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India local corporate bond guide Asia Rates Research November 3, 2011 Abhishek

India local corporate bond guide Asia Rates Research November 3, 2011 Abhishek PandaAC (91-22) 6157-3387 abhishek.x.panda@jpmorgan.com J.P. Morgan Chase Bank Ltd., Mumbai Nitin DiasAC (44-20) 7325-4760 nitin.a.dias@jpmorgan.com J.P. Morgan Chase Bank Ltd., London www.morganmarkets.com · Access to Indian bonds is not straightforward. Over the last 15 years, India has slowly opened up its government bond market through quotas called “Foreign Institutional Investor (FII) limits.” But these government quotas are now practically filled up, and India has instead switched to opening up its corporate bond market, especially infrastructure bonds. The corporate quo- tas are not filled yet, and realistically they are the only way through which foreigners can invest in India fixed income for the time being. Having said that, it is possible that the limits for government bonds may be revised higher in the future · By opening up limits in infrastructure bonds, India is attempting to direct foreign investment into areas where it is needed most. The currently avail- able FII limit for infrastructure bonds is INR1,115bn (or USD23bn), whereas only INR33bn (USD700mn) is available for government bonds. · In this primer, we look at the India corporate bond market and answer three questions. First, we answer why and how foreign investors should get in- volved. Second, we list the available instruments and highlight sizes, liquid- ity, ratings etc. Finally, we explain the market infrastructure and the main onshore players The certifying analyst(s) is indicated by the notation “AC.” See last page of the report for analyst certification and important legal and regulatory disclosures. Contents 1. Growth of the India corporate bond market 2 2. Uses of corporate bonds for foreign investors 3 3. Limits for Foreign Investors in Corporate Bonds4 4. Infrastructure corporate bonds 6 5. Corporate debt market: Instruments & Issuers 7 6. Corporate debt market: Ratings and Maturity 11 7. Corporate debt market:: Investors 13 8. Corporate debt market:: Market dynamics 15 9. New Developments 15 Appendices Steps for FIIs to register and bid for limits 16 WHT on FIIs based on location 17 SEBI notifications on FIIs 18 Useful Web addresses 19 Abbreviations used in the primer 19 FIMMDA credit spreads matrix 21 -50 50 150 250 350 450 550 Jan-06 Oct-06 Jul-07 Apr-08 Jan-09 Oct-09 Jul-10 Apr-11 1y 5y 10y Source: Bloomberg In bp Chart: History of Indian AAA corporate bond credit spreads 2 J.P. Morgan Securities (Asia Pacific) Limited Abhishek Panda (91-22) 6157-3387 abhishek.x.panda@jpmorgan.com Nitin Dias (44-20) 7325-4760 nitin.a.dias@jpmorgan.com Asia Rates Research India local corporate bond guide November 3, 2011 1. Growth of the India corporate bond market The Indian non-sovereign local bond market also referred to as the Corporate bond market has evolved swiftly in the last few years. The size of the corporate market has grown to INR8,900bn (US$151bn) this year, and the gross issuance doubled from INR1tn (USD21bn) in 2007 to INR2.4tn (US$48bn) in 2010. The rapid growth in recent years is because of a number of technical reforms instituted by the regulators: SEBI and RBI. These include compulsory reporting of trades on the reporting platforms, overhauling the disclosure norms for public offers and reducing stamp duty on corporate bonds. The settlement system improved even further when SEBI mandated that all trades in corporate bonds must be cleared and settled through the National Securities Clearing Corporation (NSCCL) or the Indian Clearing Corporation (ICCL). This step also helped address investor concerns about settlement and counterparty risk by establishing Delivery vs Payment (DVP) settlement by a central clearing agency. While the growth in the Indian corporate bond market has been impressive, the government bond market still dominates (86% of the total bond market). The dominance of the government over corporate bonds in India is also evident when we compare the Indian bond market to that of other countries. By definition, corporate bonds include bonds issued by financials, corporates as well as public sector companies (PSUs). The term government bond market refers to Chart 1: Gross Issuance of corporate bonds in India Chart 3: Percent breakup of total Indian outstanding bonds 1,057 1,431 2,026 2,378 1,506 0 500 1000 1500 2000 2500 2007 2008 2009 2010 2011 YTD Source: SEBI INR bn Chart 4: Comparison of percent breakup of outstanding bonds by issuer across countries (Dec 2010) 91% 88% 86% 7% 9% 11% 4% 3% 2% 0% 20% 40% 60% 80% 100% 2008 2009 2010 Government Financial Corporate Source: BIS, RBI, JPM 86% 85% 80% 66% 62% 54% 44% 11% 9% 18% 21% 37% 29% 45% 7% 13% 17% 11% 1% 1% 4% 0% 20% 40% 60% 80% 100% India Japan UK Germany Brazil China US Government Financial Corporate Source: BIS, RBI, JPM 8,895 8,535 8,338 7,940 7000 8000 9000 10000 Jun-10 Sep-10 Dec-10 Mar-11 Source: SEBI INR bn Chart 2: Total Outstanding corporate bonds 3 J.P. Morgan Securities (Asia Pacific) Limited Abhishek Panda (91-22) 6157-3387 abhishek.x.panda@jpmorgan.com Nitin Dias (44-20) 7325-4760 nitin.a.dias@jpmorgan.com Asia Rates Research India local corporate bond guide November 3 2011 securities issued by the central government, state governments and some special securities like oil bonds, fertilizer bonds and food bonds. 2. Uses of corporate bonds for foreign inves- tors 2a. Corporates as an alternative to government bonds When we compare risk and retun of corporate bonds over govenrment bonds, we find that the former offer value. Over the last five years, the average yield of 5-year India corporate bond was 9%, i.e. higher than the average yield of 7.6% for government securities, implying credit spreads of about 140bp. Interestingly, our analysis shows that this additional return did not come at the expense of too much extra volatility. Vol. of corporate returns over the period was 0.8% vs. 0.7% for government bonds. In recent months, credit spreads have traded around their historical average of 130bp. Chart 7 shows that 5-year spreads trade in a 60-170bp range, except during the financial stress of 2008 when the 5-year spread reached 400bp. In other words, credit spreads in India are generally stable, but have a tendency to witness excessive volatility if significant risk aversion arises. But what is interesting is that in recent Chart 5: Timeline of events in India corporate debt market months India local spreads have been stable, whereas in the rest of the world credit spreads have widened. The most actively traded INR corporate bonds are rated ‘AAA’ and are issued by PSUs (‘Public Sector Undertakings’). Therefore, it appears that in most cases investment in corporate bonds is a view on interest rates rather than credit risk. As large majority of issuance (44%) in the corporate space is done by state-owned enterprises, such bonds are viewed by investors as quasi-sovereign risk with a slight premium. Chart 6: 10-year benchmark Corporate bond yield BSE sets up reporting platform to capture trading data of corporate bonds SEBI made regulator for primary and secondary market RBI responsible for market repo of corporate bonds 2008 2008 2011 2009 2010 2007 NSE sets up reporting platform for corporate bonds Disclosure norms for listed bonds is rationalized Listed corporate bonds made exempt from TDS (Tax deducted at source) First public issue of non- convertible of debt securities Compulsory clearing and settlement of all trades through centralized clearing houses FII limits for investment in infrastructure bonds announced First corporate bond repo trade SEBI formalized infrastructure bond guidelines for FIIs RBI eases norms for FII investment in infrastructure bonds Proposed introduction of CDS on corporate bonds January 2007 March and April 2007 February 2008 February 2009 Shut period in corporate bond is reduced Actual day count convention is made mandatory for new bond issues Use of electronic payment facility for coupon and redemption started Order driven trading platforms become operational on NSE & BSE October 2010 March 2011 and afterwards… 7 9 11 13 Jan-07 Oct-07 Jul-08 Apr-09 Jan-10 Oct-10 Jul-11 AAA AA A % Source: Bloomberg 4 J.P. Morgan Securities (Asia Pacific) Limited Abhishek Panda (91-22) 6157-3387 abhishek.x.panda@jpmorgan.com Nitin Dias (44-20) 7325-4760 nitin.a.dias@jpmorgan.com Asia Rates Research India local corporate bond guide November 3, 2011 2b. Bonds hedged with currency forwards Given the past volatility in USD/INR (see chart 8), it may be advisable to hedge the currency exposure by paying the forward premia in USD/INR. Many FIIs prefer to match the hedge with the maturity of the bond. For short-dated bonds (1y), the investor may hedge using the 1y forward, but for a 5y corporate bond the hedge may be done using 5y MIFOR. This can be attractive as often the FX implied interest rate sits well below the bond yield. In other words, for a 1-year tenor the investor would then be receiving the spread between the 1-year corporate bond yield and the 1-year forward premia in implied interest terms. Chart 9 illustrates the FX hedged returns for a 1-year paper as well as a 5-year ‘AAA’ PSU bond. After hedging the currency exposure (maturity matched), the average carry works to 550bp and 230bp in the 1-year and 5-year bonds, uploads/Ingenierie_Lourd/ indian-bond-guide.pdf