RBI report calls for guarantee mechanism to boost bond market

“Development of a vibrant corporate bond market in India remains crucial for meeting the financing requirement of corporates and the infrastructure sector and thereby achieving India’s growth aspiration,” said the report released on Friday.

This even as a specialised lending institution for infrastructure is coming up. The new institution should do the right balancing act of making profits and meeting social needs, it said.

The report was prepared by the RBI’s research team and its recommendations should not be construed as those of RBI.

Foreign portfolio investor (FPI) investment limits are underutilised due to liquidity considerations, the report said.

The proposed institutional framework to provide liquidity to mutual funds and other participating institutional investors in the corporate bond market, particularly during times of stress, may instil confidence among market participants, it added.

Overseas investors used up about 30% of their total limits in government bonds, as per data from Clearing Corporation of India. Cumulative limits are pegged at Rs 4.87 lakh crore across central and state government bonds. In corporate bonds, they have used up about 19% of the total limit at over Rs 6.37 lakh crore, according to data from National Securities Depository Ltd (NSDL).

“A credit enhancement mechanism offering partial or full guarantee on corporate bonds can also help in moderating the risk perception of infrastructure projects to levels compatible with risk appetite of investors and attract greater fund flows,” the report said.

In the secondary bond market, mutual funds are the only major active players, contributing around 40% of the trading volumes. While institutional investors like insurance companies, pension funds and provident funds are typically allowed to invest in high-rated papers only, retail participation in the bond market is also limited in India. This needs to be enhanced, the report said.

The recent credit default swaps (CDS) directions issued by the Reserve Bank are expected to go a long way in developing the corporate bond market, especially the lower rated bonds, and pave the way for more and better resource allocation in long-term loan markets.

In the aftermath of the Covid-19 pandemic, yields on corporate bonds fell to their lowest levels since 2004. The risk premium or spread on AAA-rated three-year bonds (over 3-year G-sec) decreased to 23 basis points from 122 bps for public sector undertakings, financial institutions and banks. A basis point is 0.01 percentage point.