Political Connections and Bond Market

Mechanisms

• Using Reputation
• Social lending Argument
• Collusion Argument
Using Reputation
• political connections of firm executives serve as an alternative
channel for establishing firm reputation when quality disclosure is
absent
• This helps firms gain easier access to debt capital
Social lending Argument
• The bond issuance process is guided by the government’s efforts to
improve social welfare, and the government assigns bureaucrats to
firm executive teams in order to better monitor firms use of financial
resources that are granted to perform these socially beneficial
projects
• Firms use their connections to engage in activities that will influence
the government’s bond issuance approval decisions, and the
government shows partiality to firms whose executives promise to
return politicians’ personal favors
Collusion Argument
• Here politicians and issuing firms collude during the bond issuance
process
 Validation
If Reputation If Social Lending Argument If Collusion Argument holds
enchantment holds true true
holds true
• political • Political connections •The effect of political
connections affect influence offering amounts connections on offering
bond offering amounts with politically
in the state-owned
amounts of firms influential executives will be
operating in a poor enterprises (SOEs) , but not
in the non-SOEs , since the stronger in firms with poor
information
environment, but government is more likely corporate governance
not in firms that to engage SOEs in socially mechanisms.
operate in a quality beneficial projects but not •This is because managers in
information non-SOEs firms with poor governance are
environment better able to return favors
from politicians
Problems of government backed corporate bonds

• Corporations issue bonds to fund expansions and projects, or tide over budgetary deficits.
• The government cajoled publicly owned banks to lend for large corporate investments, resulting
in mega-sized debt defaults.
• Absence of a systematic corporate bond market in India has close down the major development
finance institutions (such as IDBI, IFCI and ICICI) by converting them into commercial banks,
which do not have the benefit of special funding either from the Budget or the Reserve Bank of
India.
The accumulated value of outstanding corporate bonds stood
at 16.3 per cent of the GDP at the end of March 2018 whereas
that ratio for government securities was around 33 per cent
and general government debt is placed at close to 70 per cent
of the GDP.

Source:www.thehindubusinessline.com
ILFS crisis
• Maturity mismatches
• When a large player like IL&FS defaults on debt, the flow of credit to
the rest of the non-bank financial sector tightens, resulting in
“liquidity” problems that can precipitate collateral default and
increase the risk of more systemic effects.
• NBFC failures threaten a systemic crisis
Source:www.thehindubusinessline.com