India’s prominent Public Sector Undertaking (PSU) banks, including major players like Canara Bank, Bank of Baroda, Bank of Maharashtra, and Bank of India, are meticulously charting their strategies to access the burgeoning debt market, specifically through infrastructure bond issuances. These financial institutions are poised to tap capital markets as early as March, yet a palpable reluctance persists, driven by a strategic wait-and-watch approach for borrowing costs to recede from their current elevated levels. This collective hesitancy underscores a critical juncture for the Indian banking sector, grappling with persistent funding pressures as robust credit growth continues to outpace deposit accretion, compelling banks to seek more stable, long-term funding avenues.
The timing of these significant capital raises, according to discussions with multiple debt merchant bankers and senior treasury officials, is intricately linked to expectations of further accommodative liquidity measures from the Reserve Bank of India (RBI). Market participants are actively sounding out potential investors, gauging appetite and pricing sensitivities, but a definitive move is contingent on a more favourable yield environment. While rates on shorter-term instruments like Certificates of Deposit (CDs) have shown marginal softening in recent days, yields on longer-tenor corporate bonds, particularly those relevant for infrastructure financing, remain stubbornly high. This disparity renders the issuance of infrastructure bonds economically less attractive at present, forcing banks to hold their ground in anticipation of a more conducive market.
The central bank’s recent monetary policy announcement, which largely abstained from fresh liquidity-boosting measures, initially disappointed bond markets, leading to an uptick in benchmark yields. For instance, the yield on the 10-year corporate bond issued by the National Bank for Agriculture and Rural Development (NABARD), a bellwether for long-term corporate debt, saw an increase of 6-8 basis points post-policy. This reaction highlights the market’s acute sensitivity to the RBI’s stance on liquidity. Investors and banking treasuries are now keenly watching for signals that the RBI might lean towards supporting liquidity, perhaps by foregoing variable rate reverse repo (VRRR) auctions in favour of continued variable rate repo (VRR) operations or targeted Open Market Operations (OMOs). Such a shift would inject much-needed comfort into the financial system, potentially easing bond yields and making infrastructure bond issuances more palatable for banks.
The underlying impetus for these planned issuances stems from a structural imbalance within the banking system: the widening gap between credit demand and deposit growth. India’s economy continues its robust expansion, fueled by significant government-led capital expenditure and a resurgence in private sector investment, especially in infrastructure. This robust economic activity translates directly into an escalating demand for credit across various sectors, from large corporations to retail borrowers and micro, small, and medium enterprises (MSMEs). However, deposit growth, the traditional and most stable source of bank funding, has struggled to keep pace. As of recent data, the banking system’s credit-deposit ratio has touched an unprecedented 82.2% for the second consecutive fortnight, signaling diminished headroom for further credit expansion without securing alternative funding.
This persistent liquidity mismatch has direct implications for banks’ cost of funds and, consequently, their profitability. When deposit growth falters, banks are compelled to turn to wholesale funding sources, which are often more expensive and shorter-term. Infrastructure bonds, with their minimum maturity of seven years, offer a crucial strategic advantage by providing long-term, stable funding that aligns better with the tenor of infrastructure projects. Moreover, these bonds come with significant regulatory benefits, including exemptions from mandatory Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR) requirements. This makes them capital-efficient instruments, allowing banks to support critical infrastructure development, including affordable housing loans which also qualify under this framework, without tying up excessive capital in regulatory reserves.
Despite the inherent advantages, the current market dynamics present a formidable challenge. While one-year CD rates have eased by approximately 15 basis points to around 6.85%, they remain elevated, creating an inversion where short-term borrowing costs are still relatively high compared to what banks would ideally want for long-term debt. This "waiting game" is further complicated by investor expectations. Large institutional investors, such as retirement funds, provident funds, and insurance companies, which are natural buyers of long-duration assets like infrastructure bonds, are also adopting a cautious stance. These investors typically seek attractive yields for their long-term liabilities and are therefore also looking for the opportune moment to lock in higher returns.
The tepid activity in infrastructure bond issuances during the current fiscal year underscores this market dynamic. According to data from ratings agency Icra Ltd., only two banks have successfully raised approximately ₹15,000 crore through infrastructure bonds so far, a stark contrast to the ₹94,488 crore mobilised by eleven lenders in the previous fiscal year. This significant drop illustrates how yield sensitivity has curtailed banks’ willingness to tap this market. Anil Gupta, Senior Vice-President and Co-Group Head of Financial Sector Ratings at Icra, noted that investors have largely adopted a "wait-and-watch" approach amidst the ongoing interest rate cycle, leading to lower yields compared to the previous year. However, he also observed that the recent inching up of bond yields, partly driven by increased state government bond issuances, could paradoxically improve investor appetite for long-term corporate bonds, including infrastructure papers, by offering more attractive returns.
The broader liquidity picture, while seemingly comfortable at the system level with a surplus exceeding ₹3 trillion on certain days, masks underlying unevenness. This uneven distribution means that while aggregate liquidity might appear ample, individual banks or segments of the market could still experience tightness, impacting their borrowing costs. The struggle to increase the share of low-cost current and savings account (CASA) deposits further exacerbates this challenge for banks, pushing them towards more expensive wholesale funding. This structural issue, coupled with strong credit demand, creates a persistent upward pressure on the cost of funds.
Looking ahead, the resolution of this funding conundrum hinges significantly on the RBI’s liquidity management strategy and global monetary policy cues. As major central banks like the U.S. Federal Reserve navigate their own rate cycles, global capital flows and sentiment towards emerging markets like India can influence domestic bond yields. For India, continued robust economic growth, coupled with ambitious infrastructure development targets under initiatives like the National Infrastructure Pipeline and Gati Shakti, necessitates sustained, long-term funding. The government’s emphasis on infrastructure as a key growth driver means that banks’ ability to finance these projects efficiently is paramount.
Should bond yields soften in the coming weeks, driven by either explicit or implicit liquidity support from the RBI, a flurry of infrastructure bond issuances could be anticipated. This would not only provide much-needed long-term capital for banks but also facilitate the continued financing of India’s critical infrastructure projects, which are essential for sustaining the country’s growth trajectory. Conversely, if yields remain elevated, banks might be forced to consider alternative, potentially more expensive, funding options or slow down their credit growth, which could have broader implications for economic expansion. The delicate balance between managing inflation, fostering growth, and ensuring financial stability continues to define the landscape for India’s public sector banks as they navigate the complexities of the debt market.
