For India, corporate bond reform would be like a good monsoon
LAST month, Union Bank of India became the latest state-controlled lender to be downgraded to junk by S&P. “The pick-up in corporate performance, and the de-bottlenecking of stressed sectors, in India is likely to be gradual, hurting Union Bank’s asset quality,” the rating agency noted. “The stress has pushed up the bank’s non-performing ratio.”
Neither India’s economy nor its banks are in the greatest shape. Growth slowed from 7.9pc in the first quarter to 7.1pc in the second (and according to the — probably more accurate — methodology the government used to employ, the first-quarter figure was just over 4.3pc).
Fixed investment contracted more quickly, hardly surprising given that utilisation of the economy’s current capacity remains low. It is just above 70pc overall, while in some industrial sectors such as steel and paper the figure is as low as 50pc, according to data from IHS Global Insight.
Foreign investors will find it easier to hedge their rupee exposure — something that has in the past been a big cap on their involvement in the local bond market
At the same time there had been ‘a near full stop in bank lending to industry’, IHS noted. Without credit, economies cannot grow. However, for many sectors there is both little demand for bank credit and little supply, thanks to the combination of broken bank balance sheets and excess industrial capacity. Cost of capital, especially for bank borrowers, remains lofty — far higher than almost anywhere else in emerging Asia.
But there are signs of a potential easing of the logjam. The Reserve Bank of India is introducing rules that should reinvigorate the corporate bond market, creating “less dependence on banks funding the next leg of the investment cycle”, says Samiran Chakraborty, Citigroup’s chief economist in Mumbai. “The development of the bond market will reduce pressure on the banks.”
It could be that the RBI is pushing an open door. Banks, with their need for capital to fix balance sheets, have been reluctant to pass on any rate cuts to corporate customers. It is more attractive for companies to issue debt than bow down to their bankers.
To make sure that large companies turn to this alternative source of funds, the RBI is imposing higher capital charges and provisions for loans to bigger borrowers. To encourage smaller companies to access the market — and to encourage investors to bet on them — regulators raised the credit enhancement limit from 20pc of the bond size to 50pc.
Foreign investors will find it easier to hedge their rupee exposure — something that has in the past been a big cap on their involvement in the local bond market.
“Previously, the challenge always was the lack of depth and liquidity,” says Mr Chakraborty. “The turnover was less than $1bn a day.”
Although these measures are incremental, they should ultimately make a difference when there is more basic demand for credit.
The promise for an Indian economy that has slowed does not end there. A significant swing factor is the monsoon — it largely accounts for the difference between the worst and best economic cases. After two disappointing years the rains have been generous, giving rise to lower food prices. That should lift rural income, boosting consumption.
Meanwhile, to the extent that there will be a re-acceleration in economic growth, some of it may come from the government, as it ramps up spending to build desperately needed roads, upgrade decrepit railways (the average speed of a freight train is 25kmh) and improve ports.
The government has been a big part of the problem. Organisations such as the National Highway Authority would rather dispute than pay bills for work from the big infrastructure companies, contributing to both the physical and the financial logjam. As the corruption that gave rise to blockages and delays eases, fiscal spending will be more effective.
With inflation coming down and public spending less wasteful, the RBI can finally move more aggressively to cut rates and reduce borrowing costs. That is the proper sequence of actions — a sequence from which other governments and central banks could learn.
Published in Dawn, Business & Finance weekly, September 12th, 2016