Indian One Thousand Rupee Banknotes (Photographer: Dhiraj Singh/Bloomberg)

Commercial Paper Issuance On Course To Hit Record High

More and more companies are choosing to borrow short-term money from the commercial paper markets where rates have fallen steeply in the last three months.

Indian firms borrowed just under Rs 1.15 lakh crore through commercial paper in the fortnight ended August 31, data released by the Reserve Bank of India on Friday showed. The amount is almost at par with the fortnight ending December 15, 2015 and the second highest borrowed in a single fortnight since October 2011. Data prior to that is not available.

For the calendar year so far, commercial paper borrowings stand at Rs 13 lakh crore compared to Rs 15.26 lakh crore in the full year 2015. If borrowings continue at the average pace of above Rs 80,000 crore per month, volumes in the commercial paper market will outstrip last year’s record high.

The increase in commercial paper issuance is driven entirely by the fall in rates. Commercial paper rates have fallen to below 7 percent which allows good companies to borrow at very competitive rates. Most of the regular issuers are active in the markets along with some who have been out of the markets for some time.
Shashikant Rathi, Head - Debt Capital Markets, Axis Bank
Chart showing volume of commercial paper issuance. Source: Bloomberg
Chart showing volume of commercial paper issuance. Source: Bloomberg

The increase in the number of companies choosing to borrow short-term capital from the markets is a direct consequence of the fall in interest rates. The bond markets have seen a fall in rates across tenures after the Reserve Bank of India (RBI) said that it would move towards neutral liquidity conditions as compared to maintaining a liquidity deficit.

This has helped market rates fall much faster than bank borrowing rates and pushed a greater proportion of short-term borrowings to the market.

Three month commercial paper rates, for instance, have fallen to 6.85 percent now from a peak of 9.31 percent in February. 12-month commercial paper rates have fallen to 7.51 percent from a high of 9.23 percent in February. At current levels, rates across most tenures are the best in atleast six years. Long term rates have also fallen with the benchmark 10-year bond yield now trading at a seven-year low below 6.80 percent.

In contrast, bank base rates have not seen much of a drop. State Bank of India’s marginal cost lending rate (MCLR) for three months is at 9 percent while its one-year rate is at 9.10 percent.

“There is almost a 2-2.5 percentage point difference between bank lending rates and commercial paper rates. It has been a long time since we have seen such a strong arbitrage,” said Rathi.

Pranav Haldea, managing director of PRIME Database adds that along with a fall in rates, an increase in bank investments in commercial paper due to their reluctance to lend has also played a role. Saddled with bad loans, banks have stayed away from any lending perceived as risky. Instead, they prefer to deploy surplus funds through other means such as commercial paper investments, thereby pushing up demand for such paper.

Weighing On Bank Credit Growth

The shift of short-term borrowings to the commercial paper market and the lack of any long-term demand for credit has meant that bank credit continues to be skewed towards the retail sector.

According to the latest data from the Reserve Bank of India, non-food credit growth between July 2015 and July 2016 stood at 8.3 percent. Credit to industry, however, remained almost stagnant with a growth of 0.6 percent. In contrast, personal loans grew at 18.8 percent and credit to the services sector grew at 10.8 percent over the same period.

Rathi noted that the arbitrage between bank rates and market rates will eventually narrow as bank lending rates come down and increased commercial paper issuance should push up rates in the market but that “will take some time.”

The central bank has cut rates by 150 basis points since the start of 2015 while also easing liquidity conditions. Banks, however, has reduced lending rates by only 60-75 basis points as they seek to protect margins at a time of weak demand for long term credit.

“Given dull corporate capex and reluctance of banks to lend to risky businesses, credit growth is expected to stay subdued at 10-12 percent in FY17,” said ICICI Direct in a research report on Monday.