Why Private Companies Avoid Bond Markets

Ever since the government turned its focus to borrowing through Iran’s debt markets two years ago, their volume has surged.

The government, municipalities and state companies are now the largest issuers of debt. Currently, 88% of the 450 trillion rials ($11.25 billion) of outstanding debt in securities markets are from state actors.

Corporations do not borrow much. A combination of high borrowing costs, regulatory requirements for transparency and guarantees is keeping corporate borrowers at bay, according to Alireza Tavakkoli Kashi, Iran Fara Bourse’s head of new financial instruments.

Corporations only borrowed 10.6 trillion rials ($265 million) in the six months to September 21, which is only 8% of all the bonds issued during the period.

The main deterrent to corporate borrowing is its high cost. Bond rates are 21-25% per year and on the rise, mainly because of high demand for money from banks. The money market is enormous compared to 450 trillion rials in the bond market.

Banks have 9 quadrillion rials ($225 billion) of debt between themselves. Their poor financial state, read enough overdue debt to qualify most of them as bankrupt, is keeping up borrowing costs.

“As long as interest rates in the banking system is around 21 to 22%, bond yields are going to remain in their current range,” said Tavakkoli to the Persian weekly Tejarat-e Farda.

Such rates are neither attractive nor economical for private companies. So, they either avoid borrowing or seek loans from banks that are subsidized by the government or are provided at a discount by the National Development Fund of Iran, the country’s sovereign wealth fund.

  Need for Bank Guarantees

The need for bank guarantees is another factor driving up the cost of borrowing. There are no credit ratings agencies in Iran.

The regulations to create them were written last year, so it will be some time till Iran has some proper ones.

Lack of references and ratings makes borrowing and even getting a bond issue permit tough.

In the absence of ratings agencies, the Securities and Exchange Organization requires a bank to guarantee debt repayment by the bond issuer.

Naturally, banks charge fees to offer this service, in turn increasing the cost of issuing corporate bonds.

  Transparency

There is also an internal reason that keeps a lid on corporate borrowing: transparency. Most Iranian companies have opaque books. Borrowing regulations require companies to provide a transparent stream of news about their decisions, and more importantly have clear financial statements.

However, “many private companies do not really like to produce transparent audited financial statements”, said Tavakkoli.

For this reason, they avoid and are unable to pass regulatory requirements for offering bonds.

There are, of course, many other reasons for the low share of corporate bonds in securities markets, including aggressive borrowing by the government.

Not only government bond issues dwarf corporate offerings, but also the high yields the government is paying to sell its bonds, now around 24%, put companies at a disadvantage.

And then there is also the issue of future economic prospects. With the crisis over overdue debt still in development in the banking system, uncertainty over the future state of foreign trade and poor domestic growth prospects for industries, at least in the medium-term, companies can rarely justify expansion, let alone borrow to do so.