Govt bond market likely to see an explosion of new products in FY24

After a long time, the market for government and public sector debt papers has started to diversify. At the start of 2023, the Centre announced the roll out of Sovereign Green Bonds. All the state governments now have a significant presence in the bond market, having sharply lowered their dependence on the Centre for borrowing ever since Covid struck. 

Or take the example of the Reserve Bank of India’s recent paper (November 2022) debating the prospects for municipal bonds. A related development is the coming of age of debt papers of infrastructure investment funds (InvITs), five years after the first one was issued in 2017. “Government companies have begun to issue InvITs in a big way,” noted India Infrastructure Finance Company Limited Chairman, PR Jaishankar.  

For India’s hopes to reach a gross domestic product of $5 trillion by FY26, this diversification of bond offerings is also necessary. The debt market has to expand rapidly beyond its over-dependence on the plain vanilla 10-year tenor central government papers. While the hope of Indian bonds to be included in global indices such as Morgan Stanley Capital International, Bloomberg–Barclay’s and FTSE Russell is unlikely to be fulfilled in Budget 2023-24, there are other positive changes. 

It is also no accident that the supply of these varied papers will come at a time when the demand for them has also begun to expand rapidly. The Employees Provident Fund Organisation (EPFO) and LIC, which between them have a purse of close to $700 billion, will be big buyers of debt in FY24. 

In the case of LIC, the necessity to invest well is now guided by the zeal to maximise shareholder returns after it listed on the markets in May last year. The EPFO has been forced to take the plunge as the returns of 8.10 per cent it offered its subscribers up to December 2022 are impossible to secure by investing only in AAA-rated government papers. 

The other two organisations that will be a big market for debt papers are the National Infrastructure Investment Fund (NIIF) and the development bank, National Bank for Financing Infrastructure and Development. These developments are unlikely to stir the market for corporate debt, though. 

In the case of Sovereign Green Bonds, for the first time, the government has agreed to: (a) sequester the expenditure to be made from the proceeds into a separate account that will be created and maintained by the finance ministry within the Consolidated Fund of India; and (b) to showcase globally that the expenditure will only be for the development of environment-friendly projects. S&P Global company Cicero Shades of Green, which it recently acquired, will evaluate the projects as an independent second party. The finance ministry “has approved the alignment of the Sovereign Green Bond Framework of the Government of India with the International Capital Markets Association Green Bond Principles,” noted a November 2022 report on the bonds by North Block. 

This is the first time the Government of India has agreed to carve out an item of expenditure from the Consolidated Fund of India to be shown separately. It is also for the first time that it has agreed to an oversight of such expenditure by an independent evaluator. The volumes are expected to rise soon in FY24, from the Rs 16,000 crore earmarked to be raised from these bonds, to be issued in two tranches.

 

“Bond markets will have to contend with a busy bond pipeline (in FY24),” noted Radhika Rao, senior economist, DBS Group Research, in a commentary on how the markets expect the government borrowing calendar to pan out.

For decades, the central government and the RBI have nursed the government debt market to operate in a narrow channel, to finance the borrowing requirements of the former. In FY24, a Goldman Sachs report puts the Centre's total net borrowing at Rs 13 trillion from an estimated Rs 11.8 trillion in FY23, a 9.3 per cent rise. For the state governments, Goldman Sachs projects a borrowing of Rs 5.3 trillion, a 15.2 per cent year-on-year rise. In FY 23, Tamil Nadu, Uttar Pradesh, Karnataka and West Bengal account for over 45 per cent of total borrowing by the states.

The change in attitude towards bonds may also have something to do with the views of former Comptroller and Auditor General Rajiv Mehrishi, a confidant of the current government. He has often said the major reason for the crisis banks face is the absence of a developed bond market in the country. “India has no bond market, so banks have been forced to lend for long-gestation infrastructure projects, which have then run into trouble,” he said. 

The diversification also helps since the supply of some of the old market favourites -- such as the tax-free bonds also known as Section 54EC capital gains bonds -- has dwindled. In the current financial year, the largest issuer of these bonds, the National Highway Authority of India (NHAI), also discontinued its issue after the Centre asked the road construction agency to cut its massive debt overload. The other issuers, Power Finance Corporation, the rural electrification financer REC and Indian Railway Finance Corporation (IRFC) have also been asked to reduce their dependence on this route and opt for InvITs. 

The emergence of InvITs (19 of them are already in the market) has been one of the most significant changes in the debt market. These bonds, a sort of amalgam of stocks, bonds and mutual funds, are regulated by the market regulator, Sebi. The NHAI and Power Grid are already there. The Railway board is still in discussions with a clutch of investment companies. 

The RBI paper on municipal bonds points out that city governments depend heavily for finance on grants from the Centre and state governments. This, it says, is unsustainable and the municipal bosses should instead tap the bond market. The RBI says municipal revenues/expenditures in India have stagnated at around 1 per cent of GDP for over a decade. “In contrast, municipal revenues/ expenditures account for 7.4 per cent of GDP in Brazil and 6 per cent of GDP in South Africa”. The paper is unusual, since the RBI does not dabble with the affairs of the third tier of government. Analysts such as Vinayak Chatterjee, the founder and managing trustee of The Infravision Foundation, said this interest could portend the development of a robust bond market by the municipal authorities.

But even before that happens, the government bond market will be busier than ever in FY24.