IFR India CM Roundtable 2010: Part 1
IFR: I’d like to start off the conversation on the topic of the Indian economy, which generally seems to be in very good shape. Sunandan, as the economist on our panel, could I ask you to comment on the RBI’s latest rate decision, then talk more broadly about what’s driving the Indian economy and outline any potential red flags?
Sunandan Chaudhuri, SBICAP Securities: Thanks, Keith. The RBI decision was broadly along expected lines. We were looking at 25bp on the repo and the reverse repo. It has come at 25bp on the repo and 50bp on the reverse repo. Clearly the RBI has been giving inflationary expectation management a greater emphasis vis-à-vis the growth-inflation trade-off. And taking a step back if we look at the numbers, the industrial production numbers have been fairly strong as far as the last month was concerned. The GDP numbers have also been robust. So by and large, if we are looking at the long-term growth story in India that’s pretty much intact as far as the consumption and investment drivers are concerned.
One would have liked to see a bit more robustness in terms of the GDP by expenditure figures restated as they were. Private final consumption expenditure could have been a bit more robust. So could have private investment to conclude that we were seeing a decisive turn in the capex cycle. But there have been good numbers all the same, added to which the fiscal deficit-to-GDP ratio at 5.5% seems to be achievable this time. So I think the positives are clearly stacked up in our favour.
The only red flag that one could see on the horizon is inflation, but inflationary expectations suggest that inflation is going to taper off as we move into the fiscal year-end. The monsoons have been good and with a conducive base-effect we should see inflation in the RBI’s comfort zone as we move forward. So I think what I would re-emphasise again is the need to support our growth story on the domestic front and the need for external capital to complement the gap in savings and investment that we seem to have.
The flip side of the savings-investment framework is that the current account deficit-to-GDP ratio is moving from 2% of GDP to around 3% of GDP. Now that has to be managed and therein lies the need of foreign capital, apart from domestic sources of capital and this should flow into productive uses such as infrastructure. That how I see the Indian story panning out going forward.
IFR: Raman, do you agree with Sunandan’s assessment of the economy and are you in full agreement with the policy framework?
Raman Uberoi, CRISIL: I would tend to agree. I think the outlook continues to be robust. We don’t see any immediate issues on the horizon which would force the growth story to taper off. As Sunandan mentioned, I think if private consumption figures had been more robust, it would have been a little more encouraging. But on the demand side, the story appears to be pretty good across most sectors, which is encouraging. So I think it should hold. Anticipation of at least 8% growth over the next few years is out there and should not concern us at this moment of time. I think the only other dampener which could emerge in the slightly longer term is the whole issue of managing growth with adequate quality of manpower. I think that is where India will probably start seeing some issues going forward.
IFR: Actually that’s a big issue you’ve raised. How does India deal with that problem?
Raman Uberoi, CRISIL: We are seeing issues we had started to see prior to the crisis in early 2008, in construction and infrastructure, for example. Availability of quality manpower is starting to be an issue. I think that is likely to continue. I think it’s important that we figure out issues with respect to technical education, higher education and technical proficiency. I have started hearing that it’s difficult to get quality technicians, even electricians. I think ITIs (industrial training institutes) and other such entities that can help promote this could be the key going forward.
IFR: So, Kalpesh, some pretty optimistic views there generally. Sunandan brought up the issue of foreign capital, which is obviously much needed here. Capital flows into India have been extremely robust in 2010 across a range of market segments, equity markets, loan markets, and infrastructure. Is there a danger that India could suffer from too much capital coming in too quickly? Or is it actually the other way around; not enough foreign capital coming in to feed demand?
Kalpesh Kikani, ICICI BANK: Before I answer your question Keith, just an overall comment. Sure the comments so far are optimistic and indeed a lot of the people here are bullish. But in my mind we are still not optimistic enough. We run businesses in North America, in Europe, in other parts of Asia and frankly the conversations there are so much more depressing. We do try to hedge our comments here to say it’s good but we do see these dark clouds on the horizon.
The points people have mentioned are true, but in the context of where the world is at this point in time, I think we need more optimism. Will India face challenges? Sure. But just look at 2007, which was the peak year. If you take external commercial borrowing, India-linked foreign currency loans and foreign direct investment coming from structured finance routes into India, my estimate would be it would add up to around US$50bn. So there is US$50bn of proven capital which came into India. Real estate got a little bit stuck, but barring that, the only reason investors shied away from investing more in India was due to other problems.
But we are back and we have seen a lot more demand for India paper. If you pick infrastructure as a sector (which is always of interest because that’s something that we are lacking sorely on the physical side), we have seen global banks, go all the way to about 12, 13 years on India limits, which is a good thing. Global banks lending 13- year money to India was unheard of and I am seeing some of these guys pushing their credit committees to 15 years, which is amazing. So the specific answer to your question: is there enough money coming in? There is a lot of money coming in. We believe that number is going to increase in the next few months and India can absorb all of that and some more.
IFR: Rakesh: Kalpesh mentioned the conversations he’s having in other parts of the world being depressing. The US is a case in point. There’s political uncertainty, uncertainty around fiscal and monetary policy, and a general lack of confidence. Is India completely divorced from what happens in the US? There was all this decoupling talk a year or two back that turned out to be mythical but I’m not so sure at this stage. What are your thoughts about where India faces the global marketplace?
Rakesh Singh, Rothschild: I think the answer about decoupling is yes and no. For the infrastructure and domestic consumption sectors, the answer is yes. They seem to be pretty much insulated from what you see currently happening around the world. So most of the capital today has moved towards financing or providing capital to these two sectors, which has driven GDP growth etc.
But if you look at sectors which are closely linked to exports, the picture is different. Shipping companies, for example, are having a tough time raising capital. Similarly outbound textile companies are a mixed bag and one does not know how markets will react. Currency appreciation is affecting their earnings significantly. You see textile companies recording significant mark-to-market losses on their exports. Similarly mining companies have an uncertain outlook.
The outlook of companies that are facing outward is very short term at this point of time. But banks, private equity firms, investors and other capital providers are pretty bullish on financing companies focused on domestic consumption.
IFR: So getting into some financing specifics, the Indian loan market raised around US$45bn in the first nine months of the year, which has certainly thrust Indian banks into some stellar league-table positions. Nirav, I wanted to pick up on the offshore versus domestic loan dynamic. Until recently, the offshore loan market was the first port of call for Indian borrowers. This year, there’s been more a lot more activity in the rupee loan market. Will borrowers continue to use the offshore market as the anchor market for their funding and the rupee loan market as a complementary channel? Or is the balance shifting in favour of the domestic market?
Nirav Dalal, Yes Bank: There has been overwhelming interest in the domestic capital markets vis-à-vis the offshore market, particularly in the post-Lehman period of the past couple of years. Indian corporates have experienced one of the disadvantages of borrowing offshore, which is that when crisis hits the global economy, you might have a very strong balance sheet but you might still see your credit spread going out to 500bp to 600bp. That may have nothing to do with your balance sheet, it’s more an issue of global risk aversion.
So given a choice between borrowing locally and borrowing offshore, even where borrowing local is 50bp to 100bp more expensive, I know corporates that would still prefer to borrow locally. That’s because the local credit committees and local investment desks in India know and understand the credits a lot better and therefore are able to handle any credit stress events far better than the international markets. So that’s clearly a factor that we have seen here in the last couple of years.
IFR: So continuing on this local funding theme, Kishore, assuming borrowers prefer to fund in the local market, can they get similar size and tenors?
Kishore Kumar, HDFC Bank: First of all I agree with Nirav that corporates will have a preference for borrowing in the local market. But let’s focus on the quantum of borrowing that will happen in the next couple of years. The major segment is going to be infrastructure. Infrastructure borrowings will have to be pretty long-term and although Kalpesh mentioned that of late some foreign banks are ready to lend long, my view is that it is more an exception than a rule. I know of some very large power project developers who are going out of their way to bring down the average maturity to six to seven years to borrow through the ECB (External Commercial Borrowing) route whereas a similar project, an expansion project for that particular venture could be easily borrowed in rupees for a much longer tenor.
Having said that, there is another genuine constraint, which is very relevant in this context. When you talk about Indian banks, the reality is that 74% of Indian banks are government-owned and the government banks in certain sectors are already fast reaching their lending caps, and project developers are facing a lot of capital-raising challenges.
So while it is good to raise Indian money, the availability of that capital needs to be diversified. One of the agenda items here today relates to the Indian bond market. There’s a long way to go there. One of the issues relating to the bond market is how many infrastructure projects will have an investment-grade rating, particularly those developed at the SPV level? That plays into the restrictions that are placed on long-term participants in the bond market, such as insurance companies. And here again we’re faced with the fact that the largest insurance company in India is owned by the government.
Insurers face big challenges participating in low-rated bonds, so there are so many things which need to be factored in. Getting funding will be done on a case-by-case basis. But let’s not forget that some Indian corporates have been bold enough to borrow rupees to finance outbound acquisitions, preferring not have recourse to external funding at an SPV level abroad. But I broadly agree with Kalpesh that we need to be more optimistic because there’s a lot to do.
IFR: We’ll get to discuss the bond market in due course. But staying on the loan market, one of the issues I wanted to bring up is the issue of Indian banks’ funding costs, which tends to make it difficult for them to compete for mandates with international banks. Kalpesh: isn’t this a perennial problem?
Kalpesh Kikani, ICICI BANK: What you need to look at is the overall delivered cost of money to the customer, right? So even if, as Nirav mentioned, credit spreads widened out dramatically a couple of years back to 400bp to 500bp over Libor, the fact was that Libor was at around 0.5%. So even during the worst times, the delivered cost of money to the customer never went crazily high. The challenge was availability, in that there weren’t too many people out there lending to anybody, not just to India.
Coming to the cost of funds disadvantage, it’s true that the cost at which Indian banks raise money in the international market is much higher these days than it was two years back. Having said that, with the Basel III capital accord, the credit rating and hence the risk weightings of global banks will make Indian assets so expensive in their internal models that it will compensate for the Indian banks’ funding disadvantage. For an Indian bank, companies such as ONGC are Triple A. They’re not for a foreign bank. So that evens up the field.
So there are pluses and minuses. There are large deals being priced in the market today, multi-billion dollar deals, with foreign banks and Indian banks neck and neck on the deals. So I don’t see a significant disadvantage to any single party at this point.
IFR: And what about deal structures? The US$7.5bn financing backing Bharti Airtel’s US$10.7bn bid for Zain Africa; and the US$6.5bn loan backing Vedanta Resource’s US$9.6bn bid for Cairn India both have a multi-tranche offshore piece and a smaller though significant rupee offering. That looks like a smart way forward. Does anyone have any comments on whether we are going to see this split solution being adopted more frequently?
Nirav Dalal, Yes Bank: I think there will be definitely a movement towards combo deals. For some of the project developers we act for, what we recommend as an intermediary is to tie up the rupee piece and look at the availability of ECBs, so depending on the factors prevailing at that point of time, we can have a combination package.
Prakash Subramanian, Standard Chartered Bank: I would tend to agree with you, Keith, especially in the larger ticket transactions, where there may be limitations on the extent of funding that can be obtained from the domestic market. That can also be constrained by the use of proceeds of the funding. So there are certain limitations that may prohibit Indian lenders from extending credit either in terms of size or purpose. So yes you will see well-rated corporate groups accessing both these segments simultaneously to diversify their requirement. So to answer your question, yes I think you will see a lot of this happening going forward especially in the large-ticket transactions.
IFR: One of the areas that is perhaps underperforming in India is corporate bonds, in spite of moves by the government to kick-start the market. From the perspective of borrowers, my sense is that they are more comfortable with the loan market and don’t particularly like the transparency or mark-to-market conventions that come with the bond market. And pricing tends to be much keener in the loan market. Prakash: is there a future for the Indian bond market as a core funding tool for Indian corporates?
Prakash Subramanian, Standard Chartered Bank: Broadly speaking, when the offshore market starts to pick up, the onshore market slows down and vice versa. But as far as development of the local bond market is concerned, ratings and mark-to-market do throw up some real challenges. But there have been some positives since 2008, post the crisis. The bond market helped a lot of issuers on the local currency side because the offshore market was completely dead. If you look at Indian corporate bond market volumes from 2009 to 2010, they have increased by almost 50%, and we’ve seen 10 to 15-year tenors getting done. This is because we’ve seen a huge amount of money coming in from insurance companies and pension funds.
At the same time, however, we’ve seen a complete wind-down of activity by asset managers on the debt side since 2008. They had been the largest set of investors during 2007. Most of those guys are playing at the short end, one to two years. And the banks have completely gone out of the bond market to concentrate on loans right now. So the largest group of investors operating in the bond market are insurance companies and pension funds. But from an active trading perspective, they are buy-and-hold buyers; so once it goes into their portfolios it rarely comes out so there’s not a lot of secondary market activity. So there are still challenges.
IFR: Rakesh, does India have proper benchmarks against which to price corporate bonds?
Rakesh Singh, Rothschild: I think it does. We don’t use mid-swaps like the offshore market does, but issuers can price over government securities or the bank prime rate. The worry is that investor interest is pretty much restricted to the top three rating categories. It’s only at this level that you can price something and have liquidity. If you go down the rating curve, you can pretty much try and guess what the pricing might be.
The concern is more on the investor side. Only if there is more deregulation as to what investors can buy, and only if we have pools of capital that are slightly longer in nature will we possibly see some depth in the bond market. Insurance company money is largely unit-linked money and they tend to stick to the five-year segment and they only really look at Triple A or minimum Double A paper. They are not going to go too low on the rating scale.
Top-rated issuers always have other pools of capital to finance them; there is a lot of choice. But if you go a step below and look even at lower-rated investment-grade companies, I don’t think there is an insurance company out there to fund them. As Kishore pointed out, they should have liability profiles which should enable them to finance longer-term assets but you don’t see that actually happening because the pools of capital are unit-linked capital which expects redemption in five or seven years so fund managers are not keen to commit money.
We were doing a hospital project where we were simply asking insurance companies for 10-year money and we couldn’t even pull together US$100m. So, there are gaps: a lot of liquidity at the top end and very thin liquidity at the lower end of the rating scale.