The current optimism in the debt capital market was hardly expected given the fact that the financial year started with various uncertainties. The scenario would have been really tough for debt market, but for the various regulatory announcements. The beginning of the financial year saw a sharp risk aversion to corporate bonds that was reflected in widening of credit spreads on the back of demand for moratorium on servicing of bonds similar to bank loans, resulting in uncertainty on underlying asset quality. The winding up of few debt schemes by a mutual fund house meant that the debt capital market was heading for tough times over the next few months.
However, positives like the improvement in economic activities post the lifting of lockdown restrictions, various measures taken by the government and the Reserve Bank of India (RBI) to keep interest rates soft and ensure ample liquidity in the system have improved sentiments and resulted in high issuances of bonds over the last few quarters.
In fact, the total bond issuance in H1 FY2021 increased 75 per cent over the corresponding period last year. Though bond issuance volumes during Q1 FY2021 were supported by Targeted Long-Term Repo operations (TLTRO), which provided low-cost funding to banks for buying corporate bonds from primary and secondary markets, strong issuance volumes of Q2 FY2021 reflect improved investor appetite in general. The overall corporate bonds outstanding as on Sep 2020 at Rs 34.1 lakh crore accounts for about 33 per cent of the systemic bank credit as compared to about 24 per cent in Sep 2010.
With a sustained improvement in collections reported in September and October 2020 by various lenders, we can expect an increase in disbursements volumes in the second half, if the collection trend continues. Further, with some of the stronger financial services entities already reporting disbursements volumes at close to pre-covid levels, any revision in growth estimates can help sustain bond issuance volumes in the second half as well.
While these positives create a near-term optimism, continued regulatory reforms undertaken during the last few months could lead to further development of bond markets, as it is believed to be a panacea for the improvement of the credit markets. The recent circular from Securities and Exchange Board of India (SEBI) for creation of security against corporate bonds and due diligence of such securities by debenture trustee for sufficiency of such assets to service the obligations is another positive step to protect the rights of investors.
After a few quarters of outflows, net inflows have started again in debt mutual funds. This bodes good for the market as MFs are active participants in the bond markets with 17-18 per cent of bond volume outstanding held by them. The recent episode of winding up of a few debt schemes by a fund house shows the relative lack of depth and illiquidity in our corporate bond markets. Such an illiquidity in secondary markets and open-ended nature of debt schemes creates its own challenges.
SEBI’s proposal to create a back-stop facility to purchase such illiquid investment grade bonds could be a step in the right direction to improve liquidity in such corporate bonds. In addition, the proposal to have a framework for stress-testing methodology for open-ended debt schemes, which could necessitate higher holding of liquid securities by open-ended funds, can improve investors confidence and bring in a sustainable growth in AUMs of debt MFs.
In the meanwhile, with a growth of 75 per cent we expect fresh bond issuances to rise to Rs 8.0-8.2 trillion during this fiscal, as compared to FY 2020’s Rs 6.55 trillion. With an estimated redemption of Rs 4.95 trillion in FY 2021, the volume of corporate bonds outstanding is estimated to rise to Rs 35.5-35.8 trillion, translating in a YoY growth of 9.2-10 per cent for FY 2021.
Buoyed by regulatory measures and surplus liquidity, not only the yield on corporate bonds have declined, but the spread on corporate bonds over government securities (G-sec) of similar tenures has also declined to pre-Covid levels during Q2 FY2021. For example, a 3-year AAA rated corporate bond yielded 5.31 per cent (36 bps over G-sec) in September 2020 as compared to 6.48 per cent (64 bps over G-sec) in February 2020. Similarly, a 3-year AA rated corporate bond yielded 6.13 per cent (117 bps over G-sec) in September 2020, as compared to 7.17 per cent (133 bps over G-sec) in February 2020.
Certainty on funding availability at competitive rates has improved. Spreads have now declined to levels below the daily average for the last five years and hence, the scope of further decline, if any, remains limited. However, lower investor risk aversion and cheaper cost of funding could mean improved certainty of funding and hence, lower need for maintaining a high on-balance sheet liquidity as was witnessed during H1 FY2021 amid the uncertain funding environment.
(The author is Senior Vice President, Financial Sector Ratings, ICRA Ltd. Views are his own)