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Finance Management | Building a Junk-bond Market in India & its Impact on Overall Economy

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Building a Junk-bond Market in India & its Impact on Overall Economy

- by H. Sandeep Reddy & Puneet Jain *

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Funding through bank loans, meanwhile, could subject companies to maintenance covenants, which typically demand that the company reduce the ratio of its total debt to EBITDA (earnings before interest, taxes, depreciation and amortization), say from 4 to 1 to 2.5 to 1 in three years, which is an hindrance to the growth.

A promising company would, therefore, best meet its funding requirement through bonds because the cost of debt is cheaper than equity, and because interest payments, in most cases, are tax-deductible. And while more expensive than bank loans, high-yield bonds do not make the issuer beholden to any maintenance covenant that could hinder financial planning and make life difficult for the CFO.

Importantly, the junk bond market will accommodate long-term funding, something to which commercial banks are still averse. Also, issuers have the flexibility to redeem the bonds through call options.

A Market for Junk Bonds

Hence, having established the need and rationale for a junk bond market, we look at the necessary market infrastructure required: -

  • A Strong Regulator

    The regulatory mechanism is key to fair pricing of securities, as it prevents colluding and intermediary pricing bias and inefficiencies. Without effective regulation, transparency will remain a pipe dream. In the Indian context, the regulatory functions are divided between two entities - the Securities and Exchanges Board of India (SEBI) and the Department of Company Affairs of the Government of India. The primary functions of the SEBI are to over-see the public issue of new securities, including specifying the listing conditions and disclosure norms, and to supervise the operation of the markets in order to prevent anti-market behavior. SEBI has the expertise and the power to play this role well. It can take stringent action against any junk bond issuers or players indulging in malpractices. SEBI has infact laid down guidelines known as Disclosure and Investor Protection (DIP) Guidelines, 2000, to maintain transparency in the market and make it efficient.

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    * Contributed by -
    H. Sandeep Reddy & Puneet Jain,
    Indian Institute of Management Kozhikode,
    Kozhikode, Kerala.

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