By Raghav Saraogi
Eight years have passed since the 2008 financial crisis and the United States is finally showing signs of recovery. Unemployment is down and job creation is growing. With the Federal Reserve rising interest rates in December, the US is attracting foreign capital quickly.
However, there is still a chance for Indian markets to attract global investors.
Unlike most other major economies, India is on a high-growth trajectory. Capital that is seeking riskier investments for higher returns, is actively looking for better risk-reward opportunities.
India offers riskier markets than the West (and hence greater returns) but as the European Central Bank (ECB) and the Fed slowly normalize (tighten) monetary policy, Indian markets will be faced with tough competition overseas.The Indian economy and government debt. | Photo Courtesy: India City Blog
The Indian economy relies on government debt
One way that Indian firms and the Government of India (GoI) can attract foreign capital more effectively is through the development of the bond market. Bonds can offer a useful set of securities for investors and allow them to diversify their portfolio of investments in India.
[su_pullquote]Corporate debt markets provide an extensive set of investing opportunities, with a host of debt instruments (bonds and bond derivatives), offering exposure to the Indian economy.[/su_pullquote]
The Government Securities (G-secs) market is fairly developed; about 75% of the Indian market is Government-issued debt. This is unusual. For most other major debt markets, the corporate debt (company issued bonds) portion of it plays a much larger role. Corporate debt markets provide an extensive set of investing opportunities, with a host of debt instruments (bonds and bond derivatives), offering exposure to the Indian economy. Debt markets traditionally offer a less-risky investment than stocks (equity).
Currently, it is mostly only large Indian banks and the government that issue tradable bonds in the market. Most other entities use private placements (loans from banks) as debt. India lacks a centralized database for information about tradable bonds and a functional trading platform. There are inconsistencies in how bond prices and yields are calculated and listed.
Corporate bonds are the key
The most important piece of the need for a better developed bond market in India is access to capital for more firms. Currently only the top-rated borrowers have access to the corporate bond market. Further, banking and financial services account for 74% of primary bond issues in the country.
Hence a more developed, unregulated bond market might allow more firms access to cheaper or more efficient debt capital, through a higher risk-taking culture among investors.
On the policy side, Raghuram Rajan, the previous RBI Governor, mentioned that bank lending rates are inefficient in passing through changes in the interest rate by the central bank. He has also said that markets reflect interest rate changes more efficiently. Further reforms from the central bank are required if more firms are to gain access to the bond market. This comes at a time when the independence of the RBI is constantly questioned in the light of demonetisation in 2016. The government may attempt to protect the traditional public sector banks and hence private debt markets.Raghuram Rajan, previous RBI governor. | Photo Courtesy: Quartz
It is important to remember that 95% of debt in India are bank loans. Thus, there is a dire need for a more efficient credit market to pass through shifts in monetary policy. This becomes particularly important for infrastructure projects. If they can get access to cheaper capital at interest rates that better reflect monetary policy through tradable bonds, then they might not choose to get bank loans to finance projects. And when infrastructure projects can be financed more efficiently using publicly traded bonds, more of them are executed.
A whole new asset class
[su_pullquote align=”right”]Thus, there is a dire need for a more efficient credit market to pass through shifts in monetary policy.[/su_pullquote]
Developed bond markets will create a new asset class in India that attracts foreign capital. It will be an efficient allocator of capital and will bring more firms into the market. To realize these benefits, the RBI took an important step in August 2016 to liberalize bond markets by allowing banks to raise capital through rupee-denominated bonds (Masala Bonds) in foreign markets.
It also allowed both resident and non-resident Indians to maintain big open positions in the bond market. This step will expand the investor base and hence the capital inflow into the economy. With more deposits in banks today than ever before, there is a lot more money available to facilitate this move. And for you, it’s a chance to earn high returns on otherwise immobilized money.
Featured Image Courtesy: Benzinga
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