Missing the Mark

For a number of years now, banks have had limited headroom to extend fresh credit to the infrastructure sector, and this has pointed towards the need for a well-developed bond market. A common source of debt in many countries, the corporate bond market still remains at a nascent stage in India. While some uptick has been witnessed in the past couple of years, there is still a long way to go with regard to the development of a deep and mature bond financing mechanism.

Overall scenario

In terms of size, India’s corporate bond market (16 per cent of GDP) is dwarfed by that of many Asian countries such as Malaysia (46 per cent), South Korea (73 per cent) and China (56 per cent). However, to meet the growth aspirations, the development of this segment of the debt market is no longer a choice. A regulatory push and well-timed market-making measures are going to be crucial. With regard to bond issues in infrastructure, the past couple of years have brought some cheer. Bond floats peaked during 2016-17 at about Rs 1 trillion. However, soon after, rising bond yields and investor risk aversion eroded interest in these instruments. Issuances fell for two consecutive years, to reach

Rs 0.6 trillion in 2018-19. Some correction, though, was witnessed in the first five months of 2019-20, which saw Rs 0.4 trillion worth of issues, as compared to Rs 0.2 trillion in the corresponding period of the previous fiscal year.

Sector-wise, power, roads and telecom remain the major issuers of the paper. Some of the key issuers in the past year include THDC Limited (Rs 15 billion), India Grid Trust (Rs 24.85 billion), NRSS XXIX Transmission Limited (Rs 30 billion) and Coastal Gujarat Power Limited (Rs 27 billion).

Within the overall bond market, segments such as municipal bonds, green bonds and masala bonds hold significant potential, but much needs to be done to tap it.

Municipal bonds

It has been over two decades since India’s first municipal bonds were issued by the Ahmedabad Municipal Corporation. Yet, the municipal bond segment remains a non-starter till today. A key reason for this has been the lack of transparency with regard to the financial standing of urban local bodies (ULBs) that has resulted in investor diffidence. For years, lack of appropriate and timely financial disclosures along with substandard accounting practices by ULBs has resulted in opacity with regard to their creditworthiness. As a result, investors displayed poor appetite for the papers issued by these civic bodies. The issues that did manage to attract some interest, although feeble were for water and sanitation projects.

Today, the scenario is changing for the better. The market is gradually evolving with a considerable push towards urban infrastructure development through flagship schemes such as the Atal Mission for Rejuvenation and Urban Transformation (AMRUT) and the Smart Cities Mission (SCM). In recent years, some key measures have been taken to unlock the potential of the municipal bond market. Aligned with the government’s vision, the market regulator, the Securities and Exchange Board of India (SEBI) introduced regulations under the Issue and Listing of Debt Securities by Municipalities framework in 2015. Rules were further eased in 2017.

So far, eight cities have raised a total of Rs 34 billion through municipal bonds. These are Pune, Hyderabad, Bhopal, Indore, Visakhapatnam, Amaravati, Ahmedabad and Surat. Some reports estimate that about 50 cities will reach out to capital markets with bond issues by 2024.

The municipal bond market is also receiving attention from the central government as well. The Ministry of Housing and Urban Affairs (MoHUA) has taken the credit enhancement route to help municipal bonds be better received in the market. The MoHUA has started assigning credit ratings to civic bodies that are executing projects under AMRUT. So far, this exercise has been done for 465 cities.

Green bonds and masala bonds

Globally, green bonds form a minuscule share in the overall bond market. The decade-old segment gained steam when countries such as China, France and the US emerged as key issuers of the instrument. Factors like increasing risks associated with climate change and issuing entities trying to showcase their environmental integrity by tapping “green funds” have aided the sustainable finance market in attaining critical mass. Green bonds, as a result, have become the new hot instrument in global capital debt markets. While India lags far behind mature green bond economies, recent floats mark a fair-paced progress, placing it as one of the fastest growing green bond markets in Asia. In 2018, the country’s green bond market was worth $5.2 billion. These include Azure Power, NTPC Limited, Greenko, ReNew Power, YES Bank, Exim Bank, L&T Finance, Axis Bank and IDBI Bank. The euphoria associated with the new financing instrument was reflected in the extent of oversubscriptions which ranged from over 1.5 to over 5 times.

Like municipal bonds, green bonds too have witnessed a regulatory push. SEBI has been in the process of setting up a framework for green bond issuances since 2015. A draft was first floated in December 2015. In 2016, the regulator approved the issuing and listing norms of these papers. In a follow-up move in 2017, guidelines regarding disclosures were firmed up.

Moreover, the launch of the Global Securities Market [GSM] Green by the India International Exchange (India INX), the overseas arm of the Bombay Stock Exchange, is expected to buttress the fledgling framework. Shortly after the launch of the platform, three subsidiaries of Adani Green Energy Limited listed their green bonds worth $500 million on the GSM. The Indian Railway Finance Corporation (IRFC) raised $500 million in 2017 from a 10-year green bond issue through India INX. IRFC has also set up a green bond framework for fundraising, the proceeds of which will be deployed towards the development of the dedicated freight corridor and electrification of rail tracks.

In September 2019, the Kerala Industrial Infrastructure Fund Board embarked on its plan to raise $250 million through its debut masala bonds. Masala bonds are a currency-risk-free variant of a vanilla bond. Barring the recent issue, this segment too continues to witness patchy demand from investors that are shying away from parking funds at present, given the heightened US-China trade tensions. This is owing to the instrument’s structure – the foreign exchange risk is borne by the investor instead of the issuer. At least in the near-medium term, masala bonds are expected to remain dormant till the global trade cycle picks up.

A variant of green bonds that are Indian rupee denominated, known as masala green bonds, has also seen only a handful of floats. These were by the Indian Renewable Energy Development Agency that raised Rs 19.5 billion in September 2018, the National Highways Authority of India that raised Rs 30 billion in May 2017, and NTPC Limited that raised Rs 20 billion in August 2016.

 Partial credit enhancement

To improve the ratings of bonds in a bid to generate investor interest, the partial credit enhancement (PCE) mechanism is resorted to. However, this has met with limited success. The mechanism acts as mere liquidity support and has failed to raise ratings to the desired extent. In August 2019, the government introduced the Partial Credit Guarantee Scheme for public sector banks for purchasing high-rated pooled assets from financially sound non-banking financial companies and housing finance companies. However, further clarity is required with regard to certain clauses. Overall, if structured well, it should bode well for the bond market.  That said, the proposed Rs 20 billion Credit Guarantee Enhancement Corporation announced in Union Budget 2018-19 is yet to be formed. It is aimed at providing guarantees to bonds issued by special purpose vehicles (SPVs).

In sum

Bonds remain a lucrative option for infrastructure financing. However, regulations, credit ratings, tenors, issuer strength, market scenario, depth and liquidity of secondary markets and quality of underlying assets are some of the factors that will determine how quickly this source can be developed. Going forward, a multi-pronged approach by the government, regulators and institutions will prove vital.

Priya Mishra

 

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