A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it needs and in return the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate. When the bond expires, or “reaches maturity,” the payments cease and the original investment is returned.

The backing for the bond is generally the ability of the company to repay, which depends on its prospects for future revenues and profitability. In some cases, the company’s physical assets may be used as collateral.

Why the corporate bond market is small in India

• The Indian corporate bond market has remained small in size despite a long history, several committee recommendations, and continuous reforms.
• It is besieged by several problems ranging from illiquid secondary market, narrow investor base, lack of diversity of instruments, crowding out by large public issuance of G-Secs, high costs of borrowing, information asymmetry, regulatory restrictions on demand, unavailability of repo options, to absence of well-functioning derivatives market and credit enhancement facilities that could absorb interest and default risks.

Relevance of corporate bond market is  small in India

• According to Crisil, outstanding corporate bond market in India is expected to double and reach ₹65-70 lakh crore by 2025. Given the vacuum created by erstwhile development finance institutions (DFIs) such as ICICI and IDBI in the long-term corporate credit market, the government’s thrust on infrastructure financing to boost economic growth, and recent improvement in India’s ease of doing business, the time is ripe for developing a deep, liquid and vibrant corporate bond market.
• Further, the Indian bond market has been dominated by sovereign bonds and the corporate bond market has a smaller share (27 per cent ) during the last decade. This calls for a power shift since an efficient corporate bond market complements a sound banking system and provides an alternative source of finance to the real sector, diversifies risks (mitigating asset-liability mismatches), and reduces financial sector fragility.
• They are a major source of capital for many businesses, along with equity, bank loans, and lines of credit. They often are issued to provide the ready cash for a particular project the company wants to undertake. Debt financing is sometimes preferable to issuing stock (equity financing) because it is typically cheaper for the borrowing firm and does not entail giving up any ownership stake or control in the company.
• Globally, corporate bond markets witness higher trading volumes and liquidity because there are enough market participants even for low rated bonds. The bulk of infrastructure projects and long-term investments are financed through these markets. However, in India, the lack of well-developed bond markets put the pressure of financing investments on India’s banking system or government expenditure. This pressure on banks is problematic as financing long-term investments creates an asset-liability mismatch.

Measures

• Financial literacy and education: According a survey conducted by Standard & Poor’s in 2015, over 76 per cent of adults in India do not even understand the basic financial concepts like interest rate, inflation, and exchange rate. Though some of the people are financially literate, they are not necessarily digitally savvy. Therefore, audio-visual contents/booklets may be developed as part of the digital/financial literacy drive, which will be a prerequisite for development of corporate bond market in India.
• Incentives for retail investors: Indian corporate bond market is dominated by a few institutional investors and professional fund managers. Further, it is mainly concentrated in financial services sector (72.1 per cent) rather than manufacturing sector. Hence, the government may think of tax incentives to channelise household savings into financial assets such as corporate bonds from real estate and gold.
• ESG framework: Corporates following the ESG (Environmental, Social, Governance) framework may have greater strategic freedom and will be the primary choice of market-savvy investors. Corporate bond market will get a fillip if ESG compliance is promoted by the policy makers. According to Crisil, ‘AAA’ rated companies in India constitute just 0.85 per cent of the market, the lowest among the emerging economies.
• Credit guarantee enhancement: As on date, credit guarantee fund scheme exists for MSMEs (Micro Small & Medium Enterprises) to extend collateral-free credit. Similarly, the government may think of credit guarantee enhancement for corporate bonds through creation of an earmarked fund by collecting cess from the cash-rich companies. Besides, market for credit default swaps needs to be developed.
• Maintaining price stability: The government’s massive public debt needs to be gradually downsized for effective transmission of monetary policy in order to crowd in private investment. This will reduce inflation, and the cost of borrowing of the corporates, and lead to higher real returns to the investors.
• Enhancing liquidity: Over 90 per cent of the trading in the secondary market takes place in respect of the corporate bonds with ‘AA’ rating and above. Also, insurance and pension funds hold the bonds till maturity. As a result, the market is shallow, with the absence of market makers, lack of liquidity, and consequent pricing anomalies. Therefore, tri-party repo market may be developed for corporate bonds to provide liquidity for the participants in the market. The regulators may act in unison to allow ‘A’ rated corporate bonds as collateral to expand the universe of issuers and expand the investor base.
• Functional autonomy: Stakeholders such as independent directors, and credit rating agencies should have functional independence to improve corporate governance, accounting as well as auditing standards, financial reporting systems, and legal protection; this will certainly boost the investors’ confidence and attract more participation.

Further, a dedicated corporate bond index enables real time monitoring of the market and fosters price discovery, thereby increasing investor’s buoyancy. Since India is being considered as a new manufacturing hub of the world, a deep, liquid and vibrant corporate bond market is the need of the hour.

How to structure:

1. Give an intro on what corporate bond market is
2. Write the importance of it
3. Suggest measures to develop it, mention any related schemes, initiatives, associated governing body etc.
4. Mention any associated challenges as a side note.
5. Conclude

Reference:

1. https://www.thehindubusinessline.com/opinion/we-need-a-vibrant-corporate-bond-market/article37403478.ece