Vishal Sharma
There is finally a good news for India amidst what is/ has been an all pervasive gloom and doom in its financial system for some time now! Remember RBI and the Government run in, the huge non performing loans in the banks and the resultant credit squeeze, the nonbanking finance companies’ capital base erosion and the currency depreciation! The list looked almost endless until this piece of news. Indian stock market has gone past the German stock market on its way to becoming the seventh largest stock market in the world. It’s not an ordinary achievement considering that western stock markets have always been deep and liquid while Indian stock market has always played a second fiddle to the banks, both as a savings vehicle and a credit purveyor.
There is a reason to why stock market in India has not grown in size. Indians by nature are risk averse savers. They have always found more value in locking their moneys in fixed income instruments/banks where returns are assured albeit low. This tendency has also been helped in no small measure by the financial sector in which savings yield good returns compared to the abysmal ones in the western world including the US. In the western world, on the other hand, low returns on savings have incentivized the savers to take bets on the stocks/bonds in the markets.
Indian equity market has traditionally performed well and is reasonably deep and liquid. With two stock exchanges- BSE and NSE- with a market cap of a little over one trillion USD each, Indian stock market is held reasonably good by the westerner market watchers. In Asia, only Chinese and Japanese stock markets out value Indian market in the market cap. And we all know why it is so.
The corporate bond market continues to be a cause of worry for developing India though. Historically, the development of bond markets in the world has preceded that of equity markets. Surprisingly, in India’s case, the equity market has antedated the bond market. And this is something that has upended the very rationale that is generally associated with the growth of the markets in India.
Bond markets are many times safer for the savers in terms of the predictability of returns than the equity markets although on average the returns are not seriously half as attractive as that of equities. Therefore, if their nature were anything to go by, risk averse Indians should have been investing more in the bonds or corporate debts. But instead they continue to try their luck in the uncertain world of the equities and now in relatively more certain universe of mutual funds/hybrid funds.
For an economy, which is growing at more than 7 per cent of GDP, it is imperative that the continual high growth shows up in the development of its capital markets and other associated institutions. When its stock market out values the stock market of an advanced industrialized economy like Germany, it may not reveal much about how the two countries compare ( for they are incomparable in every conceivable way), but one thing it certainly does is that its markets inspire confidence amongst the savers. The other big plus is that while Germany’s stock market’s cap is based on around 40 percent exports, Indian market’s export base is lowly 11%.
This indicates two things: One, India is not an export economy and that should be a cause for concern. Second, stock market growth in India is essentially driven by the home savers, which means it has protection from the dangers of the hot money swings or what the economists call the phenomenon of ‘sudden stops’.
While it’s indeed a moment to feel joyed, the next big test is to fix the plumbing of the corporate debt market. India’s infrastructural requirements are huge and they can’t be met by the financial sector alone especially as its banks and non banking companies are already in bad shape. The size of the non performing loans accumulated over the years in our banks due to supervisory gaps and poor regulatory architecture is begging for another bank recapitalization and the ever obliging government is ready to infuse around Rs. 80000 crore in these ailing banks.
Ailing Indian Banks ought to be fixed for a well functional financial sector complements the stock market. The best way to fix the system is to close down the bad banks and merge a few large and small banks to create only a few large banks and more small banks. A few niche banks in identified social and economic sectors including strategically important sectors are important in a country like India where credit needs vary from sector to sector and region to region and national security forms an important component of national thinking. While the Government can lead these niche banks, rest of the large and small banks dealing with the commercial and retail banking can be left to fend for themselves after ensuring that they conform to the Basel III norms.
Whether RBI should continue to regulate the banks is a question that the planners need to seriously grapple with? RBI has been recently found lax in this aspect of its duty and perhaps its obsession with controlling inflation has taken/is taking too much of its time? A separate, banks-exclusive regulator, whose independence is guaranteed by a bipartisan consensus in the parliament, as such, could be an option well worth considering. Given the current state of our banks, our legislators need to go into a huddle sooner than later to find a suitable fix.
While banks have to be the overriding focus at this stage, the corporate debt market should now move to be the next item on the agenda of our planners. G-secs have a functional market what with electronic trading platforms and anonymous order matching system, guaranteeing the settlement. But all G-secs have a captive market in our banks and hence the traction. This has effectively crowded out the corporates from the market though. The size of Indian corporate bond market is just 16 % of GDP compared to 73 % in South Korea and 46 % in Malaysia, which are much smaller economies than India.
In order to improve corporate bond market, restriction on netting of mark to market provisions for capital and exposure norms should be lifted to activate the credit default swaps segment. Foreigners in CDS segment should be let in as the domestic participants are not coming/have not come forward to make full use of this instrument. Also, bond exchange traded funds should be allowed to create the secondary markets. Remember in the absence of a near guarantee to trade in the second market, primary dealers and market makers will always be reluctant to enter the market. Finally, RBI has to accept the corporate bonds to inspire confidence amongst the primary dealers and market makers to invest in the corporate bonds. Improving the disclosure norms for the bond issuers at par with equity issuers and allowing access of the market participants and rating agencies to the information/data of the corporates is another step that will help deepen the bond market in the country.
A deep and liquid corporate bond market is absolutely necessary for India to diversify its fiscal space, aimed at crowding in the private investment in the country. India can afford a little bit of time lag in its development, for the same is not a single step process. But it can’t afford its sustained underdevelopment. Else it would be an endless waiting game for its massive infrastructural needs.
( The author is a former Asian Age correspondent)
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