Firms raise bets on floating rate bonds to meet funding needs

The Reserve Bank of India’s (RBI) easy money policy and promise of continued accommodation have changed the fundraising strategy of Indian companies.

The Indian firms are slowly leaning towards floating rate bonds, instead of issuing plain vanilla fixed rate papers to meet their funding needs.

To be sure, floating rate bonds were always in vogue, but their share was barely one per cent of the total bonds issued. However, in calendar year 2020, and 2021 so far, Indian companies have increased the share of these bonds to over 5 per cent.

For example, in 2019, the total issuance of floating rate bond was ~7,798 crore, which was just about 1 per cent of the total issuance. In 2020, the total issuance reached ~53,706.50 crore, about 5.3 per cent of the total outstanding. In 2021 so far, the floating rate bond issuances have been ~30,453.86 crore, which is 5.1 per cent of the total outstanding, according to Bloomberg data.

As the RBI started lowering the interest rate in response to the coronavirus crisis, preference for floating rate bonds surged in 2020. They are still getting issued in 2021 when the RBI is widely expected to be done with its rate cuts, pushing the bond yields up.

Non-banking financial companies (NBFC) are the primary issuers of floating rate bonds, even as some big name conglomerates have also chipped in. These bonds use the 91-day treasury bill rate as the reference rate, but a few of these have been issued in international markets as well. Most of the bonds mature in less than two years, though there are some that will mature in 2032.

Economists Harsh Vardhan, Executive in Residence at the Center for Financial Studies (CFS) at the SP Jain Institute of Management and Research, and Rajeswari Sengupta, assistant professor of Economics at the Indira Gandhi Institute of Development Research (IGIDR), blamed the phenomenon to an “erosion of credibility” in the sovereign yield curve, brought forward by the increased intervention of the Reserve Bank in the bond market.

The RBI, till at least June, heavily intervened in the 10year benchmark bond, accumulating most of the outstanding in its own books to keep interest rates low. However, yields on the other segments inched up, distorting the yield curve.

“The yield curve is a fundamental construct in a market economy, as it defines the interest rate structure that is used to price debt. As a result, if the yield curve is distorted, then interest rate risk is being mispriced,” the duo wrote in their blog.

“The associated misallocation of resources could prove to be costly, damaging the economy just as it struggles to recover from the Covid crisis,” they said.

However, there could be a simpler explanation for this floating rate bond phenomenon — a classic game of expectations between the issuers and the investors.

“Indian companies expected further rate softening, whereas the investors guessed the rates had floored. It was okay for the issuers to do so in 2020, but is a wrong strategy to follow now. This is the time when companies should lock in the soft rates and issue longterm bonds,” said Prabal Banerji, ex-group Finance Director at Bajaj Group.

He said investors prefer floating rate bonds most of the time, but they cannot force companies to issue one. And so, these bonds are mostly the idea of issuers, and should come down in share when the rates normalise.