An Underdeveloped Corporate Bond Market: The Achilles’ Heel of India’s Growth Story

India's goal of becoming the world's third largest economy by 2027 and a developed nation by 2047 hinges on the establishment of a robust, efficient debt market. Currently, the country lacks a liquid and deep debt market, hindering banks from supporting long-term projects due to their short-term liabilities. A more effective corporate bond market in India, characterized by lower costs and quicker issuances, could offer a cost-efficient financing option for Indian companies. This analysis evaluates the current state of India's corporate bond market and recent regulatory actions by the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (SEBI), proposing concrete steps to enhance competition, efficiency, and liquidity in order to deepen and expand the market. India boasts a well-developed, liquid, and robust equity market that has demonstrated remarkable resilience over the past three turbulent years, surprising experts worldwide. With a global ranking of fourth in market capitalisation, as of 17 August 2023, the total market capitalisation of listed companies in India reached INR 309 trillion, equivalent to about 105 percent of GDP. The equity market in India is known for its top-notch regulation, surpassing even that of developed Western economies. The key question that arises is why India's debt market remains underdeveloped despite its strong equity market performance. In order to support India's ambitions of becoming the world's third-largest economy by 2027 and a developed nation by 2047, a liquid, deep, and well-functioning debt market is essential. Without such a market, private-sector investments cannot be fully leveraged, potentially disrupting India's growth trajectory. A vibrant bond market could serve multiple purposes, offering borrowers an alternative to bank credit and reducing the cost of long-term finance through corporate bonds. Unlike banks, which typically lack the capacity to fund long-term projects due to their short-term liabilities, an efficient Indian corporate bond market could provide a cost-effective source of long-term finance to domestic companies. Furthermore, it could create a favorable environment for institutional investors such as insurance companies, provident funds, and pension funds, enabling them to better match the tenures of their assets and liabilities.

From a macro-financial perspective, a robust corporate bond market plays a crucial role in mitigating the risk of financial instability. Given that banks form the backbone of India's financial system and provide essential services such as liquidity, credit, and payment systems to the economy, managing their risk becomes paramount. Introducing a market-based financing option like the corporate bond market can effectively distribute risk among a wider range of investors, thereby enhancing overall financial stability. A well-established corporate bond market could serve as a contingency mechanism, helping to cushion financial shocks and uphold financial stability. In light of this, it is imperative for the Indian government and regulators to support the growth of the corporate bond market in the country. For instance, the infrastructure sector is in urgent need of feasible and sustainable financing solutions. The Indian government has outlined a national infrastructure project pipeline that necessitates an investment of INR 111 trillion spread over five years starting from 2019–20. Solely relying on banks for financing these projects will not be sufficient. The financing of infrastructure projects faces a fundamental mismatch between assets and liabilities, which was a key factor leading to banks accumulating significant non-performing assets (NPAs) in the past. While Indian banks currently boast healthy balance sheets, they must exercise caution to avoid repeating past errors. Additionally, the government cannot sustain its substantial annual budget allocations for capital expenditure in the long run. A high fiscal deficit and increasing debt burden are warning signs for macroeconomic stability, particularly when compounded by concerns regarding insufficient public sector implementation capacity, inefficiencies, and a lack of financial restructuring. Excessive government borrowing from the market may also impede the private sector's ability to raise funds. One potential solution is the National Bank for Financing Infrastructure and Development (NaBFID), which was established in 2021 but has not yet gained significant momentum. The track record of development financial institutions in India has been unsatisfactory, often evolving into cumbersome bureaucracies that lead to ongoing issues for borrowers related to delays and increased costs. Even with an optimistic outlook, NaBFID's impact is likely to be minimal due to its limited size and scope compared to the substantial funding needs of the infrastructure industry. Hence, there is an immediate requirement to establish a strong ecosystem that supports the expansion of market-driven debt financing.