• Money

To begin from the point of truism, one of the essential elements of a successful enterprise, among other key factors, is the availability of capital. Even at that, it is the accessibility and the economy of debt capital that has come to play an important role in the sustainability and growth of a firm.

Not the least bit to be compared with the significance of equity (owners’) participation, debt capital helps in mitigating the enterprise risk across the entire capital structure. Other than that, debt capital also frees up the risk capital for the more vital functions and helps in leveraging the business potential of the firm.

Given this strategic nature of debt capital, it becomes all the more necessary that students and practitioners of entrepreneurism have an in-depth understanding of how the market for debt operates in India.

History of India’s debt market
India was a late entrant into the capitalist form of economy. And we are still in the transitory phase. Consequently, the evolution and the development of the formal debt market, as we know it, was initiated much later than other developed economies.

It was only after the financial reforms of 1991-’92 that the bond market in India received a major push. This era saw the end of the administered interest rate mechanism, and led to the introduction of the auction system for the sale of gilts and T-bills. Innovative products like zero coupon bonds, capital indexed bonds, etc., were also introduced during this period.

Much later, the NDS (Negotiated Dealing Settlement) and the WDM (Wholesale Debt Market segment) system were launched by the RBI, BSE and NSE to facilitate the trade settlement. In short, it was in the last two decades that the technical and regulatory infrastructure was developed to make the debt capital market as we see it today.

The debt market in India is categorized by many standards. But the most important of them is based on duration. The market that deals with short term debt, which basically means debt of less than a one-year maturity period, is called the money market. On the  other hand, debt maturity that exceeds the
one-year timeline is considered to be a part of the bond market.

Both these forms of market are dominated by government debt, which is classified under T-bills and gilt. This categorization is again based entirely on the duration of the maturity of the paper issued. That is, gilts normally refer to government borrowings whose maturity is scheduled after one year.

Concurrently, T-bills are government borrowings whose maturity is scheduled within one year. The dynamics of the corporate bond market are slightly different from the gilt. The activity and the size of this market are relatively marginal, given the large shadow of government borrowings under which it has had to operate.

Additionally, the lack of a wide investor base, the opaqueness and information asymmetry have been some of the reasons for the tepidity in the growth of the corporate bond market. The depth and the appetite of this segment have started to expand lately, though. But from the point of view of this article, we shall dwell further on the money markets.

Money market opportunities for SMEs
To begin with a brief rejoinder, the Indian money market is a market for short term securities like T-bills, certificates of deposits, commercial papers, repos and others. These debts are issued by the government, banks, companies and financial institutions, respectively. The papers traded are almost like a promissory note which usually has a fixed interest rate and a maturity of less than one year.

Since the securities in this market are less than one year, and the source of these securities is the government/banks/highly-rated companies, the credit risk involved is considered to be low (though slightly higher than an FD). Moreover, the tax incidence on the income from these schemes (depending on the plan) is usually lower than the one that the interest on savings accounts or FDs invite.

Therefore, from the SME point of view, the leveraging of the debt market can actually come in two forms. First, as a supplier of debt, and second, as the buyer. The capacity of the SME to tap the debt market is correlated directly to the growth trajectory of the corporate debt segment. However, the real and immediate gain potential for SMEs rests on their ability as the buyer of debt, especially of short term debts.

Now, most of you might have already been doing this unknowingly! That is, your money—parked in the current, cash or FD accounts—is used by the banks to buy the debt and the money market securities for you. However, the earning it might be delivering to you may range from nil to almost nil.

A convenient alternative and yet a potentially enhanced ‘revenue-generative’ method of parking the surplus is in the liquid, ultra-short term and the bond/gilt schemes of mutual funds. These schemes usually also invest your money in the money market and debt market securities, depending on the investment mandate of the fund.

An investor can invest in money market mutual funds for a period of as little as one day. Avenues are also available for investing for longer horizons according to your risk appetite.

In conclusion, in my understanding as an entrepreneur, the ability of a continuously evolving and self-propelling enterprise is its ability to not only learn and adapt to changes and opportunities, but also to make full use of them as and when possible.

LAKSHMI IYER is the Head (Fixed Income and Product) of Kotak Mahindra Asset Management Company.

©Entrepreneur June 2010

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debt market, Lakshmi Iyer