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Market Survey

By: Pramath Nath Acharya

raising funds through


COMMERCIAL PAPER
Commercial paperan innovative step in the Indian financial systemwas introduced in India
in the early 90s on the recommendations of Vaghul working group. Since its introduction, the
commercial paper market has grown many folds and it needs further growth for providing
liquidity to the industrial growth. This article gives an insight into the concept of commercial
paper and examines its pattern of development in India.
ment, commercial papers have become very popular not only in the
developed world but also in the developing world. In the recent years,
the commercial paper has gained
popularity in India and the amount
of commercial paper outstanding has
also increased many folds.
The present study has two objectives. The first is to understand the
concept of commercial papers. The
second is to examine their pattern of
development in India.

Concept of
commercial paper

inancial market plays


a crucial role in facilitating the provision of
surplus and bridges the
gap between surplus
spending units and deficit spending
units. It helps in the process of capital formation which has the ultimate
objective of economic development.
Financial market, ordinarily, pro-

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FACTS FOR YOU

March 2013

vides capital in two ways: long term


and short term.
The market for financial assets having longer maturity period
of more than one year is termed as
capital market, whereas the market
for the short-term provision of funds,
i.e. up to one year, is known as money
market.
Being a money market instru-

Commercial paper is a money


market instrument which is issued
by corporate houses for raising shortterm financial resources. It is an
unsecured instrument issued in the
form of a promissory note with fixed
maturity period of less than one year.
Commercial papers are, normally,
issued in a bearer form on discount to
face value basis and in the denominations of 500,000 or multiples thereof.
The issuance of commercial papers is
governed by the guidelines issued by
Reserve Bank of India (RBI).
A corporate house would be eligible to issue commercial paper pro-

Market Survey
Table I

Chronology of Policy Changes in Commercial Paper


Item

Jan. 1990

July 1990

Tangible net
worth

Rs 100 million

Rs 50 million

July 1991

WCFBL#

Rs 250 million Rs 150 million Rs 100 million

Minimum size

June 1994

July 1995

Sep. 1996

Feb. 1997

Oct. 2000

Oct. 2004

Rs 40 million

Rs 40 million

Rs 500,000

Rs 10 million

Rs 5 million

Rs 2.5 million

Maximum
size

20% of

30% of

75% of
Cash Credit
Component

Denomin
ations

Rs 2.5 million

Rs 1 million

Rs 500,000

500,000

Maturity
period

91 days to
6 months

3 months to
1 year

15 days to
1 year

7 days to
1 year

P1+ by CRISIL

Credit rating

MPBF*

MPBF

100% of Cash 100% of WCFBL Should not


Credit Compo
exceed WCFBL
nent

#WCFBL = Working Capital Fund Based Limit; *Maximum Permissible Bank Finance
Source: Collated from circulars issued by the RBI

vided: (a) the tangible net worth of


the company is not less than Rs 40
million; (b) the company has been
sanctioned the working capital limit
by a bank or any all India financial
institutions; (c) the borrowal account
of the company is classified as a
standard asset by the financing bank
or financial institution.
However, it is mandatory on the
part of the issuing company to get
a minimum credit rating of P-2 of
CRISIL or such equivalent rating by
other agencies as approved by RBI.
Commercial paper can be issued either in physical form or in a dematerialised form through any of the
depositories approved by SEBI.

Development of
commercial paper market
In the early years of nineteenth
century, the commercial paper was
introduced in the USA as a measure of short-term financing. Following the founding of General Motors
Acceptance Corporation (GMAC)
in the year 1919, the commercial
paper market expanded. It is only
after 1980 that the issuance of commercial paper became popular in
European and Asian countries. It

was introduced in the UK in the


year 1986, in France 1985, in Japan
1987, Singapore 1984 etc. During
this period, there was a wave of financial liberalisation and innovation
together with industrial growth that
swept across the globe, which made
the use of commercial paper popular
as a means of short-term financing.
The commercial paper market in different countries is regulated by the
regulations of their respective authorities.
In pursuant to the recommendations of the two noted committees on
Monetary system, i.e. Chakravarty
committee in the year 1985 and the
Vaghul working group in the year
1987, the commercial paper was
formally introduced on 1st January
1990 by the Reserve Bank of India
(RBI) as a money market instrument with a view to enabling highly
rated corporate borrowers to diversify their sources of short-term borrowings and also providing an additional instrument to investors.
In the same year, RBI issued the
necessary directions to regulate the
issuance of commercial papers in
India, which were amended from
time to time by the bank. Initially,
only the companies having tangible

net worth of Rs 100 million were


allowed to issue the commercial paper. However, this stipulation was
relaxed to Rs 40 million in the year
1994 with a view to energise the
commercial paper market. Similarly, working capital fund based
limit was also reduced from Rs
250 million to Rs 40 million in the
year 1994. The details of the policy
changes in the commercial paper
market are shown in Table I.

Present position of
commercial paper market
Following the various relaxation
in terms and conditions for the issuance of commercial paper, the
market has witnessed a consistent
growth. Soon after its introduction
in the Indian market, the demand
for commercial paper increased significantly from Rs 5770 million in
March 1993 to Rs 32,640 million in
March 1994. But in the year 1995
and 1996, the outstanding amount
in commercial paper declined sharply due to withdrawal of the stand-by
facility of the paper coupled with
rising interest rates and shrinking
of surplus funds with banks. However, the market experienced slugMarch 2013

FACTS FOR YOU

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Market Survey
Table II

Table IV

Commercial Paper:
Outstanding Amount,
Range of Discount

Major Issuers of Commercial Paper

As at endMarch

Total
outstanding
(Rs billion)

Range of
discount
(per cent)

1993

5.77

1994

32.64

1995

(Rs billion)
End of
period

Leasing and finance


Amount

Manufacturing

Share
Amount
(per cent)

Financial institution

Total
outstanding
Share
(per cent)

Share
(per cent)

Amount
42.50

Mar-09

271.83

62

127.38

29

441.71

15.7616.00

Jun-09

11.0112.00

Sep-09

344.37

50

234.54

34

108.30

16

687.21

316.48

40

315.09

40

160.71

20

792.28

6.04

14.0015.00

Dec-09

360.27

40

424.43

47

118.35

13

903.05

1996

0.76

20.1520.15

Mar-10

394.77

52

223.44

30

136.85

18

755.06

1997

6.46

11.2512.25

Jun-10

425.72

43

433.30

43

138.90

14

997.92

1998

15.00

14.2215.50

Aug-10

571.61

45

559.33

44

134.55

11

1265.49

1999

47.70

10.0511.50

Sep-10

580.98

52

404.85

36

134.20

12

1120.03

2000

56.63

10.0012.00

Oct-10

803.06

54

548.94

37

144.20

1496.20

2001

58.46

8.7511.25

Nov-10

588.71

50

454.57

39

134.65

11

1177.93

2002

72.24

7.4110.25

Dec-10

492.82

60

249.60

30

83.00

10

825.42

2003

57.49

6.007.75

Jan-11

555.91

55

356.01

35

105.60

10

1017.52

2004

91.31

4.706.50

Feb-11

513.39

51

402.62

39

96.90

10

1012.91

463.50

58

226.95

28

112.60

14

803.05

2005

142.35

5.207.25

Mar-11

2006

127.18

6.699.25

Source: RBI Bulletin, May 2011

2007

178.38

10.2513.00

2008

325.92

9.5014.25

2009

441.71

6.412.5

2010

760.56

5.309.00

2011

803.05

7.9315.00

2012

911.90

9.7515.25

Source: Handbook of Statistics on Indian Economy,


RBI (various issues)

Table III

Average Daily Volume in


Domestic Commercial Paper
Markets Since March 2012
Months

Amount
(Rs billion)

Growth Rate
(per cent)

Mar-12

911.9

Jun-12

1258.1

37.96

Jul-12

1732.3

37.69

Aug-12

1878.9

8.46

Sep-12

1705.8

0.09

Source: Compiled from RBI Bulletin, Nov. 2012

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gishness during the period 2000 to


2004. Due to surge in prime lending
rate (PLR), the corporate houses
felt the need for issuing commercial paper. As a result, the market
revived from 2004 onwards.
Since its inception, Indian commercial paper market has grown
to become an important source of
short-term finance for many business houses. Table II shows the
trend in the amount of commercial
paper outstanding since 1993. During these two decades, outstanding
investments in commercial paper
increased from Rs 5770 million in
1993 to Rs 911,900 million in the
year 2012. Amid tight liquidity, the
rates on commercial paper increased
to an all-round high of 15 per cent
at the end of the financial year 2011.
Discount rates of commercial paper
depend on the demand and supply of
the types of business finance options
prevalent in the market. Currently,
the commercial paper market grew

steadily as both borrowers and investors shifted into commercial paper from alternative money market
instruments.
According to the recent data released by RBI, the corporate sector
has increased its average fortnightly issuance of commercial papers
(CPs) by around 22 per cent (q-oq) to 330 billion during Q2 at discount rates in the range of 9-15 per
cent. This rising trend continued
up to the month of August. However raising funds through commercial paper is becoming difficult
for the corporate sector following a
series of defaultsand rating downgrades, resulting in lack of investor
confidence in these instruments.
Commercial banks and the mutual
funds are parking most of their
surplus amount in commercial
papers as they are yielding better
returns than any other short-term
money market instruments. Hence
banks and mutual fund houses

Market Survey
are the primary investors. With
the number of downgrades rising
in the recent months, the volume
of commercial paper issuance has
decreased. From Table III, it is
evident that the growth rate in average daily volume of commercial
paper issuance is showing a declining trend.
Issuers profile in commercial
paper market has changed remarkably in the recent period. Major
issuers in the commercial paper
market are shown in the Table IV.
During the period 2009-11, leasing and finance companies continued to remain the major issuers
of commercial papers followed by
manufacturing and financial institutions. In the quarter ended
on 31st March 2011, the share of
leasing and finance companies was
58 per cent of the total amount of
commercial paper outstanding,
whereas the share of manufacturing companies, which stood as high

data of the commercial


paper market rates,
Volatility in Commercial Paper
which shows that the
Market Rates
commercial paper marYear/statistics
April 1993- April 1996- April 2000- ket witnessed lower
March 1996 March 2000 March 2007
volatility over a period
Average (per cent)
13.4
11.7
7.8
of time as the SD of the
commercial paper rates
Standard
deviation
2.6
2.2
1.8
was reduced from 2.6 to
1.8. Reduction in volaCoefficient of
tility will be helpful in
variation
0.2
0.2
0.2
maintaining financial
Source: Report on Currency and Finance, 2008-09
stability in the country.
This lower volatility
as 82 per cent in end-April 2001,
is in consonance with the Reserve
declined to 28 per cent. The share
Banks emphasis on financial stabilof financial institutions was found
ity, which is a key consideration of
to be 14 per cent. Total outstanding
the monetary policy.
in commercial paper showed an inTo conclude, the commercial
clining trend, except in the month
paper market was developed to
of December 2010 and March 2011
meet short-term requirements
where it showed a declining trend
of the firms at interest rates and
as the corporates preferred bank fiterms more favourable than the
nancing once the commercial paper
bank loans. In comparison with the
rate rose above the base rate.
US commercial paper market, the
RBI has released the volatility
Indian commercial paper market
is still considered to be young in
terms of its growth.
In recent past, prominent corporates like Power Finance Corporation, Tata Power, Tata Motor and IDFC have been observed
raising short-term funds through
commercial papers. The recent announcement of SAIL to raise Rs
22.50 billion via commercial paper
will add to the growth prospect of
this market. The secondary market
for commercial paper is moribund
because of little activities. However, precautions should be taken
with respect to the quality of the
commercial paper issued. Therefore there is the need to introduce
asset-backed commercial paper in
India for further deepening the
commercial paper market.
Table V

The author is an assistant professor in


Accounting and Finance, Department of
Management Studies, National Institute
of Science & Technology, Berhampur,
Odisha
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