by non-banking financial companies (NBFCs) and housing finance companies (HFCs). The purpose of issuing PCE bonds is to refinance any existing debts of the NBFCs/HFCs. This has the potential of reducing refinancing risk for issuers, given that insurance companies and mutual funds may be able to participate in the offerings with enhanced ratings. In October 2018, masala bonds were excluded from the limit for investments by foreign portfolio investors in corporate bonds. They are to be treated as external commercial borrowings and will be monitored accordingly.
The first Indian corporate issuer of masala bonds was the Housing Development Finance Corporation (HDFC) on the London Stock Exchange (LSE) in July 2016. These bonds were well received by the global investor community and recently the International Finance Corporation also launched a masala bond worth $1 billion to fund its investment activities in India.
The issuance of masala bonds peaked in the fourth quarter of 2016-17, reaching $5.81 billion, before declining significantly in the subsequent three quarters of the fiscal year. The average tenure of these bonds has been around five years. Borrowings via the masala bond route have been largely for on-lending to corporates with only a few instances of borrowing for capital expenditure. A few notable masala bond issuances were the Rs 19.5 billion green masala bond issuance by the Indian Renewable Energy Development Agency in September 2018 and Rs 30 billion issuance by the National Highways Authority of India in May 2017. A major shortcoming of the masala bond instrument impeding its uptake is that the currency risk is borne by the investor due to which tenures are short. This does not render the instrument viable for funding infrastructure projects.
India entered the green bond market in 2015 with YES Bank issuing the first green bond to finance renewable energy projects. This was followed by the Export-Import Bank of India launching a five-year green bond worth $500 million in March 2015. CLP India launched the country’s first corporate green bond in September 2015. Later, in June 2016, Axis Bank came out with the first internationally listed green bond. More recently, the State Bank of India raised $650 million via a green bond issue in September 2018. The proceeds will be used to fund environment-friendly projects.
As per London-based Climate Bonds Initiative, as of October 2018, the Indian green bond market has been estimated at $7 billion, making the country the world’s eighth largest market. However, it is very small as compared to other major markets such as the US and China. Also, the major challenges for India’s green bond market include the not-so-robust regulatory monitoring mechanisms, high currency hedging costs, poor sovereign rating (BBB-), lower tenures, lack of standardised reporting, and exposure to credit risks. That said, the country has huge potential to attract clean energy investments given the well-established domestic supply chain which has facilitated the development of clean energy projects.
Municipal bonds have not tasted much success in India. After the Bangalore Municipal Corporation’s first municipal bond issuance in 1997, the market saw little action. Two decades later, the Pune Municipal Corporation kick-started activity with the issuance of bonds aggregating Rs 2 billion. Thereafter, between June 2017 and September 2018, five municipal bonds were issued (including those by Indore and Hyderabad), raising a total of Rs 8.7 billion. However, municipal bonds have not received as much acceptance as was expected. This is mainly due to lack of publicly available information on indicators such as fiscal performance, debt and contingent liabilities of urban local bodies (ULBs), which prevents their proper credit assessment. Further, weak governance by ULBs is also limiting investments in these bonds. After a year’s wait for the central government nod to issue tax-free bonds, the Ahmedabad Municipal Corporation has announced plans to issue green bonds worth Rs 2 billion in 2018-19. The proceeds will primarily be utilised for projects in sanitation, cleanliness and waste recycling.
The way forward
The Indian bond financing market has seen slower than expected progress in the past couple of years. To mitigate risks, a liquid bond futures can be created in order to hedge duration risk. For issuances in the infrastructure space, proper risk management becomes critical. The financial, construction, legal and operational risks should be appropriately allocated to institutions best equipped to handle them. Further, a well-managed financial market also reduces the dependence of developers on bank loans for project finance. Meanwhile, to expand the role of the corporate bond market over the medium term, the government is considering recognition for investment in bonds to include A-rated bonds as well (in addition to the existing stipulations of including only bonds up to AA rating) and is attempting to introduce a uniform stamp duty for issuance of bonds across the country. All said and done, the bond market can play an important role in infrastructure financing but this cannot be achieved without a robust secondary market, since liquidity is key.