India’s Growing Fixed Income Market

The Indian debt market has grown to USD 1.5 trillion over the past decade, largely due to the issuances from the central and state government. The ratio of government securities to corporate issuances is about 75 to 25, reflecting the subdued state of corporate bond markets in India. With a lack of participation, the Indian debt market remains smaller than the equity market—an anomaly among other global markets. Most corporates in India tend to fund themselves through bank borrowings, and, with lax controls and tortuous legal processes, this has led to underperforming assets in bank balance sheets, putting the stability of the Indian banking structure at considerable risk. Pushing corporates to fund themselves will encourage more accountability, responsibility, and a healthier means of financing.

Indian investors with rich equity returns, high interest rates, and booming property prices haven’t ventured to the fixed income market due to a lack of understanding, access, and liquidity. Due to caps on the amount of foreign fund flows permissible into the sovereign and corporate Indian rupee-denominated securities, these have been limited too. While caps have incrementally risen recently, these haven’t been enough to include Indian bonds in global emerging market fixed income indices. In 2016, some impetus was given when the Reserve Bank of India allowed banks to use their corporate bond holdings as collateral against their overnight repo credit facility and corporates to issue Indian-rupee-denominated bonds in offshore markets. Still, with a GDP to corporate bond ratio of about 20%, one of the lowest in the world, an urgent need is felt to stimulate the demand and supply of corporate issuances.

Most of India’s debt market remains outside the reach of domestic investors due to its illiquid nature and large issuance size. Even institutional investors in India tend to buy sovereign issuances and rarely follow the “mark to market” policy as practiced by investors globally. The illiquidity of the fixed income space was a theme even in developed markets, but, about a decade ago, the concept of fixed income ETFs gained traction and is now a booming concept in most developed markets.

Bond ETFs can bring liquidity and accessibility to markets with inherent opacity due to lack of exchange trading on the underlying securities. Indices standardize and democratize an investment space, consolidating the information in a consistent, transparent manner. When buying a bond, investors may be forced to hold to maturity. Bond ETFs predefine the term of the bonds to be held, and maintain a consistent, fixed-term range. New bonds are constantly bought and old ones sold to maintain this consistency and give investors access to a diversified, continuously renewed portfolio. Even if an underlying bond is illiquid, the bond ETF remains liquid. Over the past decade, the U.S. bond ETF AUM have grown to USD 600 billion and are growing faster than equity ETFs.

In order to kick start the corporate Indian debt market, the government is thinking of working with an asset manager to launch a bond ETF with securities from corporates, in which the government has large stakes. Similar to the S&P BSE Bharat 22 Index and S&P BSE CPSE, a cycle of corporate issuances can be used to constantly feed the ETF. This has several advantages. Corporate bonds can be sold more effectively, with a wider reach than single issuances. Domestic liquidity can be created in the market with involvement from institutional investors. Finally, corporates can create a regular cycle of issuances with a consistent stream of funding.

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