CB issuance plunges on regulations, pricing

India stands on the threshold of economic greatness, if only it can ride out the global credit squeeze and overcome an innate desire to regulate itself out of international competitiveness. Economic growth remains robust but may slow to a credible 7.5%-8% this year despite the wider global slowdown but, like elsewhere in the region, inflation poses the biggest immediate threat to prosperity. Strong commodity prices are feeding through the supply and production chains and sharply higher food prices have given this year’s bout of inflation a serious political dimension. Looking further into the medium and longer term, inadequate infrastructure is probably the biggest brake on India sustaining its impressively high growth rate. The government, in recognition of this shortcoming, has set itself the daunting challenge of investing US$500bn in infrastructure by 2012. Meeting such a target will be hard to realise. It will require significant public and private investment as well as substantial amounts of foreign capital. International investor appetite for Indian assets is strong, but the Indian government, rather than just tinker with its capital controls every time the markets run too hot or cold, may well need to rethink its entire capital account framework if it is to attract such large sums of money. It will also need efficient domestic capital markets, and that is where the regulators come into play – and their record in this field has been patchy over the years, to say the least. It does not seem to be getting appreciably better. Indian equity markets are down and out, for instance, and while tough market conditions have obviously been a factor, the role that regulations have contributed to the virtual disappearance of India’s IPO market this year has been frustrating. The Securities Exchange Board of India (Sebi), the country’s famously obstructionist securities regulator, has taken steps to make issuance easier but, predictably, has not done enough. Sebi revised the floor price formula for the pricing of qualified institutional placements and preferential allotments to institutional investors. This is welcome but, realistically, the formula only makes issuance easier in a rising market and does not offer much help in shaking off a bear market. There is hope, however, as the Ministry of Finance, which governs the issuance of ADRs and GDRs, is looking into the issue. Likewise in the equity-linked space, onerous regulations combined with credit market woes to make difficult times even worse. This time the Reserve Bank of India has come in for criticism. Throughout the recent economic boom Indian companies piled into the offshore markets, raising capital with popular equity-linked products in order to fund growth. The central bank clamped down on such borrowings, however, fearful that the economy would become too exposed to short-term foreign debt. It subsequently eased restrictions following pleas from issuers but they are still constraining. The regulators seem to be doing a better job on the bond front – or at least not interfering to the detriment of its development. The domestic bond market continues to progress – at least it did until the sharp rise in inflation – even as G3 issuance dried up on the back of a global risk aversion. Investor aversion to all but the best emerging market credits spread to India and its aspirational corporate base. Perhaps the most notable change in Indian capital markets over the last year has been the decline in offshore syndicated lending activity as M&A volumes fell. Indian corporates are using this lull to contemplate the best ways for them to access international capital in the future, which suggests foreign targets are yet to see the end of Indian suitors. The real changes need to happen at home though if India is to develop the kind of local economy necessary to keep its growth numbers intact. Opening up the domestic capital markets, combined with a more sanguine approach to foreign

Reliance Petroleum’s US$500m loan, signed in April, illustrates the group’s appeal. In the middle of a global credit crunch, Reliance Petroleum secured a seven-year loan with no fewer than 19 banks at the MLA level – a telling sign of its popularity. “The biggest reason [for taking part] was the profile of the deal,” said Tajinder Singh Setia at ABN AMRO in India, one of the 19 MLAs. “The fact that it was from the Reliance group ensured wider participation.” The loan will finance the second phase of a 580,000 barrel a day refinery in Jamnagar, Gujarat. It follows a US$2bn hybrid corporate and project finance loan signed in October 2006 which financed the first phase. The latest deal was effectively an extension of the first, with an average life of six years, and what Setia calls a “plain” structure. It paid 155bp over Libor, which he described as “very competitive in this environment.” Initially six banks were mandated on the financing: Banc of America Securities Asia, Bank of Tokyo-Mitsubishi UFJ, HSBC, Mizuho Corporate Finance, Sumitomo Mitsui Banking and West LB. It is understood that a signing among those six took place on March 19, and that Reliance Petroleum had been keen to do so before March 31 because of India’s external commercial borrowing guidelines. In any fiscal year (in this case running from April 1 to March 31) an Indian company can seek approval from the Reserve Bank of India to borrow up to US$500m in offshore funds. Sealing that approval before March 31 freed up the company to borrow that amount again from the offshore markets in the new fiscal year if necessary, perhaps to refinance existing deals in brighter market conditions. However it was after March 31 that the broader banking group – ABN AMRO, Arab Bank, Banco Bilbao Vizcaya Argentaria, Bank of Nova Scotia, Calyon, Credit Industriel et Commercial, DnB NORBank, KBC Bank, KfW, Natixis, NordLB, SG and Standard Chartered – came in to the deal, signing it in Beijing on April 28. With all of those banks participating, there was no need to hold a general syndication. On first sight the absence of American houses bar Banc of America is striking, although Setia says the lenders do not look dramatically different to the way they would have done before the credit crunch. “I wouldn’t say the banks are significantly different. It’s just the participation of banks has been widened,” he said. This naturally reflects banks wishing to spread risk. While the scale of the lending group looks unwieldy, it is not uncommon, as was illustrated by a deal from another part of the Reliance Group, Reliance Industries, when it launched a US$1.2bn five-year bullet loan in July with 19 banks in its arranger group and, by late August, 24 banks in total. “In the space of three months they have raised US$1.7bn,” said Setia. “That’s a significant achievement given the credit conditions. It is unlikely many borrowers could do that in this market, as is evidenced by the number of deals from the Indian corporate sector. There have been just a handful of deals in the last six to eight months.” There are likely to be still more. Market talk is of a US$2bn reserve-based lending deal, which is a project finance facility backed by Reliance’s known oil reserves. Also, Reliance Petroleum itself will at some stage refinance both of its loans ahead of step-up margins from the original financing coming into effect. The plant the Reliance Petroleum loan will finance is expected to be groundbreaking. It will be able to convert heavy crude oil into fuels sufficiently clean to be sold in jurisdictions worldwide, which should increase gross refining margins. As a general rule, so-called sweet (or light) crude is easier and cheaper to refine than sour (heavy) crude, but the fact that far fewer petroleum companies can convert sour crude to a level that meets strict western standards gives them pricing power. It is also ahead of schedule: it was originally slated for project completion by the end of Dec

In 2007, India’s largest papermaker Ballarpur Industries (also known as Bilt) bought a Malaysian company, Sabah Forest Industries, for US$261m. It was a distressed asset, purchased from the Lion group. It was a potentially transformational transaction for Bilt because it gave it access to pulp and fibre, a more scarce resource in India than in Southeast Asia. Sabah Forest operated the largest pulp and paper mill in Malaysia, alongside a concession for 289,000 hectares of forestland from the state government of Sabah, valid up to 2094. The deal turned Bilt into a fully integrated play, covering the value chain from the forests to the end product. It looked good, but as Rajeev Ahuja, head of debt capital markets for Citi in India, noted, “the story in the equity markets was not getting translated. There are very few obvious comparables in the pulp and paper business in India and people were not attributing a great deal of strength to the acquisition, although it was a very high cashflow generator over time.” Integrated players in Europe or in other Asian markets were being much more highly valued. Also, the transformed business needed a better approach to financing. “You need a lot of financing flexibility,” said Ahuja. “If you have the ability to do longer-term debt over a couple of economic cycles, you can manage the volatility of pulp and product prices and get cash flow flexibility.” But in India, there are tight restrictions around raising foreign currency debt. Citi and Bilt worked together on a major corporate reorganisation to get around these issues. First Bilt injected three manufacturing plants into a subsidiary, BILT Graphic Paper Products, for Rs19.5bn. Then another subsidiary called Ballarpur Paper Holdings, which crucially is incorporated in the Netherlands and which owned 97.8% of Sabah Forest, bought BILT GPP, also for Rs19.5bn, with Bilt using Rs10bn of the funds to pay down debt and conduct a share buyback. Doing so put the Indian and Malay assets into the same vehicle. This Dutch-incorporated subsidiary then brought in new investors, selling 21% of itself to the Government of Singapore Investment Corp and JP Morgan Special Situations Asia for US$175m. The restructuring, and the reorganisation of the debt structure, “is more integrated and gives lenders more comfort,” said Ahuja. “Down the road, they will be able to leverage in a more co-ordinated manner than at the piecemeal local levels.” On the financing side, a US$200m leveraged buyout and capex loan was signed in June 2007, before this year Citi set about putting together a US$560m financing. This five to six-year financing launched into sub-underwriting in late May and at the time of writing was about to enter general syndication. Citi was joined by ING, Rabobank, State Bank of India and West LB as joint leads. At US$560m, this was is a lot of offshore debt to get past an Indian regulator: sums above US$500m in any given year are typically very difficult to approve. Consequently the Netherlands domicile of the holding company was vital. “Because this is an offshore company, even though it has Indian and Malaysian assets, we really are not impacted by the Indian regulatory requirements,” said Ahuja. “It allows them to be flexible in how they raise debt and deploy capital, and it evens the field compared to Asian and European players.” While the circumstances of Bilt’s reorganisation are clearly very specific, the broader idea of a restructuring through an offshore holding company to improve access to the debt markets may have wider utility in India. “Each situation will be unique, based on assets and ownership and the market environment,” said Ahuja. “But if you look broadly at how Indian companies have grown in the last two years, a lot more investments have come from the large industrial groups going offshore. Often companies are finding the cashflows they generate offshore are bigger than those in India.” Ahuja added: “We are in discussions with a numb

Against this backdrop the Securities Exchange Board of India (Sebi) has been unrolling a slew of market-friendly measures to help revive the market. Crucially, it has revised the floor price formula for the pricing of qualified institutional placements (QIP) and preferential allotments to institutional investors. Preferential allotments to promoters will still be subject to existing guidelines. The floor price is now based on the two-week average stock price preceding a board meeting to open the QIP. In the past, it was based on the higher of the two-week or six-month average. Given that markets were falling, the six-month average took over – making it impossible to price deals since they would have to be offered at a premium to current prices. ECM bankers have welcomed these moves. “The change to floor price formula is going to be helpful and it’s a positive step by the regulators … But it depends on whether the market is on a downward trend or an upward trend at the time of taking a decision to launch QIP. Since the changes have come, the market has been on a downward trend and the two-week average is higher than the current market price. Once the market starts moving upwards, the two-week average would be lower than the market price, allowing deals to be done,” said Ravi Kapoor, managing director and head of capital markets origination at Citi in India Other issuance such as ADRs and GDRs come under the purview of the ministry of Finance so the final outcome on pricing such issues remains to be seen. The Ministry had issued a consultative paper, proposing to make the floor price the higher of two-month average or two-week average. In addition to changes on the regulatory front, there is some hope that disinvestments by the government could lead to a stock market revival – as has been the case in the past. The two major IPOs that could hit the market within the next two to three months are Oil India and National Hydroelectric Power’s US$400m–$500m float. Also in the works is Special Undertaking of UTI’s selldown of Axis Bank, which is valued at about US$1.2bn. However, these deals and others in the pipeline need stability to launch. "We want to see more stability in the market and if the index can be maintained around the 15,000 levels. We are also waiting for concerns on oil prices, interest rate and inflation to subside. There is a healthy pipeline including some new and interesting products which is just waiting to hit the market,” said Atul Mehra, co-CEO of JM Financial. Rights comeback While IPO and QIP issuance has hit a virtual standstill, rights issues have proven popular instrument for companies that really need to raise funds. And for the first time in many years an underwritten rights issue is expected to hit India’s capital markets. Hindalco Industries’ rights issue, which is expected to open mid-September, will likely be the first rights issue to be underwritten in many years. The company will raise US$1.2bn in a three-for-seven rights issue. It has mandated Citi, Deutsche Bank, Merrill Lynch, RBS and SBI Caps to handle the deal. Proceeds will be used to repay a bridge loan that matures in November. A second rights issue by Tata Motors to raise about US$1bn is expected to hit the market later this year – but it is not clear if it will be underwritten at this stage. Although underwriting of equity deals is common around the world, in India most equity deals are done on a best-efforts basis. Rights issues have become popular in rocky markets because it is an optimal way for promoters to raise money without diluting their holding in the company. Sebi has also proposed a shorter timeline for a rights issue to remain open, down to a minimum of 15 days from a minimum of 30 days previously – which will also help underwriters manage the risk. “In these volatile markets, we could see more underwriting of deals, given that in some instances, issuers need to be sure of raising the capital, specifically when the amounts are

India’s bond issuance in G3 currencies has been non-existent this year having broken all-time highs last year, building on steadily increasing volumes over the past four years. The reason for the failure to issue this year has been extreme risk aversion towards Asian credit among global investors, with only quasi-sovereign or investment-grade deals, principally from South Korea or Hong Kong, getting away. And while India is investment grade and its larger banks rated at the sovereign ceiling, it would be true to say that of those Indian issuers that might have got deals away, none was willing to pay the risk premium required to place paper in the public offshore G3 market. A key casualty of this dynamic has been ICICI Bank, which last year blazed a trail for the country in offshore markets, bringing a staggering US$6.7bn of deals in the public bond and syndicated loan markets at the parent and subsidiary levels. The bank last January formally put its offshore borrowing plans on hold, taking the view that pricing had become too expensive and that it would sit it out until market conditions improved. This decision scuppered plans to raise around US$3bn in early 2008 via a syndicated loan, a Samurai bond in Japan, a chunky private placement in the US Reg D market and a global Reg S/144a bond. Sudhir Dole, head of the international financial institutions group and transaction banking at the bank’s Mumbai headquarters stated confidently at the beginning of this year that the bank was looking to equal the amount it raised in 2007, but not at the rates which prevailed in January. “It does not make sense to be borrowing at the current levels, especially given the regulatory cap on the interest rate payable on external commercial borrowings by Indian companies,” he said. Credit spreads did not improve in ICICI’s favour as the year progressed. And despite this the Indian regulators had anyway created a challenging scenario for companies eyeing offshore borrowing by capping in May 2007 the allowable rate for three-year and five-year tenors at Libor plus 150bp and 250bp respectively. To take ICICI, for example, with its cost of five-year default protection hanging around the 350bp for most of this year, having been at around half this level during the bank’s 2007 borrowing binge, the possibility of bringing an offshore deal had been stymied. With investors demanding a hefty negative basis in the new risk-averse credit environment, particularly for a name like ICICI with a hefty wedge of offshore debt outstanding, issuance would have had to come at least at around the Libor plus 475bp mark to get over the line. Although the RBI moved these ceilings higher last May to 200bp and 350bp respectively, it was not enough to allow the country’s banks or prime corporate names to access the public markets, explaining the lack of offshore issuance this year. Meanwhile, the domestic market has chugged along nicely, with annual issuance picking up from just US$4bn-equivalent in 2003, to build to an average of around US$11bn-equivalent over the past three years and registering US$11.6bn-equivalent so far this year with four months left for the 2007 total of US$14.7bn-equivalent to be exceeded. Indeed the closure of the G3 markets this year and the consequent turning, out of necessity, of the country’s borrowers back to local markets is no bad thing. A significant example is the opening up this year of India’s domestic FIG bank capital market, which has seen a rush of perpetual issuance from the likes of Punjab National Bank, UCO Bank, Vijaya Bank and the eponymous ICICI. The reality is that emerging countries such as India should encourage domestic market issuance, given the precedent of the Asian financial crisis and the dangers of currency mismatch presented by offshore markets. Although India’s capital account is not fully open, meaning this risk is to some extent ameliorated, the country urgently needs to develop its onshore bond markets, given its

Loan markets have been the biggest beneficiaries of India Inc’s push overseas to acquire assets. Almost every acquirer, including risk-averse companies such as IT bellwether Wipro, borrowed in the loan markets last year to fund their overseas forays, leading to record volumes of around US$41.84bn in loans from India in 2007, according to Thomson Reuters data. Although year-to-date loan volumes stand at nearly US$22bn, there have been only a small number of acquisition financings, which is in stark contrast to last year, when most transactions were M&A-related financings. “Overall, the global macroeconomic environment is quite challenging, which obviously slows down the pace of M&A activity. However, Indian companies continue to explore offshore M&A opportunities. Compared with the US$77bn in India M&A deals (including private equity) for 2007, the first half of 2008 has seen this number at US$36bn,” said Kalpesh Kikani, global head of investment banking at ICICI Bank, which has been an active arranger of M&A related financings. “India Inc’s aspirations have not diminished. Companies continue to be acquisitive and are evaluating outbound opportunities,” said Sameer Nath, head of M&A at Citi in Mumbai. “Fundamentals of Indian companies are quite solid and M&A activity remains relatively robust as was evidenced by the recent acquisitions by Infosys and ONGC Videsh.” “The biggest strength Indian companies have is their ability to turn around distressed assets,” said Brijesh Mehra, country corporate and investment bank head for India at ABN AMRO. “The acquisitions by Tata Steel and Hindalco Industries have lifted the ambitions of corporate India, which is increasingly thinking on global terms. The global credit crisis has reduced their appetite somewhat and big-ticket acquisitions will be few and far between.” Indeed had the merger between South Africa’s MTN Group been consummated between either Bharti Airtel or Reliance Communications (RComm), it would have marked a bumper year not just for Indian M&A, but also loan volumes. Bharti’s merger with MTN would have led to a US$42bn-$45bn deal with a loan of around US$21bn backing it. RComm’s merger with MTN would have been for the same size, but would have led to smaller loan transactions as these would have involved refinancing of RComm’s existing debts. The merger of MTN with Bharti or RComm would have created a giant telco but, more importantly, it would have transformed the Indian company into a truly multinational company with operations in nearly two dozen countries. What is more, the change in identity would have given the Indian telco the platform to expand further into other markets if the need arose. Although the merger did not go through, it underlined the need for an offshore platform that will enable acquisitive Indian companies to pursue global expansion. Although Indian capital markets have grown in size, they still are not considered deep enough to support Indian Inc’s M&A drive. Many feel the way forward for Indian companies is to have an offshore subsidiary that is listed in London or elsewhere so that it provides them better access to capital. A precedent in this regard has already been set by Vedanta Resources, which listed on the London Stock Exchange in December 2003. Vedanta owns controlling stakes in Mumbai-listed Sterlite Industries and Madras Aluminium Company (Malco), which also gives it control of Bharat Aluminium and Hindustan Zinc. Since listing on the LSE, Vedanta has provided numerous capital markets opportunities to bankers through equity, bond and loan financings. In August 2008, it completed a US$1bn 4.75-year loan that refinanced a US$1.1bn one-year bridge signed in April 2007. The bridge was an offshore loan that funded the US$1.5bn–$1.6bn acquisition of a 71% stake in Sesa Goa, India’s biggest non-state iron-ore exporter. “Being listed on the New York or London Stock Exchanges definitely expands the company’s reach to a wider investor community and

Substantial reforms to the country’s capital and labour markets are the key to India achieving its infrastructure goals, at least according to International Monetary Fund (IMF) senior adviser Kalpana Kochlar, who recently outlined what steps the fund believes to be taken if the country is to meet its ambitious investment targets. Kochlar laid out the task ahead with stark numbers. Over the past three years, India has invested an average of 4.5% of its annual GDP on infrastructure development, which is half of the 9% of GDP that India’s Planning Commission has set as its goal for the level of infrastructure investment by 2011/2012. To meet this goal, investment in infrastructure will have to increase by a hefty 1% of GDP increase each year between now and 2011/12. Working out how much needs to be spent is one thing but the harder part of the equation is working out where this huge amount of money is going to come from and to what extent it will be publicly or privately funded and what role local and foreign capital markets can play in raising this money. India at least starts from a position of strong public finances. “From dissavings of around 1% of GDP a decade ago, public sector savings shot up to an impressive 3% of GDP in 2007/08. But given the pressures from the 6th Pay Commission, the agricultural loan waiver, and continued commodity subsidies it will likely be difficult to increase or even to maintain this level of savings in the absence of substantial improvements in tax revenue collection,” Kochar wrote. However, it seems clear that even the strongest public finances are not sufficient to raise the necessary funds and that India will require foreign capital to meet its infrastructure spending goals. This is why foreign investors and bankers are excited by the prospects, even as they ponder the Herculean investment required. However, Kochar cautioned that even with the current huge appetite for investment in India, sufficient funds would not be able to be raised without a significant retooling of India’s financial and labor markets. Kochar is rather blunt about the prescription: “India needs to rethink its capital account framework in the light of the need for $500bn in infrastructure investment.” Specifically, he recommends “refraining from ad hoc changes in capital controls in the name of macroeconomic management, and quickly expanding the country’s real and financial absorptive capacity. In particular, there is an urgent need for an expedited and time-bound plan to develop the corporate bond market,” including raising the limits on foreign participation in this market, permitting greater capital outflows, creating fiscal space to finance infrastructure investment by curbing wasteful spending, and implementing structural reforms of labour and product markets. India is one of many countries working to mobilise private participation for infrastructure projects – indeed, countries right across the region have been upgrading their infrastructure at a furious pace – and successful projects have shown investors that they can obtain healthy financial returns. Successfully bringing projects to financial closure requires optimising outcomes for the host-government, for project promoters, and for creditors. Therefore, resolving various issues is becoming more urgent for countries, like India, that are counting on private resources. These issues include the harmonisation of regulatory structures, determining the right role for competition and for choice, finding the right balance between different modes of finance. All of these are required in order to build confidence among the key parties in a project. On the financing side, there is also a pressing need for innovative financial structures to deal with a multitude of contractual, political, market, operational and credit risks. But there is also an urgent need to build credible structures to ensure that projects are environmentally responsive, socially sensitive, economically

The main reasons people are excited about the Indian economy are its size, its rapid growth and the fact that some sectors of its economy have become truly world class in pretty quick time. Let us start with its size and fast economic growth rate. India is already the world’s fourth-largest economy when measured in purchasing power parity terms and Goldman Sachs in its recent “Brazil Russia India China (BRIC) Report” predicted India would become one of the world’s three largest economies in absolute terms by the 2032. And Goldman Sachs is not alone in its optimism. John Redwood, of the UK-based Economic Competitiveness Policy Group, said that “India is now truly a land of opportunity”. ACNielsen’s Travyn Rhall attributes the excitement about the Indian economy to two core advantages: an increasing presence of multinationals and an upswing in IT exports. India’s success in the IT sector means that many international companies now believe that while India is a developing country, some sectors of its economy are already world class. Jack Welch, GE’s former chief executive officer, perhaps summed it up best with his noted comment that “India is a developed country as far as intellectual capital is concerned”. As the Goldman Sachs report indicates, many investors track India’s performance against other giant emerging markets, the BRIC economies, and India is expected to outperform its BRIC rivals, in terms of GDP growth rate, from 2015 onwards. For the 2006–2007 fiscal year India was the second-fastest growing BRIC economy with a 9.4% economic growth rate, second only to China. Stern challenges This is all good news but there are plenty of challenges ahead. Inflation is by far the most immediate threat to the economy, as it is in many Asian economies. India’s WPI inflation rose to 12.63% in the week ending August 9, from 12.44% in the previous week, while estimates of core WPI inflation rose to 11.88% from 11.62%. And while measures of output price inflation fell in late August to 10.06%, from 10.23%, for the first time in many months, input price inflation accelerated sharply to 14.88% from 14.53%, further widening the gap between input and output prices. Pressure on corporate profit margins continues to rise, but the slower pace of output price inflation suggests firms are either concerned about losing market share as demand weakens, or that they expect some of the recent softening in global commodity prices to ease input cost pressures over the coming year. Output price hikes may be in the works, however. Reports from equity analysts and in the news media suggest that some companies – especially those in the electrical, tractor and cement sectors – are planning to hike (or have recently hiked) prices, due to cost pressures. However, signs of weakening demand have deterred producers catering to the consumer goods sector from raising prices any further. The government is also taking measures to cool down food price inflation by selling rice, wheat and sugar in the open market. Food prices are obviously a political issues as well as an economic one. Analysts now expect WPI inflation to increase to 12.82% year-on-year from 12.63% in September, due to higher prices of food articles, rubber, sugar, paper products, oil seeds, textiles and rubber and plastic products. WPI inflation is expected to peak in October or November at around 13.5%-14%, but to stay in double-digit territory until February 2009. Many analysts expect economic growth to slow to 7.3% in fiscal 2009 which, along with lower oil prices, should help lower inflation some time in the first half of next year. India’s battle with inflation is part of a regional battle. Consumer price indices in Vietnam, Sri Lanka and Pakistan have risen 30% year-on-year, while inflation has been running in double digits in the Philippines, Indonesia. In China, Singapore, and Thailand headline consumer prices inflation has also been approaching double digits. India’s other big challenge lies