(D.H. Pai Panandiker is President of RPG Foundation. The views expressed in this column are his own)
By D. H. Pai Panandiker
The market for commercial paper (CP) has been active. Corporates seem to prefer CP to bank credit partly for greater ease but mainly for lower cost. In 2009-10 growth in CP was 71 per cent. Perhaps that buoyancy may not continue for long.
CP is not a new instrument. It entered the market in 1990 but was properly regulated from October 2000. It is an unsecured money market instrument and has been issued mostly by companies with minimum P-2 credit rating.
The intention of the RBI was to develop a sound money market through a variety of short term instruments. CP enabled the companies to diversify their sources of funding and gave the investors an opportunity to place their short term funds in a liquid asset.
The CP was a good means of funding receivables, inventories and short term liabilities with much greater ease than raising limits for bank credit.
Until 2007 the market for CP was rather limited. That was because the money market was short of liquidity and the banks consequently were offering attractive rates on deposits. The total outstanding CP at the end of March 2007 was Rs.19,012 crores.
The world financial crisis changed the complexion of the Indian financial market also. Interest rates were cut drastically by the RBI. The repo rate was down from 9 per cent to 4 per cent.
However, the prime lending rates of banks hardly moved from 12 per cent though priority borrowers did get credit at lower rates.
Corporates discovered that the cost of short term funds raised through CP route was lower than the rate on credit from banks. The outstanding amount against CP jumped to Rs.75,506 crores by March 2010 after crossing a peak of over Rs. 1,00,000 crores in the last quarter of 2009.
Corporates were able to raise these funds at rates which varied from 5.3 to 9 per cent depending on their credit rating. Had they opted for bank credit they would have had to pay an additional 2-4 per cent.
CP was a good short term security not only for investors like mutual funds, individual investors, companies, etc but also for banks. In March 2010 more than 40 per cent of the outstanding CP was held by banks.
That was because banks were saddled with excess liquidity. Deposits were increasing faster than credit and some of the excess money found its way either to the reverse repo window of the RBI or to the money market for CP.
A change is now under way. First, the system of PLR will change from June 1 this year.
Banks will charge a base rate to high rated borrowers which may narrow down rate differences between credit and CP.
Second, with the growth in industry, demand for credit will jump and excess liquidity will be wiped out. Both mean that CP will be more costly to the corporates and less attractive to the investors, slowing down its market growth.
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