IFR Outlook for Indian Borrowers Roundtable 2016: Part 2

IFR: What about appetite for high-yield from India?

Vikas Halan, Moody’s: One of the issues for high-yield issuers is the all-in cost ceiling, meaning they have to borrow within the 500bp limit set by RBI. That limits the overall universe to very few issuers in our high ‘Ba’ category, or you have issuers like Indiabulls and Lodha that used structures that are not captured by ECB guidelines.

Those kinds of activities are also tied to investments overseas that don’t seem to be happening at the moment, which, in my view, is a little bit puzzling, because if you look at global asset valuations, especially on the commodity side, it’s getting very attractive. We might end up seeing more M&A as we get closer to the end of 2016, which would increase the demand for credit.

Nipa Sheth, Trust Group: When investors talk about the high-yield space, I don’t really understand what range they’re looking at. If you look at bond funding relative to bank lending rates, most Triple A companies can borrow at around 100bp lower in the bond market than they can get from the banks.

If you look at the universe of rated companies, only 10% would be Double A and above. Bank lending rates for companies rated Double A and below are not as high as levels in the bond market, which prices spreads at much higher levels. So none of those companies actually access the bond market because bank funding lines are anywhere close to 10%, 11%, at the most 12% whereas the bond market probably does not have appetite at Double A minus and below.

When foreign investors are asking for higher yields, the expectations are high teens. The only space that has been able to offer that kind of yield is the real estate market because the banking sector doesn’t have capital to give to the real estate sector. Therefore we do see very attractive deals coming from a real estate side that get into the high teens.

But anything between 12% and 16%-17% is missing from the Indian market because bank funding lines are available at lower rates. So unless there is an active repo market below Double A, you will never see these companies tapping the Indian bond market. Bank credit will always be a very big part of it – unless the partial guarantee scheme changes things.

Anjan Ghosh, ICRA: I agree that 2014 issuance seems to have been an aberration. But since interest rates are coming down, local issuance will become more attractive. But even if the investment cycle revives, the market will continue to be dominated by bank loans for quite some time. I don’t really see bond issuance supporting investment activity.

Philippe Ahoua, IFC: A lot of people have been talking about the Fed increasing rates. But what’s interesting is what the Fed does going forward, and what the American economy looks like. There will clearly be a refinancing need. The challenge is going to be whether that refinancing need is going to happen offshore or onshore. And is it going to happen in the form of domestic bond markets or in the form of bank loans?

From a development institution, we’d like to see more of it happening in the bond market, rather than more bank financing. That’s been a challenge in this whole region. This region is dominated by bank financing, and we want to see more of that being refinanced in the bond market. But just to confirm what the panellist have said, that is a challenge in India, because like in other countries in Asia, it’s all locked in to bank financing for various reasons.

IFR: If you look at the onshore numbers for 2014 and 2015, rupee bond offerings amounted to RS2trn in 2014, around US$30bn equivalent. In 2015, so far, we have issuance of RS2.3trn. And we have RS1.4trn and RS1.3trn of rupee bonds falling due in 2016 and 2017 respectively. If you look at the loan markets, we saw US$50bn equivalent volumes in 2014 against US$30bn 2015 year-to-date. we have rupee loans of US$9bn and US$10bn maturing in the next two years.

Given this backdrop and India’s growth prospects, are local bond and loan markets deep enough to meet potential demand unleashed by growth?

Anjan Ghosh, ICRA: Credit growth of around 8%-9% is at least a couple of percentage points lower than deposit growth. There are two reasons why credit growth remains sluggish. One of course is the investment cycle not picking up. Second is the steep decline in commodity prices. Working capital requirements have come down substantially so as of now there is enough liquidity and headroom available in the domestic banking system itself to fund growth even if it revives in the next one or two years.

Also, as we have been mentioning, RBI and SEBI have been taking a lot of steps to provide a fillip to the bond market, such as partial credit enhancements under the IIFCL guarantee structure, infrastructure debt funds and REITs. That is essentially designed to ensure that there is quite a bit of refinancing activities that moves to the bond market from the loan market. And it’s something we are already seeing.

So once the investment cycle revives, and with interest rates going down, there will be additional bond issuance to take care of corporate refinancing needs and the space freed up can be used by the banks to extend more loans.

If the investment cycle were to revive in a big way, given the asset-quality pressures in the banking system and the Basel requirements of maintaining adequate liquidity coverage etc and the huge capital requirement the banks have, there could be a crunch maybe a couple of years down the line. But as of now, we are not experiencing anything because the credit growth is so sluggish.

The other point that needs to be raised once credit growth picks up is the type of capital requirement the banks themselves will have and whether the domestic market is in a position to absorb issuance of AT1 bonds, where investor interest is not very high at the moment.

Sanjay Guglani, Silverdale Capital: The key point the government has to look at from the policy point of view is in terms of the direction they’re going in. As Anjan just alluded to, the capitalisation of the banks is a huge issue and there is practically no way the local market will be able to finance the capital requirements of the banks.

Beyond the issue of bank capital, it’s worth pointing out that the current five-year capex programme for the railways in India is more than the entire capex outlay for the railways since India’s independence. Demand will be sufficiently large to absorb a huge amount of foreign capital. The good news is, of course, that they are inviting foreign capital to come into India and participate.

If you look in terms of defence, we’re years behind schedule. Just to give you a flavour, it takes between three to seven years before a major artillery component is approved. The cycle for testing is three years. If you’re talking big strategic items, of course there is a funding requirement.

Nipa Sheth, Trust Group: There are some interesting dynamics in play. If you look at cumulative demand for bank loans plus bonds, I don’t think it will increase significantly as there isn’t much capital investment happening. You may see some issuers refinance but banks are sitting on a lot of liquidity. If you look at the supply side and real interest rates, we’re looking at channelling funds from real estate and gold into financial savings, which will probably add to more deposits.

We are also seeing that the Indian pension industry is growing at almost 20%-25% and because of some of the steps the government has taken, I wouldn’t even be surprised at 30% growth. So domestic demand and supply should match and then it’s a question of the government’s fiscal deficit.

Until now, Indian bond markets have been dominated by government borrowing and the investment patterns of insurance companies and pension funds are geared to funding the fiscal deficit. In five years, if the government deficit does develop along projected lines, demand will be just enough for the pension funds so the supply or the absorption of the corporate bond market can go much higher.

The second point is some of the NBFC’s balance sheets are growing fast and the understanding and acceptance among international investors of cashflow-based products like CMBS, or annuity based funding, is much higher. So you could see offshore issuers tapping those segments where one is looking at alternative investors and because balance sheets are out-growing what the domestic market can take. It’s a different kind of instruments, the understanding of which is not there with Indian investors at this point in time.

David Rasquinha, Export-Import Bank of India: I just wanted to draw your attention to a couple of points. One is a peculiarity of the Indian market. Sanjay referred to it obliquely, which is that the banks are chasing high-yield credits. Those credits don’t go to the bond market; they tap the bank market. That stunts the growth of the bond market because you can’t expect it to grow on high-grade only.

Linked with that is a peculiar Indian institution of the cash credit account. I don’t know if any other country has this kind of a concept. It basically shifts your working capital management to the banks from the corporates. Internationally you have working capital demand loans, and the corporate manages its cashflow based on that. Here, using the cash credit account, the fluctuations are smoothed out. It may not be directly relevant but I think that needs to be done away with, if the bond market is to really develop.

Lastly, I wanted to make reference to the fact that corporate Ebitda is rising steadily but interest cover is dropping. That is an indication of over-leverage in the economy. The number of companies that are frankly leveraged to the point of no return is rising steadily. And even those who are not that badly leveraged are still so heavily borrowed that you have a dichotomy. They want to borrow. And the banks, despite having the money, are not that keen on lending to them, unless it’s rescue financing. Then it’s a different ball game altogether.

Philippe Ahoua, IFC: We are seeing a lot of diversification in products, in terms of financing needs from clients. We’ve been working with renewable energy companies which are looking to securitise some of their assets and sell to investors who may have FPI licenses. So that’s one example.

One of our competitor multilateral development banks is doing a lot of partial credit enhancements with some of the local enhancers. That’s a good thing. That leads us to believe that there is refinancing need out there, and that people are thinking outside of bank loans.

Vikas Halan, Moody’s: The total amount of credit in India deployed by the banks is about INR62trn. If you just take the 8% growth rate that they have been increasing the deployment by, you’re talking close to Rs5trn in additional bank credit each year. If you compare that with Rs2trn that the bond market is doing, it’s still relatively small.

Sanjay Guglani, Silverdale Capital: Let’s take a step back. We all know the dominance of the banks in India. But if the bond market is developed, what is the fundamental thing you require?

Regulation. The SARFAESI Act (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act) was initially limited to banks and it has now been extended to NBFCs. Can anyone give me any reason as to why it’s not for individuals? The problem is enforcement.

I love liquidity, I’m predominantly in the liquid space but I can compromise as long as I know that enforcement is possible. That’s the key problem and the root of the issuance issue: we need to have the governance and enforceability. And we need justice given on time. Justice delayed is justice denied.

IFR: Let’s add some spice to the conversation. I’m referring, of course, to Masala bonds, a new funding tool available to Indian borrowers. Philippe, how ready are Indian borrowers and foreign investors for this market?

Philippe Ahoua, IFC: If you take a step back and look at the Dim Sum bond market, the Chinese government came in and basically said it was going to help support the market’s growth. So you had the top SOEs and it trickled down the credit curve. What you have in the Masala bond market is a sort of ‘first come, first served’ approach but not a credit by credit approach. So you’ve got the IFC; you’ve got some of our sister supranationals and now you have the Triple A names coming out of India. But it’s too premature really to say how readily investors will take to it.

If you ask me this question six months from now when the Triple A names out of India may have issued, then I’ll be able to tell you whether the floodgates are open or not. I really want to be careful in answering that question. I think it’s just a little bit too early to tell.

Vikas Halan, Moody’s: The economics for Indian borrowers don’t make any sense; somebody borrowing in India at local rates and then going overseas and paying 5% additional withholding tax. The reason you go overseas and access international markets is because you want a broader funding pool but it certainly doesn’t seem like that’s the case here. Also you want extension of tenor. That also doesn’t seem likely.

The objective is clearly to internationalise the rupee, but I think it’s too premature. Also from an investor perspective, I just don’t see how they can make money out of something that is paying the same return as a rupee bond. If you take out the hedging costs, the returns are much lower than you would get on the international bond of that company. So clearly, it doesn’t seem to make sense at the moment.

IFR: David, are you considering one? Have you looked at the market?

David Rasquinha, Export-Import Bank of India: Never say never. But not right now. As Philippe said, I think it’s premature. We have a saying in India: ‘If a boy and a girl are ready to get married, the role of the priest is a formality’. But here, the Reserve Bank of India is the priest and is set to go but the boy and girl are still pretty far apart. The expectations of prospective Indian borrowers don’t quite correspond to the motivations or the features that overseas investors want. There is still a big gap.

In fact, if I can go out a bit on a limb, I think we’re looking at the wrong party. Everybody is looking at the top-rated Indian names to start the Masala bond market, which I think is a mistake. I can get excellent rates for rupees in India. I don’t need to go to the Masala bond market. The incremental benefit to me is little or nothing.

But the second tier, or maybe the third tier of issuers that are still investment grade or just sub-investment grade would probably be willing to pay a premium or it would perhaps be nearer to their local market rates, as compared to the Triple A names. That might work.

Nipa Sheth, Trust Group: It’s a very interesting market. As regards the Triple A issuers, I don’t really think it will make a lot of sense for them to access this market on a long-term basis. You may see one, two, three issuers get pricing established. But it’s so easy for them to access the domestic market at a fantastic rate. They may not need to go to the international market to capture those kinds of rates. Nor do they have an issue of capital, which they can raise from the domestic market.

But it’s setting the tone for times to come. As Sanjay mentioned, the kind of railway spending which we’re talking about in the next five years is huge. If you’re talking about renewable energy, the government is talking about US$10bn of projects per annum. I don’t think India has the capital to fund those kinds of projects over a period of five years. And you cannot be going to the market at the end of five years to double up that market.

At the same time, I’m not too sure about how many Singapore investors would be willing to come to the onshore market. But you have a lot of investors sitting in Europe and the US who may not want to register as FPIs to do a trade. But there are special funds, which could be for renewable energy, for infrastructure, or the social sector. So I think it’s a stage which is being set for that kind of growth for our country.

For someone like an ExIm Bank, which probably gets a better rate than most AAAs, there is no need to come to the international market. But I think it’s setting a tone for infrastructure. Of course, right now the guidelines are restrictive; only companies which can access ECB markets are permitted, but I imagine we will see some issues from the PSU side to set the tone. And it’ll be up to the other Indian corporates to take it forward.

We do see a lot of NBFCs very keen to access this market for the diversity of investors rather than the cost of funds. I think the immediate banking capital requirements will be big. And at this point of time, the rates are not matching because of the forward curves India has. But probably, at some point in time when the rupee stabilises, a lot of capital can come from this market.