The development of a capital market is incomplete without a corresponding development of the corporate bond market. Having achieved a compound annual growth rate (CAGR) of 9% over the last five fiscals, the Indian corporate bond market is poised for even faster growth, driven by multiple factors. Large capital expenditure (capex) in the infrastructure and corporate sectors, combined with the growing attractiveness of the infrastructure sector for bond investors and robust retail credit growth, is expected to increase bond supply. Meanwhile, the rising financialization of household savings should drive demand.

Developing a corporate bond market offers several key benefits, including:

1. Supporting private sector growth
2. Aiding economic growth
3. Encouraging domestic long-term and diversified investments
4. Diversifying sources of credit and associated risks
5. Promoting greater market discipline and transparency

The corporate bond market plays a vital role in the economic development of a country, providing alternative financing solutions for long-term and sustainable growth. Policymakers have been instrumental in shaping the corporate bond market, implementing regulatory reforms that simplify the issuance and trading of bonds, thereby stimulating investor interest in corporate bonds. The Indian corporate bond market is continuing to develop in terms of rating depth, with top-rated papers (AAA) dominating the market. Over the past three years, the share of AAA-rated issuances has remained steady at ~66%.

AAA-rated papers dominate the bond market

Source: Crisil Intelligence, Prime Database

The latent demand for top-rated papers is also on account of the investment restrictions that pension funds, provident funds and insurance companies face to go beyond a particular rating threshold. Alternative investment funds (AIFs) have emerged as the dominant players in the market for AA and below AA-rated securities, continuing to invest in these assets.

In contrast, mutual funds (MFs) have become more risk-averse, adjusting their investment strategy in response to a series of credit events and rating actions in recent years. The AA category has grown the highest (a CAGR of more than 20%) on account of issuance by non-banking financial companies (NBFCs) and housing finance companies (HFCs) in the last five fiscals.

NBFCs and HFCs have been issuing rated papers to meet the growing demand for short-term credit from corporates and individuals. The banking system has faced liquidity constraints in recent years, leading to a surge in demand for short-term credit from NBFCs and HFCs. As a result, they have been issuing more rated papers to raise funds. NBFCs and HFCs have also been using securitisation to raise funds, which has led to an increase in issuances by these entities.

The category A and below-rated issuances grew 15-18% last fiscal on account of investments by AIFs and credit funds of MFs, among others. The others category includes below A-rated bonds and unrated bonds, which grew the most last fiscal. Special situation funds, which invest in companies undergoing restructuring or facing financial difficulties, have been increasingly investing in A and below-rated papers. Distressed debt, which includes A and below-rated issuances, has been gaining importance as investors seek to invest in undervalued debt securities.

Investors are seeking higher yields in a low-interest-rate environment. A and below-rated issuances have been offering attractive yields, making them appealing to investors. Family offices and high networth individuals have been increasingly investing in A and below-rated issuances, providing a new source of funding for these companies.

Shift in credit fund strategy — the AA advantage

Source: Crisil Intelligence

From 2019 to 2024, credit funds significantly adjusted their portfolios, increasing their allocation of AA-rated assets to 74% and decreasing their exposure to A and below-rated instruments to 10% as of November 2024. This shift is likely driven by a desire to enhance credit quality and capitalise on the relatively high yields offered by AA-rated assets in a low-return environment, where yields on AAA-rated assets remain subdued. Assets under management (AUM) of credit MFs stood at about Rs 76,649 crore in November 2018. However, it declined 72% to about Rs 21,000 crore by 2024.

The main reason for the decline was the NBFC credit crisis, which led to a liquidity crunch in the NBFC sector and, in turn, affected credit risk funds that had invested in these companies. The default had a ripple effect on the entire financial system, causing a liquidity crisis and leading to a decline in investor confidence.

As a result, many credit risk funds faced redemption pressures and their AUM declined significantly as investors became risk-averse. AUM of AIFs was about Rs 55,552 crore in November 2018 and jumped 7.5 times to Rs 4,74,533 crore by November 2024. In the first half of this fiscal, private credit investments (majorly unlisted) increased ~12% on-year to Rs 74,000 crore, driven by sectors such as real estate, infrastructure, NBFCs, renewable energy, power, metals and airports.

Private credit provides an alternative source of financing to businesses with unique funding needs and irregular cash flow.

It is typically avoided by banks due to regulatory restrictions and higher risk. Private credit ensures steady income generation, illiquidity premium and diversification advantages. Low correlation with the public markets, which minimises portfolio volatility, is another growth driver of this market.

Growth catalysts for AIFs

Funding gap: A significant funding gap exists due to limitations of traditional banks, creating opportunities for private debt lenders to meet the demand of growth-oriented businesses.

Capex: The government’s push for large infrastructure projects and strong focus on real estate and manufacturing sectors, driven by capex, are pivotal for private credit growth.

Regulatory environment: Over the past few years, the Securities and Exchange Board of India (SEBI) stepped up monitoring of AIFs and implemented measures such as valuation, benchmarking, mandatory dematerialisation and norms for liquidation, which have helped build a strong foundation for the platform. The Insolvency and Bankruptcy Code, 2016, has expedited insolvency resolution and maximised returns for creditors, further boosting investor confidence.

Tax reforms: Private credit funds, mainly debt AIFs, have benefited from tax parity across all debt products. It has levelled the playing field for debt asset managers of various pooled investment vehicles by standardising taxation.

Shift in investor preference: Higher disposable income and better access to financial information have enabled Indian youth to make prudent investment decisions, increasingly moving them away from traditional investment avenues towards private credit funds and AIFs.

Rating-wise spreads over AAA PSU benchmark across tenures

Source: CRISIL Intelligence (Data contains bonds held by Mutual Funds)

Credit spreads reflect complex interactions between factors such as interest rates, liquidity, supply and demand, and issuer-specific factors. They are crucial for fixed-income instruments as they provide key insights into investment risk and value. Wider spreads indicate higher perceived risk and they act as a market sentiment indicator that reflects economic conditions and investor confidence in different sectors or issuers. The AA and A category spreads across sectors have reduced in the last two years, indicating growing investor interest.

Meanwhile, the AAA category spreads have remained flattish.

Shape of the corporate bond yield curve

Source: Crisil Intelligence

A comparison of corporate bond yields between 2021 and 2024 reveals a notable shift. In 2021, the average yield for 1-year corporate bonds was approximately 4.22%, while the 10-year benchmark yielded 6.85%. However, by 2024, the yields had changed significantly. The 1-year benchmark had risen to 7.76%, surpassing the 10-year benchmark, which yielded 7.44%.

Similarly, the 3-year and 5-year benchmarks yielded 7.41% and 7.57%, respectively. This data indicates a clear inversion of the yield curve, which started from late 2023, particularly between the 1-year and 10-year benchmarks, as well as between the 3-year, 5-year and 10-year benchmarks, where short-term bonds are yielding more than long-term bonds due to demand-supply mismatch.

Crowding of investments at the shorter end of the curve, coupled with demand at the longer end of the gilt curve due to the inclusion of government bonds in global indices, has resulted in the inversion of the curve because of different demand-supply dynamics in different pockets of corporate bonds. The lower supply and illiquid nature of corporate bonds have also played a part in the inversion of the yield curve.

Issuances dominated by bonds with shorter maturity

Due to lack of depth in the market, most of the issuances in the corporate bond market continue to be dominated by bonds with a tenure of up to five years. This limits the flexibility of corporates to raise long-term money with flexible payment structures, also forcing them to take the banking route for their financing needs. In these circumstances, only public sector undertakings (PSUs), with their government backing, and infrastructure companies have been able to tap the corporate bond market for their long-term financing needs.

Corporate bond issuances remain mostly in tenure of up to 5 years

Source: Prime Database, Crisil Intelligence

Sector-wise corporate bond issuances

Source: Prime Database, Crisil Intelligence

The others category includes banks, PSUs and state financial institutions. In terms of sectoral exposure, financial institutions, the private corporate sector and NBFCs lead corporate bond issuances. Last fiscal, issuances jumped 30% in the NBFC category, 45% in financial institutions and 74% in the private non-financial sector over the previous year.

Default Trends in last 5 years

Source: Crisil Intelligence, (Data contains bonds held by Mutual Funds)

*FY 2025- Until September 2024

In FY2021- 26 issuers defaulted with issue size totalling ~Rs 59015 crs, FY 2022 number of defaults reduced to 12 issuers with issue size totalling ~Rs 17000 crs, FY 2024 had only 2 defaults and FY 2025 till September saw 6 issuers defaulting with issue size defaulting ~ Rs 600 crs for each fiscal year.

Source: CRISIL Intelligence (Data contains bonds held by Mutual funds)

*Until September 2024

While lower-rated securities have higher spreads, they also carry higher default risk. Defaults happen due to multiple reasons, including economic slowdown, high debt levels, liquidity crisis, regulatory pressures, sector-specific issues, credit rating downgrades and poor governance.

Last fiscal, a stretched liquidity position, company-specific fraud and company-specific court orders were the main reasons for defaults. Based on the Crisil annual default and rating transition study for 2024, the average cumulative default rate of Crisil-rated AA and A categories for the three-year period between 2014 and 2024 was 0.31% and 0.69%, respectively, much lower than that of the below AA rating category (BBB at 2.49%, BB at 10.13%, B at 24.77%, C at 50.65%).

Credit funds will outperform other shorter funds based on potential for higher upside on account of higher lower credit quality bonds in their portfolio. This can be best illustrated by means of an example with a 3 year bond. A sample portfolio was created with AA and A-rated papers and another portfolio was created with AAA-rated papers to gauge the credit risk adjusted which will help us impact of higher default risk on returns in non AAA instruments.

Source: Crisil Intelligence

Portfolio 1 that has 80% AA-rated papers and 20% A-rated papers will yield ~130 basis points (bps) higher than a portfolio with all AAA-rated papers where as 60%-40% portfolio division will yield ~170 bps higher than portfolio with all AAA rated papers. Corporate bonds in India offer a compelling investment opportunity, with higher returns, diversification and safety than traditional investments such as fixed deposits and equities. The corporate bond market is expected to experience strong growth in the next few years, owing to legislative advancements and increased financialization of savings.

However, investors must carefully analyse the risks associated with corporate bonds, such as credit risk, interest rate risk and liquidity issues. By navigating these risks and effectively adding corporate bonds to their portfolios, investors can benefit from a more diversified and resilient investing approach, ultimately meeting their financial objectives in India’s dynamic economic landscape.

NBFCs have remained resilient amid adversities and stricter RBI norms

Between 2019 and 2024, several wholesale focused NBFCs in India, such as IL&FS, DHFL, Reliance Capital,  etc faced financial difficulties, resulting in their closure, default or restructuring. The collapse of  IL&FS in 2018, trigger a liquidity crisis, affecting several players in the wholesale lending segment. These closures created a vacuum in the market, especially in areas like infrastructure and large-scale corporate lending, which was dominated by the NBFC. As a result, the market shifted towards a more stable, diversified source of credit, such as private debt funds and alternative investment funds (AIFs), which capitalized on the opportunity, providing structured debt solutions, offering capital to mid-market businesses and filling the gap which was left by the exit of wholesale lenders within the NBFCs. This shift has caused the retail credit to drive overall systemic credit growth, supported by the focused approach of banks and NBFCs in increasing the retail portfolio.

Regulatory changes impacting credit rating and defaults

The corporate bond market has received a considerable boost through regulatory measures in the past few years.

1. Insolvency and Bankruptcy Code, 2016 (IBC): The IBC has revolutionised India's credit ecosystem by establishing a time-bound framework for resolving insolvency and bankruptcy cases. This has resulted in a substantial rise in the recognition and resolution of defaults, which has influenced credit ratings as rating agencies now factor in the heightened risk of defaults. According to a 2023 article by Crisil Ratings on the IBC, the code has successfully resolved about Rs 3.16 lakh crore of debt stuck in 808 cases over the past seven years. Notably, creditors have recovered ~32% of admitted claims and a remarkable ~169% of liquidation value on average. In contrast, other mechanisms have yielded average recovery rates of only 5-20%, highlighting the IBC's effectiveness in securing higher recoveries for lenders.
2. Corporate Debt Market Development Fund (CDMDF): In August 2023, SEBI set up CDMDF to act as a backstop facility for the purchase of investment-grade corporate debt securities from MFs during times of market dislocation. The implementation was in response to the liquidity crisis in the debt market amid the Covid-19 pandemic in April 2020. Now, MFs will have the option to sell their investment-grade corporate debt securities to CDMDF, in proportion to their contribution to the fund. CDMDF will purchase these securities at a fair market price on the given day, thereby enhancing secondary market liquidity in times of stress.
3. Introduction of corporate bonds in held-to-maturity (HTM) category for banks: Recently, the Reserve Bank of India (RBI) amended its investment regulation for banks, allowing corporate bonds under the HTM category and doing away with the 90-day holding period for securities under the held-for-trading category and the holding limit (which was 23% earlier) for securities under the HTM category. This regulation came into force in April 2024 with the intention to deepen the corporate bond market by increasing bank participation. As the investment share from banks increases over time, this shift is expected to lead to a reduction in the cost of borrowing for corporates.
4. Credit default swaps (CDS): As of December 2023, the size of the CDS market in the US was ~$3.2 lakh crore. In India, the market has been inherently illiquid, owing to lack of appetite from investors and illiquid corporate bonds. This is expected to change with the RBI introducing guidelines in May 2022, where the pool for protection sellers was expanded to insurance companies, pension funds, AIFs and MFs, subject to approval of the respective regulator. Post this, SEBI introduced a proposal for MFs to participate in CDS as buyers as well as sellers. The aim is to develop a liquid market for corporate bonds, especially for bonds of lower-rated issuers.
5. Retail investor access: As is the case with all debt markets globally, 98% of corporate bonds are privately placed with institutional buyers in India. Institutions dominate the market with high ticket trades, thereby elbowing out retail participation. Take the case of investing in a National Bank for Agriculture and Rural Development bond. The bond would yield 40-50 bps more than an 18-month fixed deposit for a retail investor. However, owing to large ticket size transactions and limited accessibility, retail participation in corporate bonds remains low. SEBI has addressed this by reducing the face value of corporate bonds to Rs 10,000 from Rs 10 lakh. In parallel with the RBI’s Retail Direct Scheme, which was implemented in 2021 to provide a platform for retail investors to directly trade in government securities, SEBI introduced a registration and regulatory framework for online bond platform providers at the end of 2022, offering an avenue for investors, particularly non-institutional investors, to access the corporate bond market. This is expected to increase retail investor participation in the corporate bond market. Also, retail investors can now choose from various debt instruments, based on their investment horizon and risk appetite.
6. Limited Purpose Clearing Corporation (LPCC): A developed corporate bond repo market contributes significantly towards providing short-term liquidity to market participants without having them sell their debt securities. As the number of participants increases in the repo market, the available pool of short-term funds will grow significantly. To increase participation, SEBI introduced LPCC, whose primary focus is to deepen the repo market. Subsequently, debt MFs have come together to form AMC Repo Clearing Corporation (ARCL), an LPCC dedicated to creating and maintaining an active repo market for short-term funding against corporate bonds as collateral. Counterparty risk was one of the major factors while negotiating yields of corporate bond repo transactions. However, ARCL will now act as a counterparty to every participant, eliminating counterparty risk and counterparty limits, among other factors. This standardisation will go a long way in deepening the market without participants having to worry about defaults.
7. Potential Risk Class (PRC) matrix: The PRC matrix, introduced by SEBI in October 2021, is designed to provide a clearer evaluation of risk in debt MFs. The classification system considers credit risk (based on the credit ratings of instruments) and interest rate risk (measured by the duration of the portfolio). The matrix categorises funds into nine buckets, helping investors more effectively understand the risk profile.
8. Minimum liquidity requirements for all funds: To enhance liquidity in the debt market, SEBI introduced minimum liquidity requirements for MFs in October 2021. The requirements mandate that funds maintain at least 10% of their assets in liquid instruments, such as cash or government securities. According to SEBI, this regulation ensures that funds are better prepared to handle sudden redemption requests, thereby enhancing investor confidence.

Regulatory changes have brought about increased transparency in credit information, allowing rating agencies to make more informed credit rating decisions. This, in turn, enables a more sophisticated approach to credit risk management, ultimately leading to improved credit ratings. However, these changes have also introduced more stringent provisioning requirements for banks, which has negatively impacted their profitability and, consequently, their credit ratings. On the other hand, regulatory changes have led to improved recovery rates for banks and financial institutions, resulting in reduced defaults. Furthermore, the implementation of more stringent credit standards has also contributed to a decrease in defaults.

India's corporate bond market is poised for significant growth, supported by robust capital expenditures and increasing retail investment. Regulatory enhancements like the Insolvency and Bankruptcy Code have improved transparency and attracted diverse investors. Challenges persist, notably in credit risks and retail participation due to high transaction values. Forward-looking, the market is set to become more inclusive, driven by policy reforms and a growing investor base. Sustained growth will require continuous improvements in market structures and investor education to support India’s economic goals.

Disclaimer - Investments in debt securities, municipal debt securities / securitised debt instruments are subject to risks, including delay and/ or default in payment. Read all the offer-related documents carefully.

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