Corporate Bond Market: Enhancing Liquidity in India and the Opportunity

A well-developed corporate bond market is essential for the efficiency and stability of a country’s financial system and the overall growth of the economy.

The size of the corporate bond market stands at 16% of the GDP of the country today, as against 75% for a developed market like Korea. The number for the US would be closer to 160% (as a % of the GDP), however, to benchmark it to a mature market like the US, is not the objective today.

Building a debt exposure in one’s portfolio is an extremely significant portion of every investor today. However, most of the exposure in an investor’s portfolio in debt comes from bank FDs vis-à-vis corporate bonds. This is primarily because of two reasons

1. Most of the issuances (more than 90% of the issuances) are with a face value of 10L, which means the issuances are private placements and open to HNIs
2. Understanding the market and transparency in the market continues to remain low.

The taxation under the new regime with the surcharges have made it suboptimal to take credit risk at 10-11% YTM (pre-tax) as they would amount to a post-tax return of 6.2% (at the upper end).

As against this, we have tax-frees trading at 5.7-5.8% YTM for similar or lower durations. As an investor, it is sub-optimal to go down the credit curve for a 40 bps pick up.

Over the last 5 years, the demand growth from the investor base has predominantly come from Mutual funds, where the AUM has grown by a CAGR of 27% over the period. As against this, banks/treasury desks alongside insurance/pension funds have seen a CAGR of 11% over the same period as an investor base.

While mutual funds continue to be an efficient way to access the debt market from a tax efficiency structure, the recent fiasco which has lasted over a period of 1.5 years around credit defaults, markdown in NAV, side pocketing of funds, have dented the confidence of the investors. More importantly, investors are looking at possible customization in the risk they want to own as a part of their debt portfolios eg: While an investor, may potentially be happy to own IndusInd bank bonds, he would not want to own Yes bank as a part of the same portfolio, and the flexibility to build portfolios or buy bonds is non-existent today in the market.

Effectively from the government’s perspective, it gives them an opportune time to look at taxation on corporate bonds, to make it more investor-friendly, in line with mutual funds. Considering the bond market is growing ( and is currently 2x the size of the Mutual fund market), it’s important to make investing in the bond market more efficient, to improve liquidity in the market.

Secondly, this also creates an opportunity to build an infrastructure layer that wraps around the existing exchange, to promote transparency around bond risk, analytics, pricing that makes data around bonds more democratized and easily available in the hands of advisors, wealth management firms and the end investors.

As an investor, building an asset allocation through corporate bonds is an extremely important part of the portfolio construction process to build diversification. As the bond market continues to grow in the country, it’s imperative that we look at creating ways to simplify access to this asset class and make it efficient from a taxation perspective for increasing the user base.

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