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For many
years now, Indian policymakers have made platitudinous
comments about the need to develop a genuine market for
corporate bonds in the country. Somehow, they never seem
to get around to doing it.
The
reluctance is neither entirely the result of
bureaucratic apathy, nor is it completely irrational.
It’s
rooted in two beliefs.
The
first assumption is that the Indian government, which
doesn’t borrow overseas from commercial lenders, must
always have the first claim on domestic savings.
Allowing
nonstate borrowers to tap the same pool of money will
leave less for the government, forcing it to pare social
spending; the poor will suffer.
And what
about expanding capital availability with a little
sharing of credit risk with foreigners?
That’s
where the second supposition comes in.
The
monetary authority needs to manage the exchange rate.
For it to do that—and still have any hope of controlling
inflation—the central bank must exercise control over
capital inflows and outflows. And that objective is
greatly helped by keeping foreigners out of Indian debt
altogether.
That’s
how the reasoning goes.
There
is, however, one big obstacle.
“We’re a
capital-starved country and we want to grow,” says Vipul
Dalal, who heads Indian broking operations at Elara
Capital Plc., a London- and Mumbai-based investment
bank.
Financing growth
In the
absence of a large local bond market, India has sought
to address the challenge of financing growth by allowing
local companies to borrow overseas, nudging them to take
on currency risk that at least the smaller corporate
treasurer in India doesn’t know how to properly hedge.
Why
should foreigners be prevented from freely holding
Indian debt, arresting the development of a local bond
market, while Indian companies are permitted to borrow
overseas?
That’s
simple enough to answer: The latter source is easy to
turn off when inflows get large.
That’s
precisely what was done in August last year when any
Indian company borrowing more than $20 million overseas
was ordered to keep the money abroad; anyone borrowing
less than that and seeking to bring the money into India
was asked to seek permission from the central bank.
Indian
companies raised only $420 million of overseas debt in
February, compared with a monthly average of $2.5
billion in the year through July 2007, before the
restrictions took effect. Moreover, very little of the
capital borrowed overseas nowadays is for local use.
Flows
curbed
“How is
our economy going to grow 9 percent or 10 percent a year
without capital?” Dalal asks.
Just
this week, a committee on financial-sector development
headed by University of Chicago economist Raghuram Rajan
recommended that
India
“steadily open up investment in the rupee corporate and
government bond markets to foreign investors.” This
suggestion, if accepted, will free up a part of domestic
savings from the tyranny of preemption by the state.
Besides,
allowing foreigners into the Indian bond market will
widen the extremely narrow base of investors.
According to Jayesh Mehta, head of the institutional
clients group at DSP Merrill Lynch Ltd. in Mumbai, fewer
than 20 investors account for 80 percent of the market.
That includes 10 banks, one state-owned insurance
company and a government-controlled provident fund.
Widening
investor base
Foreign
investors’ total participation is capped at $4.7
billion—including just $1.5 billion for corporate
bonds—by government diktat.
In the
absence of investors, “adding to the number of
intermediaries isn’t going to change the market,” Mehta
says.
Mehta
has some simple ideas on getting foreigners to
participate in the Indian corporate-debt market without
much of a risk of large capital outflows or inflows.
One such
strategy, he says, could be to allow local debt
investors to buy credit-default swaps for Indian
companies (whose bonds the investors own) from offshore
counterparties. A credit- default swap, or CDS, is a
debt investor’s insurance against nonrepayment.
“Allowing credit-default swaps with offshore
counterparties will not result in large net flows,”
Mehta says.
Once
Indian investors have effectively transferred credit
risk to overseas buyers, the capital they have had to
set aside for prudential reasons will be free to buy new
debt. The domestic bond market will grow.
This is
an awfully bad time to be championing either more
liberal transnational capital flows or greater access
for banks to credit derivatives. And yet, the
combination may help in kick-starting the corporate-bond
market in India.
Fixing
legal loopholes
It won’t
be enough, though.
There’s
much work to be done in fixing ambiguous laws on
creditor protection, including—believe it or not—coming
up with a definition for a corporate bond.
“Capital
controls in
India
have come on top of domestic distortions,” says K.P.
Krishnan, a joint secretary in the Indian Finance
Ministry’s department of economic affairs. “We don’t
have a specific definition of a corporate bond.”
Besides,
the legal process is slow in enforcing the rights of
unsecured creditors, and recovery rates are small.
Even
with all this, foreigners want in; and India is keeping
them out. That must change, and soon. |
