A solution for developing the corporate debt market can be found by weaving the fabric from the end of the household. Household financial savings are around 10% of GDP, and valued at about 10 lakh crore.
Of this, around 90% are concentrated in bank deposits, insurance and provident funds. If the corporate debt market is to appeal to this segment, which will be on the buy side, products have to be recreated that mimic the attributes of these products. This can be the clue to the growth of the debt market.
These three preferred products have characteristics of capital protection, return, liquidity and tax benefits, with insurance products also having added life protection. Bank deposits offer capital protection, fair taxable return, liquidity and very limited tax benefit for long tenures only.
Insurance offers relatively lower return, involves deferred payments; have restricted liquidity, but offer tax-free returns in general with initial investment also qualifying for tax deduction. Provident funds offer good returns, low liquidity, all encompassing tax benefits and full protection. If a corporate bond can address at least 3 of these 4 attributes, a beginning can be made.
So, what should be done? First, the returns need to be competitive to bring about migration of savings. Therefore, the interest rate offered should be between the base rate and the rate charged by banks from the company.
Second, for capital protection, credit rating becomes very important so that investors know how good their investment is. Further, a back-to-back credit default swap should be part of the process wherein insurance is provided by a third party.
This can be a bank or financial institution. By having such a link, we will not just provide protection to the investor, but also take steps in reviving the CDS market, which was introduced with much fanfare, but did not quite move ahead.
Third, to tackle liquidity, two routes have to be followed. First, companies should float paper with different tenures so that there is an array of corporate paper ranging from 1 month to 5 or 10 years so that we are able to replicate the nominal yield curve on bank deposits.
Here companies substitute bank borrowing with corporate debt which is offered to the public. Second, to make them liquid there should be institutions that will necessarily buy back the security, albeit, at a discount - just like how a bank cuts the interest rate for pre-maturity withdrawals.
Hence, there is need to have market makers, which can be any bank or financial institution, including primary dealers.Fourth, the government has to play an active part in providing tax benefits on these bonds. If public sector entities are able to raise tax free bonds, why not private sector companies?
To begin with, it could be provided for higher rated long-term bonds with maturity of 10 years or more. This will appeal to the person who is investing in provident funds and insurance.
In fact, if funds move over from small savings to the corporate debt market, the government would also be better off as presently the cost of market borrowings is lower than that of these small savings.
But governments have to pick up small savings which come in exogenously. The rationale for giving tax breaks is that if funds are long term and are being used for creating capital and not financing working capital requirements, then there must be parity with public sector bonds.
By bringing about these changes, which only require regulatory support, households can be enthused to enter this segment, which, in turn, will help to develop the secondary market gradually. The question then is whether companies are willing to go in for such issuances given the plethora of clearances involved.
Here the clue is to reduce these costs and provide blanket clearances at the beginning of the year for a target amount. To provide an icing to these bonds, the better-rated bonds should be given SLR status so that banks find them attractive to hold - there has to be a buy-in from the RBI, which has hitherto opposed this move.
By having the backup of a mandatory CDS, a credit enhancement would be provided to the instrument. This will be also be useful for mark to market (MTM) purpose for the market makers, where such bonds are marked to equivalent government yields.
Given that globally corporate debt markets are dominant, we need to make them attractive. Banks will still have their own issues of MTM (if treated differently from GSecs) and preference for cash and collateral backed credit, which the company is comfortable with.
But given that the households can provide interest for such debt, the system should make it easier for the company and attractive for the individual, which is possible by tweaking regulation. This can initiate a virtuous cycle.
Of this, around 90% are concentrated in bank deposits, insurance and provident funds. If the corporate debt market is to appeal to this segment, which will be on the buy side, products have to be recreated that mimic the attributes of these products. This can be the clue to the growth of the debt market.
These three preferred products have characteristics of capital protection, return, liquidity and tax benefits, with insurance products also having added life protection. Bank deposits offer capital protection, fair taxable return, liquidity and very limited tax benefit for long tenures only.
Insurance offers relatively lower return, involves deferred payments; have restricted liquidity, but offer tax-free returns in general with initial investment also qualifying for tax deduction. Provident funds offer good returns, low liquidity, all encompassing tax benefits and full protection. If a corporate bond can address at least 3 of these 4 attributes, a beginning can be made.
So, what should be done? First, the returns need to be competitive to bring about migration of savings. Therefore, the interest rate offered should be between the base rate and the rate charged by banks from the company.
Second, for capital protection, credit rating becomes very important so that investors know how good their investment is. Further, a back-to-back credit default swap should be part of the process wherein insurance is provided by a third party.
This can be a bank or financial institution. By having such a link, we will not just provide protection to the investor, but also take steps in reviving the CDS market, which was introduced with much fanfare, but did not quite move ahead.
Third, to tackle liquidity, two routes have to be followed. First, companies should float paper with different tenures so that there is an array of corporate paper ranging from 1 month to 5 or 10 years so that we are able to replicate the nominal yield curve on bank deposits.
Here companies substitute bank borrowing with corporate debt which is offered to the public. Second, to make them liquid there should be institutions that will necessarily buy back the security, albeit, at a discount - just like how a bank cuts the interest rate for pre-maturity withdrawals.
Hence, there is need to have market makers, which can be any bank or financial institution, including primary dealers.Fourth, the government has to play an active part in providing tax benefits on these bonds. If public sector entities are able to raise tax free bonds, why not private sector companies?
To begin with, it could be provided for higher rated long-term bonds with maturity of 10 years or more. This will appeal to the person who is investing in provident funds and insurance.
In fact, if funds move over from small savings to the corporate debt market, the government would also be better off as presently the cost of market borrowings is lower than that of these small savings.
But governments have to pick up small savings which come in exogenously. The rationale for giving tax breaks is that if funds are long term and are being used for creating capital and not financing working capital requirements, then there must be parity with public sector bonds.
By bringing about these changes, which only require regulatory support, households can be enthused to enter this segment, which, in turn, will help to develop the secondary market gradually. The question then is whether companies are willing to go in for such issuances given the plethora of clearances involved.
Here the clue is to reduce these costs and provide blanket clearances at the beginning of the year for a target amount. To provide an icing to these bonds, the better-rated bonds should be given SLR status so that banks find them attractive to hold - there has to be a buy-in from the RBI, which has hitherto opposed this move.
By having the backup of a mandatory CDS, a credit enhancement would be provided to the instrument. This will be also be useful for mark to market (MTM) purpose for the market makers, where such bonds are marked to equivalent government yields.
Given that globally corporate debt markets are dominant, we need to make them attractive. Banks will still have their own issues of MTM (if treated differently from GSecs) and preference for cash and collateral backed credit, which the company is comfortable with.
But given that the households can provide interest for such debt, the system should make it easier for the company and attractive for the individual, which is possible by tweaking regulation. This can initiate a virtuous cycle.
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