Steps to salvation

IFR Asia India Report 2013
12 min read

A motorcyclist from the Kashmir Police rides through a ring of fire during Independence Day celebrations in Srinagar.

Source: Reuters/Danish Ismail

A motorcyclist from the Kashmir Police rides through a ring of fire during Independence Day celebrations in Srinagar.

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After a summer struggle to put a floor under the rupee, India has found there is no single solution to its crisis of confidence. While short-term measures can help restore stability and ensure the capital markets remain open, policymakers also need to address a number of structural problems if they are to convince the world that India is still an attractive investment destination.

IFR asked market participants to propose the most effective measures the government and regulators could take to improve the outlook for India. The responses received include short-term and long-term proposals, targeting both the country’s financial position and investor sentiment.

“A focused approach to streamline investments in the power, roads and telecom sectors, which cumulatively account for two-thirds of five-year plan expenditure, would aid a quick revival in investment spending.”

The following list of 10 recommendations offers a snapshot of the capital markets’ main concerns, and ways to address the problems.

1. Restart stalled projects

Kick-starting many stalled infrastructure projects will serve the dual purpose of stimulating domestic investment and restoring confidence in the policy framework. Land acquisitions and environmental clearances need to be faster and, towards this end, investors have hailed as a step in the right direction the government’s recent plan to fast track around 40 projects worth over US$15bn.

“A focused approach to streamline investments in the power, roads and telecom sectors, which cumulatively account for two-thirds of five-year plan expenditure would aid a quick revival in investment spending,” said Anup Bagchi, managing director and CEO of ICICI Securities.

Structural problems also need to be addressed, before many of the stalled power projects can be restarted. Officials need to be more open to revisions to power-purchase agreements, while being careful not to give sponsors blank cheques or invite lawsuits from losing bidders.

“Some stringent covenants may be stipulated, such as a reduced return on capital, non-distribution of dividends for, say, 10 years or disqualification from bidding for new contracts for, say, five years. These measures should be substantive and punitive in nature and not merely symbolic,” said Atul Joshi, managing director and CEO of India Ratings and Research.

2. Simplify overseas borrowing rules

Restrictions on external commercial borrowings may have protected some Indian companies from building up unmanageable foreign currency liabilities, but they also leave borrowers with fewer funding options in times of stress.

Regulators need to consider steps to liberalise foreign currency funding, such as reducing the minimum tenor on ECB financings to three years from the current five or seven years, raising the cap to US$1bn from US$750m and allowing companies to refinance existing overseas loans without the need for additional approvals from the central bank. A review of margin caps will also allow a wider universe of companies to access overseas funds, helping relieve some pressure on the currency.

“Creating an environment where the market determines the pricing risk of ECBs, like what has been done with refinancing of ECBs, albeit within the limits of overall caps, provides for a more simple and transparent pricing system,” said Sameer Chandra, director, loan syndications, at Citigroup.

India should also allow more companies to refinance rupee loans in the overseas markets, potentially with the use of credit-enhancement or asset swaps, in order to access deeper pools of liquidity.

“Offshore branches of Indian banks, among other offshore lenders, are liquid on G3 currencies, and can turn their rupee exposure into foreign currency exposure,” said Chandra. “Coupled with fixed swaps against some important sectorial borrowings, this will serve as interest savings for borrowers and incentivise inflows, making rupee loan refinancing in foreign currency attractive.”

3. Raise bank capital abroad

A sovereign bond issue is off the table, but the global capital markets can still play a big role in stimulating foreign investment. India has already pledged to push some public sector agencies into the overseas financial markets as part of a package of measures to defend the rupee. It also needs to encourage the banking sector to raise Tier 1 and Tier 2 capital from the offshore bond markets.

“This will serve two purposes – help to shore up FX reserves and also ensure that banks meet their Basel 3 requirements well in advance,” said Ashwini Kapila, managing director and head of the financial institutions group at Barclays in India.

“Banks too will be open to this suggestion as the rupee markets are not yet ready for these structures with only one token trade done so far in this space. Banks may find it cheaper to tap the deeper US dollar market for such products.”

No regulatory changes will be required, although officials can grant exemptions on withholding tax to make overseas capital raisings more cost effective.

4. Review import restrictions

Oil and gold imports have hurt India’s current account position, but the halting of iron-ore exports and coal imports under a general mining ban has also added to the burden. Reviving iron-ore imports alone can bring in US$10bn–$12bn of foreign currency revenues, according to ICICI Securities’ Bagchi, who sees it as a welcome boost to the country’s finances.

Measures can go further. Bagchi also argues that better remuneration for oil-seed production can make India self-sufficient in edible oils, potentially eliminating an US$11bn annual import bill, while gold purchases can become a source of tax revenue.

“The government may also look at limiting cash purchases of gold bars and jewellery to Rs50,000, beyond which 1% of tax collection at source and the furnishing of a PAN card will be applicable,” he said.

5. Improve long-term funding

Typically, infrastructure assets in India have a payback period of 15–30 years, but a lack of long-term funding options means the usual financing package matures in only 9–10 years. The mismatch creates the potential for problems further down the line when financing terms need to be renegotiated, and adds to challenges facing infrastructure investors.

Regulators need to do more to stimulate the development of a long-term debt market to allow issuers and investors to match their assets and liabilities. The banking sector is a logical place to start, since longer-term funding will avoid a potentially dangerous build-up of short-term risk.

“Banks need to be allowed to raise unsecured senior bonds with a minimum maturity of 15 years. These can then be used to fund long-term assets,” said Joshi at India Ratings. “Long-term funding will also help improve the credit rating of infrastructure projects and reduce the risk weighting assigned to banks’ lending portfolios. Indirectly, this will improve the capital adequacy of banks.”

6. Address food inflation

Inflation, especially in the agricultural sector, remains a thorn in the side for India’s central bank. The RBI needs to give longer-term guidance of its monetary policy, but is unable to do so until inflation is brought under control.

Simplifying the agricultural supply chain will give greater visibility on food prices and give the RBI confidence to commit to a growth-oriented policy.

“Addressing buffer norms, eliminating intermediaries between farmers and consumers by way of e-auction and allowing direct selling to aggregators and processors will help effectively address the issue,” said Bagchi.

7. Restore fuel supplies

India’s embattled power sector needs greater access to fuel, both natural gas and coal, to address electricity supply shortages that are a recurring problem for large portions of the population.

Joshi at India Ratings calls fuel scarcity a “vexatious issue” that needs immediate attention. To remove supply-side bottlenecks, Coal India needs to ramp up production and permits need to be granted to allow coal blocks to commence operations. Similarly, better rail transport links are necessary to ship coal to where it is needed.

8. Eliminate policy confusion

Recent changes to tax rules have scared off foreign investors and made it harder to do business in India.

“Investor confidence has eroded, with executed contracts being reopened or threatened to be reopened by the government, stance on taxation being ambiguous and investors being consequently left in the lurch,” said the India head of a foreign asset manager.

“Such procedural hurdles vindicate the increasingly popular opinion of many fund managers that India is a difficult place to invest and do business in.”

The government needs to remove lingering uncertainties over the general anti-avoidance rule and the Mauritius-India tax treaty, among other rules, so that investors – both domestic and offshore – see greater predictability in policy.

“If it is perceived that changes happen randomly and, occasionally, also retrospectively, the ability to take long-term investment decisions is curtailed,” said R Gurumurthy, head of corporate and institutional banking at Ratnakar Bank.

9. Simplify legal framework

India needs to review its archaic laws around environmental approvals, land acquisition and allocating natural resources. The present drafts of the Food Security Bill and the Land Acquisition Bill, however, threaten to make India’s macroeconomic situation worse.

“Both the bills have come at an inopportune time and the government has to convince the markets that the Food Security Bill will not severely deteriorate the deficit and the Land Acquisition Bill will not hamper economic development,” said the head of Indian ECM origination at a global bank.

10. Reform tax regime

It is likely that the trigger for a revival in investor appetite will come only after the national elections, due by May 2014. Once voting is out of the way, however, ministers need to begin work on long-term fiscal improvements, such as the long-awaited adoption of a goods and services tax – although India’s constitution must be changed first.

Implementing GST will have fiscal benefits, boosting compliance and tax revenues for states and the central government. The higher transparency can even lure more foreign investment.

“A [GST] system would create a single common market in the country, one which hasn’t existed so far, and would rationalise and reduce the burden of taxation across the supply chain,” said Gaurav Kapur, senior economist in India for Royal Bank of Scotland.

Steps to salvation