Category: Your Money

Indian Corporate Bond Market – Waiting for Godot?

Corporate bonds, as a percentage of India’s GDP, are at an abysmal low. This is in stark contrast to the equities market which has seen tremendous growth over the last few decades. Corporate bonds in India add a mere 5.48% to GDP versus USA (90.27%), Japan (37%) and China (24.05%).

bonds
Source: BIS Quarterly Review and IMF World Economic Outlook Database

Growth of the corporate bond market is vital as it creates low cost investment opportunities for businesses apart from banks, and offers yield premium opportunities for investors. Did you know that the National Stock Exchange (NSE) was originally set up to facilitate bond trading? The picture today belies the fact.

How did this happen?

Corporate bond market in India – The premise

The bond market segment in the country predominantly consists of government securities. Corporate bonds capture a small slice of 4.74% of the debt market. YoY growth in corporate bonds is also slow – only 19% versus 90% in Treasury bills. Also, the existing corporate bond market in India is largely driven by banks and other financial institutions rather than infrastructure companies or the manufacturing sector (considered indicators of infrastructural growth in the country). The lack of participation has dampened corporate interest and media attention in corporate bonds, making bank loans the primary source of debt capital. This lack of liquidity also forces corporate borrowers to prefer private placements over public issues for bonds.

bonds as a percentage of gdp

Lastly, the RBI controls most of the bond market and is not in any hurry to loosen its control. Interestingly, there has never been a dearth of corporate bond buyers with foreign investors more than willing to put in their money into creditable bonds. There just hasn’t been much for them to buy.

Challenges facing the corporate bond market

Infrastructural improvements made to facilitate the equity market are conspicuously absent in the debt market space that has to contend with:

  • Reduced incentive of Indian banks as the statutory lending ratio of 23% requires them to put roughly a quarter of their deposits into government bonds
  • Illiquid securities
  • Low investor awareness
  • Lack of transparency – no live trading market or access to live pricing
  • Resistance from bond houses and debt arrangers

The future of corporate bonds

In February, Reliance Industries Limited [stockquote]RELIANCE[/stockquote] raised $800m via perpetual bonds from investors abroad at a coupon rate of 5.875% – a first strong move in a struggling national corporate debt market. In fact, all Indian issues that completed in Jan 2013 have been very well received and oversubscribed, demonstrating the strength of international capital markets for Indian corporate bonds.

Recently, the government decided to reduce withholding tax on infrastructure bonds – a positive move for the corporate bond market. Are these reforms too late in the day for the corporate bond market to thrive? I don’t think so. The Indian market is gradually opening up to foreign investors and larger corporate stakeholders. Once liquidity starts pouring in, corporate bonds are sure to become a critical pillar supporting India’s growth.

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Why I don’t watch CNBC or NDTV Profit or…

I don’t watch CNBC, or NDTV Profit, or ET Now, or… Let me just bunch all of these together and refer to them as CNBC – the pioneer in real-time financial entertainment.

CNBC’s goal is not to make you money, but to sell advertising. In fact, if you use any website or TV channel or magazine that shows you ads, you should understand that the product that they are selling is YOU (to their advertisers.)

The structure of CNBC is to keep you on the edge of your seat. To keep you dependent on them for information on what to do next. They want you to live in fear and react to every little hiccup in the market. The ugly truth is that by the time any news hits CNBC, you, as an individual investor, is far behind the eight ball.

Market timing is nearly impossible. It may be blindingly obvious in hindsight, but at that very moment, even the good lord Brahma cannot tell you whether something has bottomed or topped.

How can you predict where the NIFTY is going to be in a year’s time when cannot even state with certainty that are you are not going to be hit by a truck while crossing the road?

How many of their “experts” are actually accountable to you? How many times have you heard anyone of them say “I don’t know” as an answer to a question?

Does knowing what the CEO had for lunch that day make you an expert in that company?

Does it matter what Ganesha predicts?

Watch CNBC for entertainment value, not for investment advice.

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FLSRC: Government’s writ on monetary policy is suicidal

The sweeping recommendations of the Financial Sector Legislative Reforms Commission (FSLRC) headed by Justice B N Srikrishna has stirred a hornet’s nest. Prima facie, the report gives an impression that it is aimed at clipping the wings of the Reserve Bank of India (RBI) Governor and seeks greater role for the government in financial regulation, especially in monetary policy affairs.

The Finance Ministry and the RBI Governor have always been at loggerheads. Current Finance Minister P Chidambaram’s run-ins with past Governor YV Reddy and his predecessor and current Governor D Subbarao is now part of financial folklore.

POLICY RATES OF COUNTRIES The proposals that have generated much noise are setting up of a unified financial regulator by subsuming current sectoral heads like Sebi, Irda, PFRDA and FMC. Regulators will no doubt be fuming, as they will be jobless once FSLRC proposals are implemented. It is debatable if multiple regulators have stifled growth in the financial sector or lack of innovative financial products.

But the over-arching proposals concerning greater accountability of the RBI and the government setting monetary policy goals for the central bank will have wide ramifications.

According to FSLRC, policy rates will be determined by a MPC (monetary policy committee) comprising of two members from the RBI and five members appointed by the government, thereby giving the government greater say over policy. This means, effectively, the RBI governor will no longer have the final word on monetary policy.

There is logic in this view, since in a democracy, an elected government must helm policy affairs. The objective that the central bank must pursue should be defined by the government. But vesting powers with the centre can be dangerous as politically-elected governments tend to favour cheap money policy, while economically sound central banks generally are far more conservative and look for macro-economic stability and not merely growth. Also, it is debatable if the government possesses the necessary expertise and domain knowledge to carry out monetary policy functions considering that they are not elected through merit.

TREND IN POLICY RATES

 

The unified financial regulatory model has been prevalent in global financial system. But with global economy ravaged by one crisis after another, it is foolhardy to borrow a failed model. Rather, the Indian financial system, with its multiple regulators and stiff norms, had come in for immense praise after the global financial crisis in 2008. Isn’t it practical to stick to a model that has withstood the tough times?

The report said that there will be a quantifiable numerical target set by the government that must be met. In the Indian context, it is doubtful if it is feasible to set an inflation or growth target.

STRUCTURE OF FINANCIAL SUPERVISION

The committee has also suggested that the government will frame rules with respect to capital inflows like FDI, FII and NRI deposits against the present system of RBI. Four members of the panel have expressed their opposition to dilution of RBI’s powers on this front.

One area where unanimity seems to exist is the creation of a debt management office (DMO) for raising resources for the government which, at present, is managed by the RBI.

Many experts have warned of conflict of interest saying RBI’s role in monetary policy and managing the centre’s borrowing calendar may give the central bank a bias in keeping interest rates low. Creation of a separate agency will eliminate this loophole.

While FSLRC talks about accountability of the RBI, it is silent on seeking more answers from the government on fiscal policies. The government’s track record of fiscal deficit is there for all to see. The RBI, currently, enjoys the highest levels of credibility in the eyes of the public.

BAD GROWTH MIX

If the government, in its current form and public perception, takes control of monetary policy, the credibility and legitimacy of the entire process will be seen as suspect. Already, the government’s writ runs over financial regulators since almost all the current sectoral watchdogs are appointed by the government. Should we reward the government’s ineptitude with more responsibility? I think not!

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Thoughts on Inertia

It’s always easier to do nothing (new).

Change is difficult to start.

Fear of making a decision > Benefit of making a decision.

The strong desire to keep things the same.

Listening to the same advice from the same people telling you the same things.

 

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On why passive investing is a risky strategy

If you are buying an investment fund, there are two main strategies you’ll encounter – active management and passive management. Passive investing is essentially the replication of an index or benchmark. For example, buying the NIFTYBEES ETF that replicates the Nifty 50 index. The aim of active investing is to deliver returns that are superior to the stock market that the companies sit within. An actively managed fund can offer you the potential for much higher returns than what a particular market is already providing. The debate as to which of these strategies is better has been raging on for the better part of the last 20 years. Whenever stock-market indices recover from a crash, the debate re-emerges.

The problem with passive investment is that passive management is only theoretically possible.

any evaluation of passive investment funds to be complete should include withdrawal activity during draw-downs, something that can be viewed as active management by the part of the investor imposed on the passive fund.

Also, most funds that call themselves “active” are actually “passive.”

the representation of closet index funds and traditional index funds have risen to the point where they now represent approximately 40% of the active universe—making the exercise of differentiating them from true active managers more important than ever.

Traditional passive investing, using indices weighted according to market capitalisation, works best in the kind of long bull markets that ignore fundamentals, because at the end of the day, you effectively end up buying high and selling low.

Investors should be careful of simplistic arguments and biased data while allocating capital. While I remain a fan of ETFs to get broad-market exposure, it is by no means the be-all-end-all of investment choices.

Sources:
Passive Investing in Stock Indices Involves Substantial Risks
Re-thinking the Active vs. Passive Debate

 

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