VZCZCXRO7267
RR RUEHAST RUEHCI RUEHDBU RUEHLH RUEHNEH RUEHPW
DE RUEHBI #0238/01 1630639
ZNR UUUUU ZZH
R 120639Z JUN 09
FM AMCONSUL MUMBAI
TO RUEHC/SECSTATE WASHDC 7245
INFO RUCNCLS/ALL SOUTH AND CENTRAL ASIA COLLECTIVE
RUEHBI/AMCONSUL MUMBAI 2457
RUEHNE/AMEMBASSY NEW DELHI 8482
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RHMFISS/DEPT OF ENERGY WASHINGTON DC
RHEHAAA/NSC WASHINGTON DC
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 04 MUMBAI 000238 
 
SENSITIVE 
SIPDIS 
 
USTR FOR AADLER 
 
E.O. 12958: N/A 
TAGS: EINV EFIN ECON IN
SUBJECT: INDIAN CORPORATE BOND MARKET MOVING SLOWLY BUT STEADILY 
FORWARD 
 
MUMBAI 00000238  001.2 OF 004 
 
 
¶1.  (SBU)  Summary:  Since September 2008, the Indian corporate 
bond market has witnessed an increase in trading volumes as 
Indian companies found it difficult to raise money through other 
routes.  Both the Reserve Bank of India (RBI) and Securities and 
Exchange Board of India (SEBI) have taken incremental steps to 
increase market volumes.  However, while primary issuances have 
grown, trading of issued bonds in the secondary market continues 
to lag behind.  One reason for this is that many banks and asset 
management companies tend to hold corporate bonds until 
maturity, creating a lack of liquidity in the secondary market. 
In addition, the requirement for banks to hold government 
securities diverts funds away from the corporate bond market. 
Overall, many small distortions and disincentives remain in the 
system that discourage the development of a corporate bond 
market.  Since there is no one switch that can be turned on to 
create a robust corporate bond market, regulatory tinkering will 
likely continue for the near future.  End Summary. 
 
 
 
Regulators Hand in Hand to Develop Bond Markets 
 
--------------------------------------------- 
 
 
 
¶2.  (U)  In 2009, the Ministry of Finance along with SEBI, the 
capital market regulator, and the RBI, India's central bank and 
banking regulator, have continued to take steps to stimulate the 
corporate bond market.  In January 2009, the Ministry of Finance 
increased the cumulative debt investment limit from $6 billion 
to $15 billion for foreign institutional investor (FII) 
investments in corporate debt.  On May 11, SEBI simplified the 
listing procedures for debt securities in order to develop the 
primary market for corporate bonds in India.  Most trading in 
this market is over-the-counter (OTC), as there is no formal 
exchange traded platform yet.  In the annual policy statement 
released in April 2009, the RBI announced a new trade-by-trade 
settlement process consistent with OTC activity.  Interlocutors 
mentioned that much of the work for exchange-based trading has 
been done, including the establishment of corporate bond trading 
platforms at the National Stock Exchange and Bombay Stock 
Exchange.  However, the RBI's announcement is an admission that 
OTC activity will continue to dominate for the time being. 
 
 
 
¶3.  (SBU)  Dhiren Mehta, Director of Emerging Markets at 
Citibank, and Ashish Ghiya, the Managing Director of Derivuim 
Capital believe the new FII limit of $15 billion is sufficient 
to generate interest from the trading desks of foreign banks. 
However Mehta estimated that FIIs would take almost a year to 
hit this limit; since most FIIs buy bonds to hold until 
maturity, the increase in volume would not spur increased use of 
the secondary market.  Jeevan Sonparote, who monitors FII 
registration and participation at SEBI, expressed disappointment 
with the pace the new limit was being utilized, especially since 
SEBI has made it easy for corporations to issue corporate debt, 
he said.  For a company already listed on stock exchanges 
seeking to offer debt securities, SEBI has reduced the amount of 
information the company needs to disclose, and new guidelines 
emphasized electronic disclosure to save on cost and time of 
issue.  However, Mehta described the new, shortened period -- 
three weeks -- as still too long, given that market conditions 
can change drastically in three weeks. 
 
 
 
¶4.  (SBU)  Looking ahead, many minor reforms await RBI action. 
Both Mehta and Sonparote described the ability to lend, or 
"repo," bond holdings to enhance returns awaits the RBI's 
finalization of the clearance mechanism.  Exchange-traded 
interest rate derivatives should be announced in the next six 
months, which will help bond holders separate out various forms 
of risk.  The RBI has also begun the process of introducing 
"strips," where government bonds can have the principal and 
interest payments traded separately.  SEBI expects FIIs to be 
allowed to participate in primary issuance within one-to-two 
months, so they won't have to rely on miniscule secondary market 
activity to acquire positions.  Finally, Ministry of Finance 
Director Gopal Nair expected the negotiations on harmonizing 
state-imposed stamp duties to continue with the new government, 
but progress is slow. 
 
MUMBAI 00000238  002.2 OF 004 
 
 
 
 
 
Corporate Bond Market Volumes Picking up in the Primary Market 
 
----------------------------------- 
 
 
 
¶5.  (SBU)  According to data from SEBI, listed companies have 
raised about $42.27 billion of bond capital through private 
placements of corporate bonds during April 08- March 09, a 1.6 
times year-on-year increase.  Media reports suggest that as more 
companies find it difficult to access funds from issuing equity 
and external avenues such as external commercial borrowings, the 
corporate bond route has become more attractive.  Mehta noted 
extreme domestic liquidity, rather than a return to normally 
functioning markets post-crisis, driving the demand side. 
Sonparote remarked that although both the number of bond 
issuances and the capital they raised have picked up, the growth 
in the latter has not been significant.  The growth in number of 
issues is likely due to individual companies accessing the 
market multiple times for smaller offerings.  He thought that 
these companies may not be able to raise a large amount in a 
single debt offering.  Ghiya indicated that despite continuous 
reforms in the corporate bond market, volumes were not picking 
up, as the regulator lacked an understanding of the market's 
participants.  He elaborated that when stock markets were 
developed, SEBI focused on three classes of investors -- FIIs, 
domestic institutions and retail investors.  However, in the 
corporate bond market, retail investors are insignificant, so 
SEBI needs to focus on FIIs and domestic institutions and 
increase their participation.  To his disappointment, SEBI is 
trying to replicate the same approach it took with the 
development of equity markets in the corporate bond market. 
 
 
 
Increase in Primary Bond Issuances Not Translating into Volumes 
in the Secondary Market 
 
-------------------------------------- 
 
 
 
¶6.  (U)  While primary issuances have been growing, most of 
these are by public sector financial institutions and issued on 
a private placement basis to institutional investors.  Ghiya 
estimated that despite an annual issuance of about $9.5 billion 
worth of corporate bonds by public sector undertakings (PSUs), 
the most liquid segment, the daily trading turnover of the 
secondary market was only about $21 million.  The implication is 
that it could take an uncomfortably long time to sell a large 
bond holding if one wanted to exit the market.  Mehta from 
Citibank explained that bond markets are driven by liquidity, 
regulation, and the investment needs of the different classes of 
investors.  He elaborated that each investor's risk appetite 
varies due to their unique risk profile.  Asset management 
companies (AMCs), 70 percent of whose assets are institutional 
money, tend to invest in the shorter end of the bond market, 
normally maturing in one to three years.  For instance, Reliance 
Mutual Fund has assets of about $20 billion under management; 75 
percent of these assets must be in highly liquid investments 
because they could be withdrawn on a one-to-two day notice.  He 
added that generally AMCs buy bonds to park excess cash and are 
not necessarily making a strategic investment decision when they 
buy corporate debt. 
 
 
 
¶7. (U)  In contrast, insurance companies tend to hold bonds of 
maturities 10 years or longer, since they must manage longer 
term assets and liabilities.  The government-owned Life 
Insurance Corporation, one of India's largest insurance 
companies, has adopted a conservative style of investing and 
holds 10-30 year bonds.  Government- and privately-managed 
provident and pension funds are also extremely conservative, due 
to their purpose as retirement funds.  Ghiya noted that 
recently, retirement and pension funds had relaxed some of their 
investment guidelines, but he believed that they would hold 
longer term debt till maturity.  With so many buy-and-hold 
participants, liquidity comes almost exclusively from foreign 
banks and primary dealers. However, Mehta noted that when 
 
MUMBAI 00000238  003.2 OF 004 
 
 
interest rates are not favorable, these parties lose interest 
and liquidity vanishes completely. 
 
 
 
Indian Banks Find Direct Lending More Attractive than Buying 
Corporate Debt 
 
------------------------- 
 
 
 
¶8.  (U)  At present, Indian banks have different accounting 
norms for holding loans and bonds; these norms -- and the fact 
that banks earn higher interest rates from direct loans -- make 
corporate bonds less attractive.  Banks charge about nine 
percent or more interest for loans, but they do not have to use 
mark-to-market (MTM) accounting for such loans.  In contrast, 
banks earn only about eight percent interest for holding 
corporate bonds and must record them on a MTM basis, which is 
more cumbersome than accounting for direct loans.  While there 
is no risk differentiation between corporate loans and bonds, 
Ghiya pointed out that the incentive for corporate lending in 
lieu of holding corporate bonds will be lost once banks 
implement Basel II norms.  As a result, all corporate lending 
would be treated on the same risk basis for capital adequacy 
purposes, which may make corporate bonds more attractive than 
they are currently for Indian banks. 
 
 
 
Government Bond Market 
 
---------------------- 
 
 
 
¶9.  (U)  Traditionally, banks and insurance companies have been 
the largest holders of government securities (GSecs).  The major 
part of the holdings of these investors is generally in the 
nature of statutorily-mandated investments; Indian banks are 
required to maintain 24 percent of their deposits in government 
securities.  N.S. Venkatesh, Managing Director and CEO, IDBI 
Gilts, described banks as the major captive buyers of government 
bonds.  In addition, insurance companies, provident and pension 
funds are required to invest 20-25 percent of their assets in 
GSecs.  In total, the banking and insurance system holds almost 
60 percent of issuances, making them unavailable for trading in 
the secondary market, he claimed.  Non-Banking Financial 
Companies (NBFCs), another major player in the bond market, are 
also required to invest 15 percent of their assets in GSecs. 
 
 
 
¶10.  (U) Venkatesh estimated that in 2008, about Rs. 3.06 
trillion worth of government bonds, or about $65 billion, were 
issued in the primary market but the trading volume in the 
secondary market was about Rs. 12 trillion or $255 billion. 
This indicates that the trading volume is 5 times the volume of 
issuances in the primary market.  However, the same trading 
volume in developed countries ranges from 10 to 12 times of 
annual issuances.  The Indian GSec market has no retail 
participation, he complained, which he blamed on low investor 
awareness and low returns, compared to other avenues of 
investment.  Competing with G-sec, a five-year fixed deposit 
through the government-sponsored small saving scheme currently 
pays eight percent interest, tax free.  In contrast, government 
bonds pay roughly 4.5 percent taxable interest, making GSecs 
unattractive to retail investors.  FIIs are unlikely to provide 
the secondary market trading volumes in G-secs either, because 
their holding cap in this market is only $5 billion.  Many 
market observers noted that at such small amounts FIIs will not 
invest the resources to be active traders.  Ghiya further noted 
that the new scheme for allocating FII holdings, just 
implemented May 15, poorly suits the rush-in, rush-out arbitrage 
positions FIIs prefer to take. 
 
 
 
¶11.  (SBU) Comment:  While the Indian government, SEBI and RBI 
continue to take small steps to build a robust and liquid 
corporate bond market, the domestic government bond market still 
dwarfs it.  Market players dismiss regulators' apparent focus on 
 
MUMBAI 00000238  004.2 OF 004 
 
 
cultivating retail participation, and many expect FIIs to 
eventually jump-start trading.  All agree that there is no 
single switch that can turn on a robust corporate bond market, 
in part because so many distortions and disincentives remain to 
be disentangled.  Hence, regulators and practitioners continue 
to tinker and advance, hoping they eventually hit some sort of 
tipping point at which market development takes on a momentum of 
its own. End Comment. 
FOLMSBEE