The corporate bond market saw a spurt of activity on 23 April, with Hindalco and Tata Steel privately placing ten-year debt at 9.55 percent and 9.80 percent, respectively. The amount placed was Rs 3,000 crore for Hindalco and Rs 1,500 crore for Tata Steel. Both placements were taken up by underwriters.
Hindalco is rated AA+ by Crisil, while Tata Steel is rated AA+ by CARE. The spreads over corresponding benchmark ten-year government bond were 80 basis points and 105 basis points, respectively. (100 basis points = 1 percentage point.) Hindalco bonds carry a coupon of 9.55 percent,while Tata Steel's bonds carry a lower coupon of 2 percent, and have been issued at a discount to face value. Low-coupon bonds are attractive for foreign institutional investors (FIIs) as the withholding tax is lower.
The fact that these two companies could place debt at seemingly fine levels at a time when FIIs are cooling towards Indian bonds has woken up a dormant corporate bond market from its slumber. Indian Oil Corporation, rated AAA by Fitch, is in the market to raise three-year funds amounting to Rs 1,500 crore at levels of 9.15 percent to 9.40 percent through a book-building process. Others are set to follow.
The question is whether these large issuances are the first of many, which could potentially lead to a corporate bond market revival?
The corporate bond market has been wary of a large government borrowing program crowding out the market and a new SEBI law restricting a rollover of limits, which is limiting FII participation.
The government is borrowing Rs 3,70,000 crore in the first half of financial year 2012-13 and liquidity in the system is still in deficit despite CRR (cash reserve ratio) cuts of 125 basis points, RBI bond purchases of over Rs 1,00,000 crore and a repo rate cut of 50 basis points.
Banks are borrowing around Rs 90,000 crore from the RBI on a daily basis, underlining the tightness in liquidity. The fact that the rupee is at a three-month low against the US dollar is increasing liquidity worries because if the RBI sells dollars to maintain rupee stability, liquidity will tighten further.
FII activity in corporate bonds has been hit by the SEBI restrictions on rollover of limits if bonds are sold before maturity. FII's who are full-up on their corporate bond purchase limits and want to sell these bonds will not be able to buy them back as they have to apply for fresh limits from the regulator. The recent tussle on tax issues between FIIs and the government is also hurting sentiment on FII investments in bonds. A weakening rupee does not help either, as a weak currency is a deterrent for investments in debt by FIIs.
Debt limits of around Rs 30,000 crore in government and corporate bonds and Rs 75,000 crores in infra bonds with a three-year lock-in period were open at the end of 31 March, 2012.
Government bond yields are not providing comfort for corporate bonds either. Ten-year benchmark government bond yields are trading at levels of 8.56 percent, up from lows of 8.2 percent seen in February 2012. The pressure of weekly bond auctions with sizes ranging from Rs 15,000 crore to Rs 18,000 crore is telling on government bond yields. The outlook for government bond yields is not very positive in the near term.
In comparison, the positive for corporate bonds are the absolute levels of yields, and that could attract investors. Yields of 9.5 percent and 9.8 percent for ten-year bonds provide a cushion for investors as they earn higher interest. Hence, corporate bond yields could remain sticky at higher levels, despite pressure on liquidity and government bond yields.
Investors in Hindalco and Tata Steel bonds are not likely to suffer losses, and if they are patient, they will see profits if there are hints of more rate cuts ahead by the RBI. There will also be more issuers waiting to issue bonds, and that will lead to a more active market going forward.
Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors