It has been observed that 1 per cent of GDP spend on infrastructure can boost real GDP growth by 2 per cent. The government has announced a fiscal stimulus of 1.2 per cent of GDP to revive economic growth, which fell drastically due to Covid-19-related disruptions. However, falling revenues have limited the government’s ability to invest in infrastructure. To make things worse, a choked financial system and stressed banking sector are making debt financing of infrastructure projects difficult in the current times. This has increased the relevance of bond financing and capital market reforms to deepen the country’s bond market.
Corporate bonds
Corporate bonds account for around 26 per cent of the total credit market (Rs 139 trillion in 2019-20). Yet India’s corporate bond market size is small (~16 per cent of GDP) even in relation to Asian countries (Malaysia ~46 per cent, South Korea ~73 per cent, China ~56 per cent, and Thailand ~47 per cent). While traditionally banks have met the financing needs of corporates, capital markets have been playing an active role in recent years.
Corporate bond issuances have picked up momentum as companies prepare their balance sheets to weather financial uncertainties on account of the Covid-19 outbreak. During the April-October period of 2020-21, Indian corporates raised about Rs 4.4 trillion through the issuance of rupee bonds. This is a steep rise in contrast to the Rs 3.5 trillion raised through the private placement of corporate bonds during the corresponding period of 2019-20. In fact, mutual funds and insurance companies have emerged as large corporate bond investors, stepping in to fill the gap left by credit-averse banks.
Several AAA-rated entities including non-banking financial companie stapped the market to raise funds under the Reserve Bank of India’s (RBI) long-term repo operations (LTRO) and targeted LTRO facilities. In March 2020, RBI had introduced TLTRO, under which banks can access three-year funds up to Rs 1 trillion to invest in corporate bonds. Reliance Industries, the Tata Group, Larsen & Toubro, the Power Finance Corporation and the Indian Railway Finance Corporation were among the big issuers of debt papers during the first half of 2020-21. RBI’s liquidity management measures have resulted in lowering yields and borrowing costs and have led to an improvement in the overall bond market conditions.
In India, there have been a number of challenges hindering the development of a robust bond market. These include limited retail appetite, lack of a credit default swap market, preference for high quality papers, limited secondary market trading, and prescriptive investment mandates on domestic institutional investors. Further, lack of coordination among regulators could well lay the ground for future systemic instability.
Green bonds
In the past few years, green bonds have become popular among Indian and global issuers. According to RBI, green bonds, carbon market instruments and fintech-based green funds are now at the forefront of climate change financing. Green bonds continue to attract a lot of interest from public and private sector corporations alike that are opting to raise finance, especially for renewable energy projects. These include Azure Power, NTPC Limited, Greenko, ReNew Power, State Bank of India and YES Bank. These bonds have also received marked attention from regulatory authorities to encourage greater issuances.
In order to scale up environmentally sustainable investments, India joined the International Platform on Sustainable Finance in October 2019. The main objectives of this platform are exchange and dissemination of information to promote best practices in environmentally sustainable finance, compare different initiatives and identify barriers and opportunities to help scale up such finance. India has also been working towards facilitating trading in green bonds. In 2019, BSE’s arm India International Exchange (India INX) had launched its green listing and trading platform, Global Securities Market Green, which serves as a vehicle for fundraising and trading exclusively in green, social and sustainable bonds. Further, India INX recently joined hands with the Luxembourg Stock Exchange, which is the largest green bond listing platform, to promote green finance in the domestic market. The pact will provide opportunities for dual listing, enhance visibility and also increase secondary market trading in green bonds.
Currency risks, high transaction costs and inadequate knowledge of existing international practices of green bond transactions are some of the impediments to the growth of the green bond market in emerging economies, including India. Further, the possibility of green bonds undertaking “greenwashing” rather than green financing poses another concern. Greenwashing is the practice of channelling proceeds from green bonds towards projects or activities that have negligible or negative environmental benefits. In India, only large renewable energy developers have been able to successfully tap the green bond market due to strong promoter backing. A key factor impacting the rating of bond issues by renewable energy developers is the poor financial health of discoms. Counterparty risk thus deters players from issuing green bonds.
Municipal bonds
In India, the share of municipal bonds in the total debt market is insignificant. Only 1 per cent of urban local bodies’ (ULBs) financial needs are met through municipal bonds as opposed to 10 per cent in the US. This is because municipal bonds in the debt market have poor ratings. Low creditworthiness of ULBs is on account of poor accounting standards, low institutional capacities and slow governance reforms. So far, nine ULBs in the country have raised around Rs 36 billion through this avenue. The municipal bond market has not garnered interest from banks or foreign portfolio investors. Demand for such securities even among local investors has been stymied due to lack of adequate disclosure among municipalities. Transparency within ULBs will increase their creditworthiness, thereby improving their prospects of floating municipal bonds, enabling them to contribute towards building resilient infrastructure.
The Covid-19 pandemic has strained state finances, thereby hampering the funding of ULBs. However, the current economic stimulus incentivises state governments to push reforms that would bring better governance and help improve their financial situation, thus aiding in increasing the creditworthiness of ULBs. The oversubscription of the municipal bonds recently issued by the Lucknow Municipal Corporation (LMC) is a testimony to this. It reflects investor confidence in good governance and improvement in the investment climate during the pandemic. The LMC raised Rs 2 billion through muni bonds which were listed on the BSE. The funds raised will be invested in various infrastructure projects in the city, including water supply projects and housing projects being implemented under the Atal Mission for Rejuvenation and Urban Transformation. The Uttar Pradesh government has unveiled plans to launch Ghaziabad’s municipal bonds in the next three to six months, followed by a joint bond issue by Varanasi, Kanpur and Agra.
Outlook
In the past, the corporate bond market has grown at a CAGR of about 14 per cent from 2013-14 to 2019-20. However, there was demand for only top-rated bond issuances. Therefore, there is a need to diversify the investor base and encourage institutional investors to enter the market. Further, pricing of corporate bonds is benchmarked to that of government securities (G-sec) of a corresponding maturity. As a result, the absence of a continuous yield curve for G-sec and different rating and maturity buckets act as impediments. Going forward, reforms in the area of financial market unification will go a long way in propelling growth in the corporate bond market.
The smart mobility and electric vehicle market is an emerging segment gaining traction globally. There is a lot of institutional investor interest in this space as well as in renewable energy. India Inc. should leverage this opportunity and jump on to the sustainable/green bond bandwagon to finance such projects. While the government’s economic stimulus is primarily aimed at making the country self-reliant and boosting consumption demand, subsequent stimulus packages must target incorporating green policies to attract investments.