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Corporate debt: Coming of age - Views on News from Equitymaster
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  • Apr 4, 2007

    Corporate debt: Coming of age

    Recently a leading business daily in India published the news about Reserve Bank of India (RBI) working on a framework to enhance liquidity in corporate debt markets by allowing subscribers of these instruments to raise short-term finance against them in the secondary markets. The government is also making efforts to develop a single unified exchange traded market for such debt. This is to improve the attractiveness of corporate debt in a market constrained by lack of liquidity.

    Once a corporate house has reached a certain level of credibility it usually resorts to the non-banking financial markets (via ECB, FCCB, CP, Corporate bonds etc) as the process of raising such loans is faster and also cheaper (owing to the company's credibility). At the same time the tenure of such instruments is generally longer than bank credit and helps the borrower stabilize his borrowing costs.

    Indian corporate debt market
    Savings of Indian households have long been invested in the corporate debt markets indirectly. Due to lack of a secondary market for these securities and the large denominations in which such debt is usually issued, companies have not seen too much of retail participation. Lately the environment for corporate debt market in India has turned favourable with reforms in the financial sector. The tax structure of companies also favours use of debt on books, reducing tax liabilities and helping to enhance the shareholders wealth. Depth of the Indian corporate market has increased over the last nine years with volume of trade going up 32% pa. (See adjoining graph.)

    New markets, newer instruments The years have seen a surge in not just in the volumes but also in the number of offerings from the corporates. Various instruments have been designed and launched in the markets to cater to the varying needs of the corporate sector as also the investors. A company that expects the interest rates to go down over the period of time can issue a floating rate note which links the coupon rate to some underlying benchmark (like the yield on ten-year government bond, Prime Lending Rate of banks etc).

    A zero coupon bond is issued at a discount to its face value. This allows companies to raise money without straining their cash flow positions in the interim as it is required to make one lump sum payment at maturity. It also benefits the investor by allowing him to lock in at an interest rate and give him some control over the interest rate on his investments that will not change according to the future changes in market interest rates.

    Debentures, the most common form of corporate debt in India in the past, can be designed to suit the needs of maturity (short term or long term) or security of asset (secured or unsecured) or debentures allowing equity participation at a future date (fully convertible, partly convertible or non convertible debentures) etc.

    Benefits of debt market
    For the Indian households, jaded with bank and postal deposits, investment in corporate debt gives them better returns. They can assess the risk attached to the paper thanks to the compulsory credit rating requirements for all issuance. They can also tailor their investment strategies better with the availability of varied number of instruments depending upon individual risk-return preferences. Thus though conventional time deposits with banks yet retain their flavour, quality debt papers from the Indian corporate sector are also gaining a wider acceptance amongst the investors.

    For companies, issue of corporate debt is also advantageous. They are able to bypass the intermediation agencies (like banks) and raise more inexpensive money. Even though there have to be brokers and underwriters to manage the issue, their services cost is lower due to intense competition amongst these agencies. And in times of credit crunch as is happening now, corporate debt provides with an alternative source of finance.

    Credit rating
    It is mandatory for all companies raising debt to get their instruments rated by the Indian rating agencies and also publish the same (i.e. its 'rating grade') at the time of raising the funds. This helps stratification of corporate debt papers based on various rating criteria. As credit rating has been a part of Indian corporate life for the last ten or more years, all the processes are in place for a quick start to an up and running debt market.

    A repo means an instrument for lending funds by purchasing securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price, which includes interest for the funds lent. If the RBI allows for repo on corporate paper it will increase the attractiveness of the corporate debt markets as it will have a secondary market where the investor can exit the paper before maturity to meet his financial needs. This will also benefit the companies, as they will (on development of a secondary market) now be able to raise finance from the open market at more favourable terms.



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