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Monday, 23 October 2017

Indian summer

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Indian Eurobond issuance could more than double this year after nine rate hikes in a year by the Reserve Bank of India. Although financials dominate the market, the global reach for yield is driving improved funding arbitrage and investor diversification opportunities for India’s burgeoning corporate sector. Joti Mangat reports.

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Indian bond markets are feeling the pressure from central bank hawks. Acting most recently in May with a 50bp hike, the RBI has increased its repo rate by four percentage points over the past 12 months in a protracted battle to contain persistent headline inflation.

The yield on the benchmark 10-year Indian government bond is nearly 100bp higher now than it was 12 months ago, rising to an annual high of around 8.4%. Consistently higher domestic funding costs provide strong motivation to seek better terms elsewhere. “There is a natural inclination for Indian borrowers to look at the major international currencies. The RBI is at the highs, while G3 monetary policy remains close to historic lows. The yield differential between rupee and international debt markets becomes even more significant at the long-end of the curve,” said Rakesh Garg, managing director within the investment banking division of Barclays Capital in Mumbai.

While Indian banks can claim a long history in the international bond markets, activity is accelerating and diversifying into euro, yen, sterling and Swiss francs. Issuance of foreign currency bonds by Indian domiciled entities currently stands at US$7.7bn-equivalent from 17 reported transactions, according to Thomson Reuters data, versus US$8.6bn-equivalent from 16 transactions in 2010.

Moreover, non-financial corporate borrowers are beginning to build strong investor constituencies in these markets, as emerging markets funds increase exposure to India risk. Tata Motors, rated Ba3/BB- (Moody’s/S&P) is the most active Indian Eurobond issuer so far this year. Industrial and energy companies account for 30% of the market, up from 23% in 2010.

US dollar dominance appears to be weakening, as issuers diversify into new investor bases. US dollar issuance accounted for nearly 87% of non-rupee issuance in 2010, but only 80% in the first six months of 2011. Sterling and Swiss franc deals contributed almost 20% of supply.

With the prospect of further monetary tightening stalking the rupee market, dealers expect Indian Eurobond issuance to grow to US$18bn-equivalent by the end of the year, from as many as fifty transactions, implying an annual growth rate of more than 230%. “If the monetary policy trend remains intact for the rest of the year, we will continue to see Indian corporates raising funds in offshore markets,” said Garg..

Although the rupee debt market has emerged as an important funding engine for India’s remarkable economic growth story, it remains relatively small in comparison to its regional peers. This restricts Indian banks and companies’ ability to raise large volumes of long-term funding. The Associated Chambers of Commerce and Industry of India estimates the local corporate bond market represents 3.3 % of GDP – about a third of the size of the Chinese market (10.6 %), and less than a tenth of the size of the South Korean market (49.3 %). Despite encouraging developments in the local perpetual market, domestic investor appetite for large size is generally confined to the medium term sectors, with limited liquidity for corporate names at in tenors longer than 10 years.

Mumbai-based dealers said that while a weak Triple B domestic corporate might be able to achieve a five year cost of funds of around 9.7% on an annualised basis in the local market, international dollar investors can offer a five year level equivalent to Treasuries plus 225-250bp. Although there is no recent Double B minus five year offshore deal to refer to, some dealers are confident that international investors can offer a dollar cost of funds around Treasuries plus 350-400bp, versus the 10.25%-10.5% currently available in the domestic market.

Recent multi-tranche transactions including Vedanta’s record breaking US$1.65bn dealandTata Motors’ Jaguar Landrover US$1.6bn-equivalent sterling and dollar offering show that Indian corporates are fast adopting the arbitrage funding techniques of the financial sector. “Indian banks have grown their international capital markets presence over time and are now adept at using different markets to access effective funding, duration and investor diversification,” said Henrik Raber, global head of debt capital markets at Standard Chartered in Dubai. “Indian corporates are also following this pattern. It’s a sign of increasing market maturity.”

Dedicated funds

Driving this evolution is the growing conviction among international investors that India now rivals China as an engine of emerging Asian growth. While investors may have previously pigeonholed India as a BRIC (Brazil, Russia, India, China) economy, dealers now receive increasing requests from emerging market bond funds for dedicated Indian corporate exposure, some have said.

“Investment decisions are not being driven by comparison between India and other emerging markets like Brazil and Russia,” said Gaurav Dangwal, director of institutional sales at Barclays Capital, also in Mumbai. “Investors now are explicitly requesting credits which provide access to the Indian growth story.”

However, with no sovereign dollar benchmark curve and a relatively small universe of active corporate borrowers, investors face limited choices when selecting assets to buy, and benchmarking portfolio performance. Although the financial sector has enough active Eurobond issuers to allow investors to assess Indian banks against each other, the relatively small number of active corporates forces investors to make imperfect comparisons. “There are only a handful of active corporate issuers, so investors have to compare these to global corporates,” said Raber. “That can be problematic because very few global corporates are focused on Indian markets to the same extent as domestic entities.”

Major emerging markets bond funds such as Pimco’s Emerging Asia Fund, BlackRock’s Asian Tiger Bond Fund and Aegon’s Emerging Market Debt funds typically use the JPMorgan Asia Credit Index to benchmark portfolio performance. Indian bonds, both rupee and non-rupee denominated, currently comprise 6.9% of the index, according to JPMorgan. On that basis Pimco’s Emerging Asia Fund is marginally overweight India, with a market value weighting of 8.1%, while BlackRock’s Asian Tiger fund reflects the benchmark’s market weight.

After posting an annual return of 12.24 in 2010, JACI has returned just 0.87% so far this year. However, Indian dollar bonds have performed relatively well by comparison. According to HSBCs dollar Asian Dollar Bond Index, Indian dollar bonds returned just over 3% in the three months to June 9.

Sanjeev Sidhu, emerging markets porfolio manager at Aegon USA, who has participated in both public and 144a Indian Eurobond transactions, uses the relevant components of JACI to benchmark his Indian asset performance. The primary market levels achieved by these transactions leave little room for capital gains, he said. “A significant number of these corporate bonds are fairly priced and offer limited upside in capital appreciation under current market expectations.”

Like other emerging markets regulators, RBI and Ministry of Finance rules restrict foreign investor participation in the both local rupee debt markets, and domestic entities issuing in offshore markets. However, where countries like China and South Korea have sought to protect local currencies from appreciation with stricter capital controls, India’s budget deficit means it needs to attract foreign investment to fill the investment gap. In a departure from regional regulatory norms, Indian regulators in the second quarter raised the external commercial borrowing ceiling for domestic firms to US$30bn, giving their blessing to increased participation in overseas funding markets. Although individual incorporated credits face a mandatory limit on overseas borrowing of US$500m per financial year, dealers say that the central bank is flexible in to giving borrowers additional headroom on a case by case basis. 

With an entente cordiale emerging between issuers, investors and regulators, dealers are confident that offshore market access will become a structural feature of Indian corporate credit markets. “This is a long term development and ties in with the growth aspirations of the country and its companies,” said Raber. “The large national champions tend to be the first ones out issuing, but in due course we would expect to see a broad range of Indian corporates in the market.”

And although most of the issuance has occurred in the investment grade space, robust demand for the Vedanta and Tata Motors transactions proves the market is also open for high yield names. “We are seeing good appetite Indian high yield credits rated Double B minus or higher from investors looking for another method to get a higher yield,” added Garg.

Notwithstanding the global reach for high yielding credit assets, emerging markets investors would like to see further commitment foreign currency markets from the sovereign. “We expect Indian corporate issuance in US dollars to increase substantially in the coming years driven by global interest rate differentials and Indian economic expansion,” said Aegon’s Sihdu. “However, the issuance of dollar sovereign debt to establish a benchmark would help pave the way for a deeper corporate market.”

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