INSTITUTE OF LAW, NIRMA UNIVERSITY

VIII SEMESTERB.A.LLB (HONS.)

CHALLENGES FACED IN CORPORATE BOND MARKETS OF

INDIA

(LAW OF CORPORATE FINANCE)

Prepared & Submitted By-

ROHAN SEHGAL (18BAL050)

SHIVI SHRIVASTAVA (18BAL058)

Page | 1
Introduction

Literature Review

Objectives of this Report

Research Methodology

Research Analysis -
1) A Brief Introduction with Indian corporate debt
market.
2) Global Scenario to foster the growth of corporate
bond market.
3) Saturation of Corporate Debt Market as per
Percentage of GDPs of 2018.
4) Effects of pandemic on the corporate bond market,
leading to deterioration in market Liquidity.
5) Key developments in Indian corporate bond market
so far.
6) Issues with the Indian Corporate bond market.
7) Efforts to strength the Corporate Bond Market.
 Efforts Initiated by the government towards
growth of Corporate Bond Market.
 RBI’s role in Indian Capital Debt Market and
initiatives taken so far.
Conclusion

References

Page | 2
 INTRODUCTION

Economic growth is aided by a well-developed corporate bond market. It serves as a supplement

to the banking system, meeting the needs of the corporate sector to raise capital for long-term
investment. When the equity market is volatile, this segment is thought to provide a reliable
source of funding, as well as allowing companies to alter their asset and liability profiles to
lessen the risk of maturity. It also contributes to the system's risk diversification. The
development of a well- developed corporate bond market in India is significant in light of the
massive investment requirements for the infrastructure sector. With development financing
institutions (DFIs) playing a smaller role, a well-developed and vibrant corporate bond market
becomes even more crucial.1

Investors may be leery of the risks associated with stock, and long-term financing from banks
may not be readily available. The corporate bond market is likely to be more favourable for
businesses with longer-term cash flows. Experts suggest that India's rapid growth can be
sustained by strengthening infrastructure and growing its manufacturing base, and that a well-
developed corporate bond market may help with both. In addition, India's current five-year plan
calls for a one-trillion-dollar investment in infrastructure. The financial system, which is
dominated by banks, is unlikely to fund such a large sum; in this case, the corporate bond market
can be useful. While banks continue to have a significant position in India's economy, the
business sector is increasingly turning to international markets to raise equity, debt, and loans.
An underdeveloped corporate bond market could exacerbate this tendency, putting the external
sector at risk. Fortunately, India's corporate bond market will grow thanks to the presence of a
large private sector, deregulated interest rates, a well-developed government securities market, a
well- developed clearing and settlement system, trustworthy rating agencies, and a supportive
regulatory environment.2

Corporate bond enhances the risk pooling and risk sharing opportunities for investors and
borrowers. The development of corporate bond market has been a priority in the policy hierarchy
for the last few years Indian equities markets remained at the bottom of the global equity market
hierarchy until the mid-1990s. However, over the previous two decades, the introduction of

Page | 3
1
Sharma, V. K. and Sinha C. 2006. “The corporate debt market in India” . BIS Papers, No 26, 80-87.
2
Mukherjee, A. 2013. “Why India needs corporate bonds”, The Business Standard, January 15.

Page | 4
automated nationwide real-time trading capabilities, depository style of settlement, and a
growing investor base have resulted in significant changes in Indian equities markets. The
profound upheaval seen in the Indian equities markets, on the other hand, has not spread to the
corporate loan portion of the Indian economy. The considerable funding deficit in corporate
sectors, notably for infrastructure development, reflects the underdevelopment of the corporate
bond market, which is a critical component for maintaining and increasing overall economic
growth. Despite the fact that Indian regulators have taken many steps to revitalise the corporate
bond market, there has been little significant progress.3

LITRATURE REVIEW

(S. Raghavan, 2012) In their article, they have underlined how active, deep, and strong
corporate bond markets are, as well as the necessity of a country's financial system being stable,
reducing financial crises, and meeting the credit demands of the business sector, which are vital
for economic growth. Further defining the flaws and loopholes of the Indian corporate bond
market, according to (Acharya, 2011) in their research work, "Corporate Bond Market in India:
Concerns and Challenges," they have mentioned that for a number of reasons, including
regulatory challenges, procedural hurdles, and corporate preferences for private placements,
Indian corporate bond market is immensely underdeveloped as compared to its counterparts.

Adding to this argument (Banerji, 2012) talks about term such as intersecting rules, a lack of
benchmark yield curves, and a reduced degree of equilibrium, according to the research, are all
significant challenges in Indian markets. It also identifies a number of legislative flaws in India
that obstruct the effective operation of the bond market. Later (Mitra, 2009)compares the
formation and growth of India's corporate bond market to that of other developed and Asian
countries, it is clear that, unlike other countries, India obtains a significant portion of its
corporate finance via banks, retained earnings, and equity issuance.

In the study “Broad basing and Deepening the Bond Market in India”, (2001), Dr. Patil
opines that Indian financial system is not well-developed and diversified. He finds that one major
element that is absent in this system is a liquid, active and large debt market and the Indian debt
market is

Page | 5
3
Rajaram, S. and Ghose P. 2011. “Indian Corporate Bond Market”; CCIL Rakshitra, 5-24.

Page | 6
 overwhelmingly occupied by the debt instruments issued by government sectors (including PSUs
and financial institutions).

Raju, Bhutáni, and Sahay, 2004, in their study “Corporate Debt market in India: Key Issues
and Policy Recommendations”, emphasis on the issues such as poor-quality paper in terms of
timely payment of interest and principal, inadequate liquidity of the market, limited investor
base, regulatory arbitrage, lack of sufficient, timely and reliable information on bonds, existence
of skewed interest rate structure etc.

Banerji, Gangopadhyay, Patnaik, and Shah, 2012, in their study “New Thinking on Corporate
Bond Market in India”, find that the market gets trapped in the low-level equilibrium.

OBJECTIVES OF THE REPORT

The following are the objectives of the Study-

 Examine the evolution of India's corporate bond market, as well as the variables that influences it
and despite the country's world-class stock market, why India’s bond is market still
underdeveloped and dominated by the government bond market.
 Find out how a well-developed corporate bond market can help a country's economic
development while also being robust to shocks and financial crises.
 How it complements bank financing and play a critical role in meeting the needs of the business
sector for long-term funding as well as infrastructure development in the country, as well as
acting as a backup source of capital when the market is in turbulence.

RESEARCH METHODOLOGY

The study used an exploratory research technique. In order to research upon the topic, I have
attempted to triangulate secondary data by utilising a variety of sources including Journals, trade
magazines, and the internet which has good sources of information. In order to get access to the
latest developments in this area I have used a number of articles published in academic journals
and trade magazines. We have also used secondary information from Internet based discussion
forums. According to the objective of the study, the research design used is descriptive in nature.

Page | 7
 INDIAN CORPORATE DEBT MARKET: A BRIEF DESCRIPTION

During the initial phase of expansion of private industry in post-Independence India, mostly the
government-nurtured development financial institutions (DFIs) supplied long term finance to
private industries through various types of financial incentives and supportive measures. The
commercial banks were naturally not keen on providing such loans for fear of asset-liability
mismatch. Working capital finance, however, was provided mostly by commercial banks in a
regime of administered interest-rate with a differentiated rate structure. This pattern of financing
changed completely with the start of the deregulation process in the 1990’s. The DFIs
increasingly withdrew from project lending. Their withdrawal created a vacuum and thus the
need for opening alternative sources of term finance to industry and infrastructure development
came to the forefront.

At present, efforts are being made to fill up this vacuum by enlarging the scope of the bond
market and more particularly encouraging the growth of an active bond market. In pursuit of
overcoming the financial crisis of the early 1990s and evolving a well-functioning capital market
in the country, a number of reform measures were introduced during the last decade. These have
improved the functioning of the equity market and the market for government securities a lot.
However, these improvements notwithstanding, the equity market has not yet become attractive
to the majority of private investors because of the inherent high risk involved in equity market
investment. The debt market (even for government bonds) has also not become popular yet as a
destination of savings of individual savers either. This has been so essentially because of the
absence of an active secondary market for debt instruments, which makes investors feel that their
investment in debt is highly illiquid.

GLOBAL SCENARIO TO FOSTER THE GROWTH OF CORPORATE BOND

MARKET.

Corporate bond markets, particularly in the aftermath of the crisis, can be regarded a vital
component of economic development, financial stability, and economic recovery. They are an
important source of financing for businesses, enabling them to expand, develop, create jobs, and
provide the goods and services that society requires. Securities markets, particularly corporate

Page | 8
bond markets, have become increasingly important in supplying long-term finance, according to
supranational organisations such as the G20.4

In the business sector, debt capital is regarded to be better suited for large-scale, long-term
financing of fixed assets and investments, whereas bank loans are thought to be more suited for
financing short-term investments in working capital, inventories, and other current assets. Equity
capital is frequently more expensive than debt capital because investors expect a larger risk
premium and hence a higher return on equity than on equal debt. Despite the fact that debt
financing is a cost-effective choice, most nations lack a robust corporate bond market.5
Besidesthis investors demand a higher risk premium and hence a higher return on equity than on
identical debt, equity capital is typically more costly than debt capital. Despite the fact that debt
financing is a cost-effective option, most countries do not have a well-developed corporate bond
market.6

Saturation of the Corporate Debt Market (as a Percentage of GDP) in 2018

COUNTRIES CORPORATE BONDS TO GDP RATIO

USA 123.47
China 18.86
Japan 14.57
South Korea 77.3
Singapore 34.02
Malaysia 44.5
India 17.16
Brazil 99.05
Turkey 142.05
Source: IMF Private Debt Database and Crisil-Assocham Report (January 2018).

4
In November 2020, G20, Riyadh Summit, approved a proposal to help the development of Global corporate bond
markets under Global Financial Stability Report 2020.
5
Raghavan, S. Sahoo, A. Hait, A. and Ghosh, S., “A Study of Corporate Bond Market in India: Theoretical and
Policy Implications”, 2013, Development Research Group, Study No. 40, Department of Economic and Policy
Research, Reserve Bank of India, Mumbai.

Page | 9
Financial Market Advisory Department-International Finance Corporation, Report: "Development of Corporate
6

Debt Markets", The World Bank Group, link: www.worldbank.org

Page | 10
As provided in the table, India's corporate bond market must be enhanced, particularly in terms
of channelling funds to long-term infrastructure, which is anticipated to require approximately
US$
4.5 trillion by 2040,7 with a US$ 526 billion infrastructure investment shortfall. India’s corporate
debt-to-GDP ratio is now lower than that of other emerging nations such as Malaysia, South
Korea, Brazil, and Turkey. Furthermore, the overall volume of trading in the corporate debt
secondary market has gradually climbed, with the monthly total traded value of corporate bonds
reaching 1210 billion Rs in October 2018.India's non-financial company finance is evident in the
countries less established corporate loan industry as compared to other nations. In comparison to
other developing nations, India has a higher percentage of firms that utilise banks as their
primary source of operating capital.

AFFECTS OF PANDEMIC ON THE CORPORATE BOND MARKET, LEADING TO

DETERIORATION IN MARKET LIQUIDITY.

Financial markets throughout the world began a steep drop in early March, following an all-time
high on February 19, 2020, when the COVID-19 virus swept the globe. The stock market sell-off
swiftly expanded to a number of significant credit markets. Trading volume in the corporate
bond market increased by more than 50%, indicating a significant rise in selling pressure. As a
result, corporate bond prices began to decrease, while corporate bond interest rates—which move
in the opposite direction of prices—started to rise substantially.8

Unlike the 2008 financial crisis, the COVID-19 created anxiety beyond of the banking industry.
The March 2020 shock was unparalleled in terms of its scope, hitting every sector of the
economy and all jurisdictions. It urged policymakers to act promptly, concentrating on loosening
monetary and fiscal policies to promote demand and compensate for revenue lost as a result of
the COVID- 19 lockdowns. Following the declaration of large-scale and coordinated intervention
by the government and central banks, market trust and functionality were restored, and the most
severe market disruption lasted just a few weeks. As a result, there is still a lot of ambiguity
regarding the impact of policy intervention on market liquidity – and, eventually, the actual
economy.

Page | 11
7
RBI Bulletin, January 2019, Report: India’s Corporate Bond Market: Issues in Market Microstructure, link:
https://m.rbi.org.in/scripts/BS_ViewBulletin.aspx?Id=17995
8
Asia Bond Monitor submit under Asian Development Bank, September 2021, link:
https://www.adb.org/sites/default/files/publication/730726/asia-bond-monitor-september-2021.pdf

Page | 12
Nonetheless, the epidemic's ramifications and governments' response to it resulted in a
widespread need for liquidity and a significant disruption of the corporate bond markets during
those vital weeks.

While there were several factors that led to the unexpected lack of liquidity in the corporate bond
market in March 2020, two occurrences that happened at the same time appear to have had a
disproportionate impact. To begin with, the number of bonds sought to be sold by customers
increased considerably, indicating a rise in liquidity demand.Dealers' readiness to absorb these
bonds onto their own balance sheets dropped at the same time, indicating a reduction in liquidity.
On the supply side, the pandemic's effects on business profitability, as well as the possibility of
some corporate debt being downgraded to a riskier rating, prompted many investors to reduce
their corporate bond holdings.

Regulatory measures introduced after the financial crisis of 2007–2009, on the other hand, are
likely to have increased the cost of dealer banks keeping assets like corporate bonds on their
balance sheets. As a result, these dealer-banks were less prepared to absorb bonds for sale and
provide liquidity when the pandemic-related crisis hit last year. In truth, the dealer sector as a
whole did not absorb any of the significant selling pressure coming from the investor sector
between March 5 and March 23, when selling pressure escalated.

Key Developments in Indian corporate bond market so far-

Under the guidance of late R.H. Patil the government had formed a Committee on Corporate
Bond and Securitization with the goal of expanding India's corporate bond market, and the report
was issued in December 2005.In January 2007, the government identified the regulatory
jurisdiction of several bodies on the corporate bond market. SEBI is in charge of both the
primary and secondary markets for corporate debt (public offers and private placements by
publicly traded companies) (OTC and exchange traded).9 Corporate bond repo/reverse repo
activities are overseen by the Reserve Bank of India. According to the High-Level Committee on
Capital and Financial Markets, the RBI would oversee issuances of instruments with a duration
of less than one year, while the

9
SEBI (2016), “Working Group on development of Corporate Bond Market in
Page | 13
India”,link:https://www.sebi.gov.in/reports/rports/aug-2016/report-of-the-working-group-On-development-of-
corporate-bond-market-in-India_33004.html

Page | 14
Ministry of Corporate Affairs (MCA) would oversee unlisted securities with a maturity of more
than one year (HLCCFM).10

Despite a lengthy history, multiple committee recommendations, and continuing improvements,

the Indian corporate bond market remains modest. An illiquid secondary market, a small investor
base, a lack of instrument diversity, crowding out by large public issuance, high borrowing costs,
information asymmetry, regulatory restrictions on demand, the lack of repo options, and a well-
functioning derivatives market and credit enhancement facilities that could absorb interest and
default risks are just some of the challenges it faces.11

The corporate bond market in India has a long history of stagnation. Major corporations
benefited more from stock market liberalisation than from bond market liberalisation throughout
the period of the economy's opening up. In the 1970s and 1980s, policymakers were aware of the
debt increase. As a result, officials were indifferent about the state of the bond market. A boom
of FIIs and GDRs strengthened the stock market's dominance when the economy was liberalised.
The corporate bond market is currently underrepresented by retail investors, although this is
changing.12

INSSUES IN THE INDIAN CORPORATE BOND MARKET

Government-issued securities dominate the Indian bond market. In India, the central government
and state governments have continuously run a combined fiscal deficit of around 6%.
Governments can only borrow from domestic sources. As a result, government bonds account for
two-thirds of India's total domestic bond market.Companies from the public and private sectors,
as well as financial and non-financial organisations, are among the issuers in the corporate
sector. Access to bond markets, on the other hand, is restricted to debtors with high credit
ratings, primarily AAA and AA. Borrowers with worse credit ratings must rely on credit
from banks or non-banking

10
Khanna, V. and Varottil, U. “Developing the Market for Corporate Bonds in India”, 2012, Social Science Research
Network
11
Ministry of Finance (2020), “Economic Survey”, Government of India,
link:https://www.indiabudget.gov.in/economicsurvey/doc/echapter.pdf.
Page | 15
 See “Riskiness of credit allocation: A source of financial vulnerability” of Global financial stability report, IMF,
12

April 2018.

Page | 16
financial organisations (NBFCs). The main problem is that the Indian Bond market is a
predominantly cash market with the listed characteristics-

1. The corporate bond market of India has a short maturity profile. And the problem is that
the bonds with less than three years maturity rate suffers from inadequate liquidity.
2. A conventional credit spread curve does not exist. Due to low trading volumes and
bilateral transactions, credit spreads for corporate bonds with similar credit ratings often
differ significantly.
3. Corporate bond issuances are primarily undertaken through private placements rather
than public offerings, because the former is subject to less regulatory restrictions, lower
issuance costs, and faster turnaround times than public bond offerings.
4. Instruments with a short tenor (original maturity of less than one year) include
commercial papers (issued by corporations) and certificates of deposit (issued by banks).

EFFORTS TO STRENGTHEN THE CORPORATE BOND MARKET

It would not be wrong to say that the policymakers of India have always been concerned about
the Corporate Bond market of India.13 The lack of adequate depth and the stagnant position of
the market was always the matter of concern for the Indian Policymakers. In the month of
March, 2018, the Security and Exchange Board of India constitute a committee under the
chairmanship of Mr. H.R Khan, who is a former deputy governor of RBI to do an in-depth
study on the corporate bond market and advice some ways to solidify the same.14
Numerous panels and committee have been created in the past to examine the bond market's
flaws and recommend ways to make the market more vibrant. The H. R. Khan Committee was
the most recent to work on the issue, submitting its "Report of the Working Group on
Development of Corporate Bond Market in India" to the RBI in August 2016. The paper
outlined the steps taken by the government and/or regulators to strengthen the Indian corporate
bond market, as well as those that have yet to be done. Until now, policymakers have mostly
focused

13
Bose S. and Coondoo D., “A Study of the Indian Corporate Bond Market”, 2003, Money and Finance, ICRA,
January to March
14
S. Raghavan, D. S. (2012). Corporate Bond Market in India: Lessons from Abroad and Road Ahead. International
Page | 17
Journal of Trade, Economics and Finance , 20.

Page | 18
 on strengthening infrastructure and liberalizing laws governing bond market players and
products.15 This has helped remove several obstacles to the growth of the bond markets in the
past. The authorities have always tried to shift the excessive financing of loans from the banks
to the bond markets.
Some of the efforts and steps that have been initiated by the Government of India and the
Reserve Bank of India are-
1. In 2012, RBI introduced a web-based method for access to the Negotiated Dealing System
(NDS) auction and Negotiated Dealing System-Order Matching (NDS-OM) in order to
encourage direct participation by retail and mid-segment investors. This is an electronic
order-driven system. Users perform anonymous transactions and either place their own
orders in the system or accept orders that have already been issued by other participants.
2. In 2013, the RBI allowed short-term debt securities for corporate repo and CDS for
unlisted but rated corporate bonds for non-infrastructure offerings. In addition, the RBI
issued inflation-indexed bonds this year.
3. The Indian government announced the launch of exchange-based interest rate futures, the
separation of equity options from convertible bonds, TDS exemption for listed and demand
products, and a market-based system for classifying securities based on complexity in
2008.
The Indian capital market has played an important part in the country's economic development
throughout the years and is expected to play a greater role and remain in the limelight in the
future years as India develops toward becoming a global economic powerhouse. With consistent
efforts by the government and SEBI have allowed a budding Corporate Bond Market to flourish
over the last few years.16 In order to fill the gap in the bond market, supply-side innovations such
as asset pooling, a well-capitalized Credit Guarantee Enhancement Corporation, and widespread
adoption of the INFRA Expected Loss (EL) rating scale are some of the important tools17.

The Indian debt capital market will be able to play a stronger part in the country's growth
as a result of the following initiatives:

15
Banerji, G. P. (2012). New Thinking on Corporate bond market of India. New Delhi: National Institute of Public
Finance and policy
16
Raghavan, S. and Sarwano, D., "Development of the Corporate Bond Market in India: An Empirical and Policy
Page | 19
Analysis", 2012, International Conference on Economics and Finance Research, IPEDR , Vol. 32.
17
In the report of: The Working Group on Development of Corporate Bond Market in India, RBI-August, 2021.

Page | 20
  Encouragement and widespread adoption of the INFRA-EL rating scale, ensuring that the
scale is recognized by multiple agencies and regulatory authorities (The Insurance
Regulatory Development Authority of India has already approved investments in bonds
issued by infrastructure companies with a minimum "A" grade as legal investments.).
 Using exchange traded funds and other index-linked bond funds to attract local and
foreign capital, which provide cheaper costs, better transparency, increased liquidity, and
portfolio diversification flexibility. To attract international investors to India's debt
capital markets, ESG profiles for Indian companies are being developed.
 Increasing retail participation by offering tax benefits for debt mutual fund investments
that are equivalent to equity-linked savings plans, as well as assuring capital gains tax
parity between equity and debt securities.
 Creating the Limited Purpose Clearance Corporation for corporate bond repos and
allowing corporate bonds to be used as collateral under the Reserve Bank of India's
liquidity adjustment facility window to improve market liquidity.

CONCLUSION
The study looked at the various stages of India's corporate bond market. According to this
analysis, India's corporate bond market is not very deep. Administrative impediments, legal
concerns, and corporate preference for private placement when issuing are all impeding the
growth of India's corporate bond market. Finding strategies to make public offers more enticing
would assist to attract individual investors and alleviate the liquidity crisis in the secondary
market.18

A well-developed corporate bond market has an impact on a country's ability to withstand shocks
and financial crises, as well as its economic advancement. When the stock market is volatile, it
serves as a backup source of money, complementing bank financing and assisting the corporate
sector in meeting the country's long-term capital and infrastructure development demands. 19

Despite a lengthy history, many committee recommendations, and ongoing changes, the Indian
corporate bond market remains modest. An illiquid secondary market, a small investor base, a
lack of instrument diversity, crowding out by large public issuance, high borrowing costs,
information

Page | 21
18
Nath, Golaka C. “Indian Corporate Bonds market – An analytical perspective”, 2012, The Clearing Corporation of
India Ltd.
19
Nath, G. C. 2012. “Indian corporate bonds market–An Analytical perspective”, CCIL Rakshitra, June,7-33

Page | 22
asymmetry, regulatory restrictions on demand, the lack of repo options, and a well-functioning
derivatives market and credit enhancement facilities that can absorb interest and default risks are
among the challenges it faces.20 As a result, a thorough examination of corporate bond market
instruments, institutions, and laws is required. Many of the recent and planned steps by the RBI,
SEBI, and the Finance Ministry are beneficial in boosting India's corporate bond market,
according to the report.21

Acharya, A. (2011). Corporate Bond Market in India: Issues and Challenges. RBI Occasional Papers, Vol.32
20

Reddy, Y. V. 2002. “Developing bond markets in emerging economies Issues and Indian Experience”- Asian
21

Conference, Bangkok, March 11

Page | 23