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Impact of Junk Bonds on Indian Economy

The result is that the corporate bond market in India is virtually non-existent and has remained so despite numerous attempts to bring it to life. A well-functioning corporate bond market allows firms to tailor their assets and liability profiles.
If companies fear they will not be able to raise long-term resources, they are likely to stay away from long-term investments or entrepreneurial ventures that have a long-term payoff. In the long run, this can affect economic growth. The corporate bond and the junk bond market could fill this vacuum. In the absence of a corporate bond market, a large part of debt funding comes from banks. In the process, banks assume a significant amount of risk due to maturity mismatch between short-term deposits that can be readily withdrawn and relatively long-term illiquid loan assets resulting in high NPAs.

An active and efficient bond market gives companies an alternative means of raising debt capital in the event of a credit crunch. It also leads to better pricing of credit risk (since expectations of all market participants are incorporated into bond prices).

FIIs are major players in the equities market. However, thanks to the ceiling on their investment in the debt market (currently, there is a cumulative sub-ceiling of $0.5 bn on investment in corporate debt), they are present only in a limited way in the bond market.

Pension funds and the insurance sector could be another constituency, but the absence of pension funds and low insurance penetration has meant limited demand for long-term bonds. All these would help in establishing a corporate bond market for sub-investment grade.

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* Contributed by -
Ankit Chetan & Sudhanshu Duggal,
National Institute of Industrial Engineering (NITIE),
Mumbai.