Monday, 22 October 2018

IFR India Offshore Financing Roundtable 2016: Part 3

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IFR: Bharat, do you buy the notion of disintermediation taking hold increasingly in India? And could the process be accelerated given high levels of NPLs at the State banks, which in turns might constrain their ability to lend?

Bharat Reddy, JP Morgan: To answer your question in a slightly different way, we were at a meeting yesterday with one of the leading private sector banks. I was surprised to note that they said they had seen significant uptake in lending to medium and small enterprises. And this is over the last six months.

Having said that, as far as disintermediation in India is concerned India is a largely bank-funded market for a lot of industries and sectors. The government is taking certain measures to address the non-performing asset situation, which is a legacy scenario. The bankruptcy law is scheduled to be brought in the winter session of parliament.

Clearly, there needs to be a clean-up of some of these parameters. I don’t think the banking sector itself is suffering from any fragility. If you look at the Cash Reserve Ratio and Statutory Liquidity Ratio in India they are the highest in the world. So it’s all a question of cleaning up the books and getting the State-run banks to lend again as freely as they were a few years ago.

Disintermediation has to happen in India, as it does in any growing economy and developed market, but I think it will happen gradually.

Tarun Gupta, T&A Consulting: I agree with Bharat. This fits in with what our government is trying to achieve. Services have always been a strength in the economy but if we are to achieve target growth rates, we have to get our manufacturing right.

I’m glad that Bharat mentioned credit off-take at the SME level is increasing because the SME sector is still bank dependent or even dependent on the informal finance sector. There is a need for capital markets and I just hope that the supporting ecosystem is built in. [On the issue of NPLs], we are seeing some promising initiatives, such as the restructuring of State Electricity Board loans and making state governments liable for paying back the debt. Initiatives such as these will help improve the non-performing assets situation for of some of our public sector banks.

IFR: On the issue of state involvement, I wanted to move on and talk again about the government sell-downs in the equity market. If you look at ECM activity in India, this dominates activity in volume terms. It’s an active area.

But I wanted to focus not on what’s out there but more the process. The issue that refuses to go away and one that certainly continues to fascinate the media is the notion of the one rupee underwriting fees for State sell-downs. When the government put out two baskets of state companies out to tender among the banks, the response was lukewarm. Basket 1 didn’t get any interest and was scrapped. Basket 2 attracted just four banks and notably only one foreign bank.

How tenable is it for the Indian government to strong-arm the banks into underwriting this business at a loss? ‘

Sumit Jalan, Credit Suisse: It’s less an issue from the government in terms of not wanting to pay a fee; it’s partly the result of laissez-faire: as bankers, we ourselves are arguably to blame. When we go and pitch, [low-balling] is a way of winning mandates. We in the banking community have gone down that path ourselves.

I don’t think the government ever came to us demanding one rupee underwriting fees. It was more like: “this is what your competitors have proposed. Technically we like you but are you a match or not?”, which is the standard government process across sectors and not just banking or divestment-related processes.

Clearly, bankers and people from the financial fraternity clearly have monetary expectations and hence the motivations are different where you

have economics working in your favour against where you don’t. Over the years earlier [doing this business] has been driven more by its scale and size and the fact that you’re serving the country and certain factors around that in the context of building a franchise.

Those were the key considerations. Over the years, having largely built franchises, most of the firms have started making a call in the context of resource, as well as the revenue coming of it.

In the context of the two baskets you referenced and which the government tendered out recently, the issue that became was as bankers, you’re placement agents so you’ve got to be convinced about the stock that you’re out there to place. In a basket, you may not be as convinced about a couple of stocks in the basket as there may be some lemons in among the good stocks.

That’s where it starts becoming more complex when you’re working for that same one rupee: instead of one stock you’re working, potentially, to understand five stocks and possibly pushing through some stuff which the institution internally may not be as convinced about. I think that’s where the reaction from the banking community with respect to the basket approach was.

IFR: So to Sumit’s point, Bharat, it’s less an issue for the government. It’s more an issue for investment banks over-competing to get the business and effectively, backing themselves into a corner.

Bharat Reddy, JP Morgan: Yes, I think that’s right on the mark because the procedure for selection is very clear in terms of the weighting given to the technical qualification when you make the presentation, multiplied by the weighting of the financial bid. Now, if one of our community were to quote a very low number, the others are forced to match that number so in that sense there is no real arm-twisting by the government.

It’s members of our own community who take the initiative in putting in a very low number in order to win the mandate for whatever reasons, league table, you name it. But I think sense is starting to prevail in that hopefully, people will start putting in more competitive bids and they will get paid for their work.

Mangesh Kulkarni, Axis Capital: Some of the PSUs have paid significantly more than one rupee so it’s not government that is forcing us. It’s competitive pressure to be number one in the league table, to be able to showcase the market to your set of investors. That’s what’s driving this.

Jayen Shah, IDFC Bank: On the bond side in local markets many top-tier issuers don’t pay a penny when underwriters and arrangers are committing INR100m INR200m, INR300m to get a bond transaction placed. The hope is that nothing goes wrong at the underwriting price and there’s stability in monetary affairs by the ministries plus the regulator so that by the time you distribute you haven’t lost money. So that is the praying part.

If something goes wrong, then the underwriter or arranger books a negative mark-to-market, runs with it and hopes that a few months or a few quarters later he’s able to recoup his mark-to-market and sell-down. Underwriter who have a strict sell-down requirements – 30 days, 60 days, 90 days – book the losses and go home. That’s the reality of onshore bond markets for the very top-tier names.

Looking at the list of some of the issuers going for Masala Bonds, I am hoping that they start paying their way so that we can start asking more from them. Actually, forget the more part, I will start asking.

Manan Lahoty, Luthra & Luthra: We’ve had interaction with the government. We have a similar process. They also need to appoint lawyers for their transactions but we’ve always seen them fairly open to ideas.

In some of the recent situations, they’ve asked for a technical bid and a financial bid but said that while the financial element is important you can’t beat somebody else just because your financial is the lowest. Something like that might work. Maybe the government didn’t feel the need to change it because they were getting top-quality banks by paying them a rupee. But like you said, Keith, one bucket has failed this year and the pressure is on the government now.

They’re to start thinking about what is legally defensible. The process has to be transparent; it has to be open; it has to be fair. Nobody should be able to go to a court of law say: “this was not done properly”. That is the key concern government officials have.

Audience question: On the rating side, if you go for a Masala Bond or an offshore bond, can the onshore Indian rating assigned be considered equal to the offshore rating? Will investors and the rating agencies be comfortable with this?

Sumit Jalan, Credit Suisse: Answering on behalf of the investors first, let’s look at the profile of investors and their mandate. Assuming a pension fund, a sovereign wealth fund, or a real-money account is looking at a potential Masala bond; their mandates typically would direct them to participate in an internationally-rated instrument.

Only a prop desk or a prop fund will be in a position to translate onshore ratings, apply their own internal translation measures and say: “I’m good with a particular onshore rating” and not really insist on an international rating. But the bulk of the investor community will look for an international rating.

Talking about the rating agencies, while they may be Indian subsidiaries or associate of international firms, there is a fiduciary responsibility which is a differentiating element. The local arm of a rating agency, which has a fiduciary duty towards the local markets and local investors and has a local dimension to play with, is not necessarily concerned about political risk or regulatory clampdowns or currency going topsy-turvy, which a foreign rating agency will also factor in its rating criteria and rating parameters. So there would be a difference in their own mandate between, say, S&P and CRISIL

Indian issuers selling international bonds have to go and get their international ratings before they go out with a new issue. So to your answer, the bulk of investors will want international rating in the end for the instrument.

Audience question: There are two bills which are pending in the Indian Parliament: the GST and the Land Reform Bill. People say that if GST passes India will overtake China in terms of growth. But, worst case scenario, if these two bills don’t pass in 2016, what do you expect? Where will the equity markets go?

Sumit Jalan, Credit Suisse: A lot of these regulatory changes, including GST, are far more complex when you get into the nitty-gritty, just in terms of synching up all the states that we have in India. Expectation-wise, it’s fine for the regulatory change to happen immediately, but with the best of intentions it takes time. My personal view, speaking to investors, is that they seem to understand that it will take time. It won’t happen in a jiffy. It has already taken now a year to 18 months, so it may take longer than even, let’s say even 2016, as you’re alluding to.

I don’t think it will really impact so much on the market or on valuations. Yes, the positive impact of GST on the real economy obviously gets pushed out, so the acceleration in GDP growth following GST roll-out gets pushed out further. That has its own impact on impact on market valuations but I don’t think the expectation, per se, is that it’s happening over the next three months or six months.

Mangesh Kulkarni, Axis Capital: It’s already got pushed out a little bit. From a legal perspective, I doubt if this is still a good time to be able to pass the Bill and try and launch in the next three or four months. There’s a lot preparation people need to do.

Of course, from a market perspective, it’s important. From an economic growth perspective or compliance perspective, we are already at the end of November. There’s a question mark as to whether companies will be launch on April 1. The government must keep that in mind. The Finance Minister and others have been making commitments that GST will be rolled sooner rather than later.

IFR: Let’s move to the very final session. We would like to ask each of the panellists just to make a short closing statement. What’s on your agenda for 2016 and what are your expectations?

Sumit Jalan, Credit Suisse: My expectation remains that some of the good work which has been undertaken at a macro level: the regulatory changes or political desire to get back the acceleration on the economic side will hopefully continue and hopefully the economy will pick up.

I think it’s important because to my mind, it’s a make-or-break year for the current government in the context of the next 12 to 15 months. Post that, we’ll start getting into the second half of this government’s five year innings.

Investors, promoters and corporates are all are potentially waiting in the wings to take risks and to back risks. So personally I think the environment is conducive. Fingers crossed and the expectation remains that we’ll see some of those things what we have talked about over the last 18 months, hopefully with all the feedback and work which has gone in, actually fly over the next 18 months.

Jayen Shah, IDFC Bank: To start with, maybe 300bp cut by Dr Rajan would help stabilise dollar INR.

We’ve seen some green shoots in this calendar year in infrastructure; whether it’s transmission assets, new road projects, new transmission projects, or renewable projects. There are a lot of new projects being announced and they’re getting to financial close. So that part is positive, but that needs to widen across almost all sectors of the country to get the capital investment cycle up and running.

We expect the fiscal components of the country to remain as per the guidance that has been agreed within RBI and the Finance Ministry so that forward-looking inflation remains under control. So a 200bp-300bp rate cut can be given by Dr Rajan over the next 12 to 18 months.

Immediately, I’m looking for the bankruptcy law to be passed. [On December 21, the government introduced a Bill in parliament to reform the bankruptcy system].

Mangesh Kulkarni, Axis Capital: Expectations for this year would actually start with the budget. People are hoping that this budget would be a Big Bang budget. If we get a good budget, it would also followed over the next 12 months by subsequent actions. So that remains a key issue.

Along with that, I think, there is a lot of hope and anticipation. The markets are looking at India as a performer. Possibly when China is slowing down, India is looking as one of the countries doing reasonably well. The currency is fairly stable; there is a strong intent from the RBI side to help corporates and give them a reasonable regime also.

But I think this has to be matched by the performance of corporates. I think at some point of time, as Sumit said, it has to be matched by action. There are so many upcoming elections in 2016, so you don’t know how the reformist government will be able push its agenda. Having said that, I think we are quite bullish.

Bharat Reddy, JP Morgan: From my perspective, I do hope that the Depository Receipt Scheme 2014 is actually implemented finally, with SEBI, RBI and the Ministry of Finance being different stakeholders able to harmonise any remaining discrepancies which are preventing it from being operationalised. And we expect a slew of Level One OTC listed programmes, both sponsored and unsponsored, to flow once these regulations are activated.

I’d also hope that the initiative taken by the government in setting up the NIIF, the National Infrastructure Investment Fund, is successful because this would bring in a lot of long-term money from pension funds cross-border into India to start investing in the infrastructure space. I suspect a lot of this could be via international bond issuance, depending on the eventual success of the NIIF.

And lastly, I think the bankruptcy law, which Jayen alluded to, this has been a mill-stone around a lot of banks and lending institutions in terms of very high levels of non-performing assets. And once that law is actually legislated upon I think we would see a significant improvement in credit levels.

Tarun Gupta, T&A Consulting: From the overseas capital market we see two themes. Private equity has been one of the largest sources of FDI. Since beginning of 2000, we have seen close to US$100bn of private equity coming in and invested in over 3,000 companies.

One of the themes for next year is some of these portfolio companies to list overseas, which could be lack of peer group or which are IP driven. So we see that as a theme where they’re evaluating overseas capital markets. It could be, for example, our market i.e Swiss capital market for life sciences, so that’s one theme.

Second is also the theme which is emerging would be a lot of them have assets overseas and they are looking to monetise or list some of their subsidiaries overseas. These are the two themes which we see for next year.

Manan Lahoty, Luthra & Luthra: There’s an explosion of Masala bonds waiting to happen. The government has made a big statement. They’re willing to integrate Indian financial markets with global financial markets like they’ve never done before. They’re actually willing to make a statement to the effect that if you can’t develop a solid corporate bond market in India, that’s fine. Borrowers need to compete; but we will not necessarily protect them. It’s also a step in the direction that the rupee will be fully convertible at some point in time.

You will have transactions for the first time in India in rupees between two non-Indians. That’s a fairly important policy statement by the government. I think what is important is that while this government knows the big picture, understands every single element of the big picture, delivery is important. That’s a classic sort of situation when we speak about the DR scheme. It’s a great idea; a great product with simple regulations. But it still hasn’t been implemented.

The government has to start moving away from thinking about Big Bang reforms, which they were criticised for not implementing to actually implementing what they have announced. Whether it’s the GST, the bankruptcy bill, the DR scheme or even Masala bonds, I’m sure there will be some problems that people will initially face. How quickly they are able to remove those problems is the key to how the next 12 months will be for us.

Marco Estermann, SIX Swiss Exchange: We heard, at the beginning of the session that in order to grow and achieve the growth that they see as a vision by 2030, India needs capital. And therefore, my expectation and hope is that the Indian government will realise that in order to get this capital, they need to clarify some of the regulations, as Manan said, be it the DR scheme or bankruptcy law and so on.

And also give issuers the flexibility to tap into different pockets of assets to finance that growth, not least because of the quantitative easing programme in Europe; there’s a lot of liquidity that wants to be invested. I see it as a natural move for the Indian government to allow companies to tap into these pockets.

Masala Bonds are one thing, but I think some investors would prefer to make equity investments and therefore, the Indian government should clarify some of the regulations, some of the good steps they have taken into the right direction. And actually help companies raise capital going forward.

IFR: I think we covered a lot of ground and I must say it was a great session. Thank you, gentlemen, for your fabulous comments.


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