Euphoria tempered

India has long promised a primary debt market boom but little has been delivered. Still, there are pockets of hope in the infrastructure sector as new bond formats begin to emerge. Bank capital requirements, however, remain a challenge as the sector urgently needs consolidation and recapitalisation.

A new dawn for India’s capital markets beckoned when Prime Minister Narendra Modi took office in May last year. The hope was that Modi would instigate an infrastructure boom in the country as well as tackle balance sheet problems at the banks and consolidate the industry. Debt markets were set to boom as a result but frustration has set in.

The offshore funding route has been taken by the large Indian corporate with international name recognition as well as the state-owned and large private banks. But the fact remains that given Reserve Bank of India regulations demand that such issuance be hedged, the costs on a post-swap basis are high and it is cheaper for most Indian entities to look to raise capital onshore on a term-funding basis.

“There was a degree of euphoria in terms of issuance but that has abated due to external stress factors such as the China and commodities sell-off and perhaps expectations got too heady,” said Rakesh Garg, head of global finance, for Barclays in India.

“The key problem is that a lot of the companies in the traditional sectors of the Indian economy, such as steel, power, cement and textiles, are over-leveraged and not generating sufficient Ebitda to cover interest payments on debt.”

Still, India’s blue-chip corporates are willing to take the offshore route in the interests of investor diversification, and those in the investment-grade silo can tap tenor and size in the US Reg S and 144A markets, where Indian paper still commands a rarity value premium.

Much of this paper has emerged from the oil and gas sector, but in June telecoms company Bharti Airtel was able to price a US$1bn 10-year inside its implied curve for two times book cover. The demand is there, but supply remains sorely lacking from the India corporate complex.

“The domestic market is very liquid and presents a more compelling case for Indian borrowers than taking the offshore route, where hedging costs are high. There have been various phenomena such as the use of standby letters of credit, but there is a concern that the creation of contingent liabilities could become excessive. The issuance of offshore rupee bonds is waiting in the wings and we are bullish about the future of the asset class,” said Garg.

Offshore rupee bonds – dubbed Masala bonds – have been long in gestation and, after a long wait, in June the RBI released draft guidelines on the product.

Far from exciting market players, the guidelines were widely savaged as being too restrictive. Issuance in Masala bonds would be made according to the external commercial borrowing guidelines, under which most Indian companies are prohibited from borrowing more than US$750m-equivalent in any one year.

Further removing any buzz from the proposals was the imposition of pricing, volume and use of proceeds strictures on Masala issuance, as well as the prohibition of banks from issuing in the asset class.

Potential high-yield issuance in Masala bonds was headed off at the pass by the requirement that issuance in the format could not come more than 500bp wide of like tenor Indian sovereign issuance.

It seems therefore that only top rated Indian issuers with name recognition will be Masala bond issuers. Initial forays in the product came from the Asian Development Bank and the International Finance Corporation, which have typically issued in offshore domestic currency for benchmarking purposes.

The prohibition of Indian banks from entering the Masala bond space has shone a spotlight on the capital needs of the Indian banking system, where it is estimated that there is a Rs400bn (US$6.2bn) Additional Tier 1 funding requirement between now and the end of the fiscal year in March 2016.

In addition, the system requires as much as Rs2trn in Basel III-compliant funding over the next three years, according to Icra estimates.

“There is a huge need to raise capital among the top 10 Indian banks. Still, there is a tremendous need for consolidation in the Indian banking sector and a need to clean up balance sheets in order for the banks to lend. The RBI understands the pressing need to do this and there are various schemes to address the NPA issue,” said Garg.

Seven-point plan

In a reflection of the sense of urgency that surrounds India’s sprawling banking sector, which is mired in non-performing assets and urgently needs to kick-start lending, India last month produced a seven-point plan to transform the country’s public sector lenders.

The plan includes the establishment of a bank board bureau, creating a capitalisation plan, easing bad debt, reducing government oversight and cleaning up corporate governance.

The government has pressed the state-owned lenders, which own around 72% of the country’s bank assets, to lend to infrastructure projects. But many of these loans have been poorly structured and the projects are loss-making. It is estimated that in order to meet the government’s loan growth target of 15%–18% over the next three years, about Rs1trn will need to be injected into the Indian banking system.

This should provide a fertile environment for bond issuance from the banking sector and Asia-based DCM bankers envisage that the Indian bank issuance rush in the offshore dollar markets after the global financial crisis, during which the country’s large banks became serial issuers, could repeat itself.

Meanwhile, India’s infrastructure sector is tipped to be on the verge of an issuance bonanza, with recent deals suggesting in what form that bonanza might manifest itself. Renewables are top of the list, with the wind sector likely to lead an issuance charge, and the hope is that a fully fledged project bond market will emerge in India, to help fund Modi’s infrastructure push in India.

“Renewable energy is a bright spot where there is tremendous interest both from the equity and debt side,” said Garg.

A multi-tranche Rs4bn bond from wind power company ReNew Power Ventures, split into six tranches with funds raised to increase capacity at a 84.65MW wind power plant in Maharashtra, was priced in 2012 with a credit-wrapped structure of a 10-year tranche, which carries guarantees from the Indian state-owned India Infrastructure Finance Co and the Asian Development Bank.

Credit wraps and public private partnerships are seen as the way forward for issuance in the Indian infrastructure sector and it is rumoured that around another dozen-odd infra companies said to be looking to follow ReNew’s lead.

Last month, ReNew was back in the market with a Rs4.53bn credit-enhanced – again via IFC and ADB – multi-tranche deal with maturities as long as 18 years.

“India’s vast infrastructure needs cannot be fully met by the country’s capital-constrained banking sector. Offshore lending in Asia has shrunk by around 15% this year as a result of regulatory constraints and there is a pressing need for disintermediation into the bond market if these infrastructure projects are to get off the ground,” said a Singapore-based DCM head.

Green bonds

Bankers are also getting excited about the possibility of Green bonds emerging as a significant financing tool for India’s infrastructure market.

Green bond issuance from India started this year, with Yes Bank issuing Rs10bn in February and Export-Import Bank of India printing US$500m at 10 and five years, respectively. Investors responded enthusiastically to the issuance, which allowed the planned sizes of both transactions to be increased.

Green bond issuance allows for the diversification of funding sources for renewable projects outside the local and offshore bank sphere and moreover taps the deep base of capital held in socially responsible investment funds.

“There is a capital cost involved in expediting the vetting procedures required for Green bond issuance, but nevertheless given the deep pools of capital sitting in SRI funds and India’s pressing need for infrastructure that can be met via renewables, you would have to imagine that a Green bond issuance blitz is waiting around the corner,” said the DCM head.