India's Bond Market Needs to Bulk Up

Infrastructure Development Finance, a company formed by the Indian government to lend to energy and road projects, just sold 29.3 billion rupees ($640 million) in 10-year tax-exempt bonds. The sale closely follows Indian Overseas Bank's successful issuance of 15-year debt. That's pretty routine in most countries. For India, though, the deals were encouraging to investors, who can't find enough Indian corporate bonds to buy, according to bankers who did not want to be quoted.

"India really needs to develop a bond market for long-term funding," says Michael Queen, chief executive officer of 3i Group, Europe's biggest publicly traded private equity firm, which plans a $1.5 billion fund to invest in India's infrastructure in the next six months. "My biggest concern when investing in India is the availability of debt capital."

India's corporate bond market, about 30 percent the size of China's, is failing to expand at the rate analysts say is needed for the government to meet its target of building infrastructure. India has about $200 billion of corporate bonds outstanding, Bloomberg data show, compared with China's corporate bond market of $614 billion, according to Asian Development Bank figures.

Prime Minister Manmohan Singh has proposed about $1 trillion of investment in the five years through 2017 to upgrade the country's crumbling road and power networks, whose defects the Finance Ministry says shave 2 percentage points from growth. Singh plans to raise about 50 percent of the spending from private capital.

The best way to tap private capital for infrastructure is through long-term bonds, which offer fixed, predictable costs. "The success of the government's very ambitious infrastructure program hinges on developing an adequate bond market," says D.H. Pai Panandiker, president of RPG Foundation, an economic policy group in New Delhi. Though bank loans are more available than bonds in India, they're generally more expensive than bond offerings. Besides, bankers in India are reluctant to fund infrastructure projects since they take so long to pay off.

The government shoulders part of the blame for the corporate bond market's dwarfish status. Regulations raise the cost of issuing bonds and rules limit foreign investment. Pension funds and insurance companies—typically among the biggest buyers of corporate debt in other countries—are restricted in how much they can invest in bonds. That shrinks the potential market for the bonds and forces companies to offer higher rates to attract buyers.

Policymakers are trying to make amends. They've introduced credit default swaps so investors can gauge more accurately the risk of buying corporate bonds. Singh's government has also allowed foreign funds to buy more corporate debt and has introduced a 20,000-rupee tax exemption for investors buying bonds to support infrastructure projects.

More needs to be done. Allowing banks to guarantee bonds would lower companies' funding costs and increase investor confidence in the bond market. Lifting caps on foreign insurance and pension companies operating in India would broaden the investor base.

Even with these additional reforms, India would have a long way to go. Its outstanding corporate debt is only 3.3 percent of its gross domestic product, vs. 10.6 percent in China.

The bottom line: India needs to develop a more robust corporate bond market if the government's $1 trillion infrastructure program is to succeed.

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