Corporate bond market as a source of capital funds in emerging economies – the Indian experience

Over the years it has become fashionable to argue that a vibrant bond market would be vastly superior to the present bank-led model of debt finance for industries and businesses in emerging economies. While it works well in most developed economies, in countries like India, despite all efforts of the central bank and the financial markets regulators or regulatory authorities, business firms still depend largely on the banking system for their debt capital funds. This study is an attempt to enquire into whether it is the measurable parameters such as cost of funds or the buoyancy in the economy that affects the firms’ decisions or not. If not, it would follow that other qualitative or behavioral (or non-measurable) factors may be responsible for the lack of firms’ appetite for issuing bonds. Corresponding author: N. R. Bhusnurmath Email address for corresponding author: bhusnurmath@mdi.ac.in First submission received: 9th February 2018 Revised submission received: 18th May 2018 Accepted: 12th June 2018 Introduction Over the years it has become fashionable to argue that a vibrant bond market would be vastly superior to the present bank-led model of debt finance in most developing countries such as India. Over the past few decades the Reserve Bank of India (the central bank of India) and the Securities & Exchanges Board of India have been trying desperately to create an active and vibrant corporate bond market. But all their efforts have not brought about much change in the scenario. Firms are still largely dependent on the banking industry for their capital needs. Either banks are their first choice, or they are unable to tap the market as there is very low appetite for corporate bonds from the investing public. It has become a bit of a vicious cycle! The often-quoted refrain is that corporates should raise their debt funds from the capital market rather than from the banks. Very little research seems to have gone in trying to understand the firms’ perspective as to why they prefer banks. This study is an attempt to explore and figure out how the firms in India decide to raise their debt capital; chose between capital markets and banks. 1.1 Literature review Corporate bonds markets have been the subject of numerous studies. But most of them are in the field of capital structure. Cobham, David, and Subramaniam (1998), Turner (2002), Guha, Basudeb, and Bhaduri. (2002) Bhole & Mahakud (2004), Chakraborty (2010). Titman and Wessels (1998) analyze the explanatory power theories of optimal capital structure. Taggart (1977), in his study on corporate financing decisions, concluded that movements in the market values of long term debt and equity are important determinants of the corporate security issues. Myers (1977) found that corporate borrowing is inversely International Journal of Business and Economic Development, Vol. 6 Number 2 July 2018 www.ijbed.org A Journal of the Academy of Business and Retail Management (ABRM) 52 related to the proportion of market value accounted for by real options. It also rationalizes other aspects of corporate borrowing behavior, for example the practice of matching maturities of assets and debt liabilities. Mason & Jeffrey (1990) found that firms are concerned with who provides their financing, not just with the debt/equity distinction. Debt is more than just debt; equity is more than just equity. Gabbi & Sironi (2005) examined the factors that determine corporate bonds pricing by analyzing the spreads of Eurobonds issued by major G-10 companies during the 1991–2001 period. He found that bond ratings appear as the most important determinant of yield spreads, with investors’ reliance on rating agencies judgments increasing over time. And, the primary market efficiency and the expected secondary market liquidity are not relevant explanatory factors of the spreads and cross-sectional variability. Further, rating agencies adopt a different, ‘through the cycle’, evaluation criteria of default risk with respect to the forward looking one adopted by bond investors. Elton et al (2004) investigate several bond characteristics that have been hypothesized as affecting bond prices and show that from among this set of measures default risk, liquidity situation, tax liability, recovery rate and bond age leads to better estimates of spot curves and for pricing bonds. Titman (2002) presents anecdotal evidence that suggests that financial markets, often, are not integrated and discusses the implications of this lack of integration on corporate financing strategies. He argues that market conditions, which are determined by the preferences of individuals and institutions that supply capital, can have an important bearing on how firms raise capital and the extent to which they hedge. Cantillo & Wright (2000) investigated which companies finance themselves through financial intermediaries and which borrow directly from arm's length investors. He found that large companies with abundant cash and collateral tap credit markets directly; these markets cater to safe and profitable industries and are most active when riskless rates or earnings of the financial intermediaries are low. Some studies have concentrated on Indian and other emerging markets. Sameul (1996) studied the role of the stock market in providing finance to firms in India and concluded that the development of the stock markets is unlikely to spur corporate growth. Anand (2002) studied the corporate finance practices vis-a-vis capital budgeting decisions, cost of capital, capital structure, and dividend policy decisions in India. Sengupta (1998) found evidence that firms with high disclosure quality ratings from financial analysts enjoy a lower effective interest cost of issuing debt. Apart from academic studies, there have been numerous policy papers and committee reports which have studied the issues regarding reluctance of firms in raising debt capital through issue of bonds. There has been a number of reports by committees set up by the Reserve Bank of India (central monetary authority of India) and the government of India, on development of corporate bond markets in India viz. Report of High Level Expert Committee on Corporate Bonds and Securitization (R. H. Patil Committee, 2005), Report of the High Powered Expert Committee on Making Mumbai an International Financial Centre (Percy Mistry Committee, 2007), A Hundred Small Steps [Report of the Committee on Financial Sector Reforms (CFSR) headed by Raghuram Rajan (2009). Report of the Khan Committee (2016) is the latest in a series of policy papers. All these committees have recognized many structural features of the corporate bond market in India which hinder the development of a deep corporate bond market. As mentioned earlier, there has been a dearth of research and understanding of factors that affect the firms’ decisions to raise funds through bank loans or to tap the bond markets. Several academic and other articles and reports have indicated many issues with the current state of bond markets in emerging economies such as lack of appetite and the buy & hold attitude of the few investors who do invest. A sense of frustration appears to have gripped the regulators as to why despite so many initiatives the corporate bonds market does not seem to have evolved. The main issue is whether it has made a significant progress and whether basic factors considered by prudent business persons or firms influence decisions International Journal of Business and Economic Development, Vol. 6 Number 2 July 2018 www.ijbed.org A Journal of the Academy of Business and Retail Management (ABRM) 53 regarding where to raise funds. As such an empirical study using available data and from the perspective of various stakeholders, might help to add to the understanding. This analysis could bring out the relevant economic factors that influence the firms’ choice for raising capital. 1.2 Objectives of the study The objective of the study is to enquire whether economic factors influence the firms’ decisions to tap the bonds market vis-à-vis from banks. The study attempts to examine specifically: • Has there been an improvement in the amount of funds raised in the bonds market in India? • Do economic factors play a significant role in influencing the firms’ decisions to tap bond markets? • Do firms decision to tap the bonds market gets influenced by the current bond market yields? • Does the buoyancy in the economy influence the funds raised in the bonds market? 1.2 Methodology The analysis of the study is based on secondary data. This is because it is not feasible to collect primary data on how and when firms decide to tap the bonds market as it tends to be strategic information which the firms are unwilling to part with. Therefore, a survey may not take us far as it is not likely to be reliable. Moreover, the study is an exploratory first attempt to examine whether actual data supports the widely held opinions and heuristics. 1.2.1 Design of the study Firms need capital funds and they decide on the leverage ratio. Based on this, firms have a choice of raising the required debt funds either from banks or by tapping the bonds market. The economic factors which could influence, and logically should, are whether it is time for investment (buoyancy in the economy), and the cost of funds. Other factors such as ease of raising funds, rules and regulations etc are relevant but tend to be qualitative variables. 1.2.2 Variables considered in the analysis are: • Bank credit to commercial sector (RBI) • Bonds issued during a calendar quarter (SEBI). This indicates the amount of funds raised in that quarter. • Base rates of banks (RBI) – banks are required to announce the “base rates”. These are the rates at which they lend to their AAA rated customers and are equivalent to the ‘prime lending rate’. Firms are charged a risk premium over this base rate. While different firms are charged different rates, to study the significance