Public promise

IFR India Special Report 2013
11 min read

The introduction of real estate investment trusts, simplified tax rules and a bigger privatisation pipeline have all underlined a new determination to reform and reinvigorate India’s equity capital markets.

It is hard to envisage a more resounding political endorsement from any diverse pool of stockholders, let alone India’s notoriously skittish investor community, but when the scale of Narendra Modi’s win in India’s general election became clear in early May, domestic and foreign institutional investors rushed to snap up shares in locally listed firms.

In the month after the landslide victory that elevated the former Gujarat governor to the position of prime minister, India’s flagship stock index, the Sensex 30, gained 15% in value. It then paused before continuing to rise and finally burst through the 27,000 mark for the first time in early September.

Another notable early moment in the Modi era occurred in late June, when Anil Ambani’s Reliance Communications launched a US$217m preferential share offering, alongside an US$800m qualified institutional placement. The Mumbai-born billionaire had regularly attempted lightning raids on the domestic capital markets over the previous six years, only to be rebuffed time and again by investors that took bad hits from his US$3bn 2008 IPO of Reliance Power.

Few saw RComm’s sale as a validation of Ambani and his sprawling business empire. It was cannily timed, to be sure, and topped out as the largest rupee-denominated QIP from a domestic corporate issuer. However, the glory was again reflected onto the country’s new premier.

“We believe the government has a very dynamic divestment plan and they are working on getting companies prepared for monetisation. We expect them to move swiftly towards (hitting) their targets.”

Modi’s pledge to push through tough-but-necessary reforms, slash red tape and open new industries to foreign capital got the pulses of portfolio and institutional investors everywhere racing. To many, he is seen as the country’s last best hope of fulfilling its enormous potential. OP Bhatt, former chairman of State Bank of India, the country’s largest lender in asset terms, notes that, if Modi cannot get the country moving again, “probably no one can”.

Four key factors are set to play out in the months and years ahead, all of which will come to define the relative success or failure of the Modi era. While it is still far too early to talk about legacies, the 64-year-old premier has a full five-year term to transform how the global business community views Asia’s third-largest economy, and to ram though a host of painful and protracted reforms vital to get India moving again.

First and foremost, there is a multi-year plan to sell slices of inefficient state assets, and inject private capital in ailing companies or industries. From his first day in office, Modi has made clear his plan to divest chunky stakes in publicly owned firms, partly to help trim the fiscal deficit; partly as a way of signalling to the private sector that the country is open for business.

The first asset set for the slab is a 5% share of Oil and Natural Gas Corporation. Finance Minister Arun Jaitley expects to raise up to US$3bn from the disposal of 5% of the state-run energy explorer, in an auction organised by five banks, including Citigroup and HSBC, slated for the second week of November.

Next up: a similar divestment in two other all-powerful state firms, Coal India and hydropower giant NHPC. In total, the trio of sales are set to net India’s treasury around US$7bn, with further divestments expected involving a host of other state firms, from Hindustan Zinc to aluminium giant Balco. Jaitley expects total earnings from state divestments to top US$9.5bn in the Indian fiscal year to end-March 2015.

That is just the start of the privatisation process. Divestment is set to become a regular occurrence over the next five years, with the state annually earning north of US$10bn. This will force the government to shed stakes in its most powerful, yet underachieving, firms. Prabhat Awasthi, head of Indian equities at Nomura, said: “You aren’t going to trim (India’s) fiscal gap by selling stakes in smaller firms”.

Among other leading firms preparing for partial divestment are Steel Authority of India and, further down the line, Life Insurance Corporation of India, as well as a host of underperforming state-run banks.

“We believe the government has a very dynamic divestment plan and they are working on getting companies prepared for monetisation,” says Ravi Kapoor, head of corporate and investment banking at Citi India. “We expect them to move swiftly towards (hitting) their targets.”

Yet more capital can be earned from opening up industries to new sources of capital. During the increasingly timid reign of Manmohan Singh, India’s last prime minister, policymakers had to choose between their desire to court foreign investors to generate more dollar-denominated earnings and their need to pander to protectionist-minded members of a Congress party-led coalition.

Modi, whose Bharatiya Janata Party holds an overwhelming majority in India’s lower house of parliament, has no need either to pander or vacillate. India’s premier is likely to throw open the doors wide to foreign investors, focusing on sucking investment into struggling or capital-intensive industries.

Delhi has expressed its determination to loosen Coal India’s throttling grip on domestic coal exploration, opening the door to foreign mining giants, such as Rio Tinto and BHP Billiton, with the aim of boosting production and ending the chronic blackouts that stunt the country’s economic ambitions. In recent months, Modi has sent a host of bills to the Congress-dominated upper house, seeking to increase to 49% from 26% the share of joint ventures that foreign investors can own in the insurance, defence, and railways sectors.

Others expect to see greater foreign investor participation across the infrastructure sector, as well as in high-end manufacturing and power production.

“Look at any sector with a pressing need for foreign capital and technology, such as the railways industry, which is looking to build a new-generation fleet of high-speed trains,” says Nomura’s Awasthi. “Wherever there is a pressing need for capital, you’re going to see more deregulation.”

Red tape

Another purely practical aspect of Modi’s reform plan is a concerted push to make business easier. Since taking power, he has ordered top civil servants to begin the arduous process of slashing red tape and stamping out endemic corruption. In August, the stock regulator lifted a ban on the creation and listing of onshore real estate investment trusts, a boon for cash-strapped property developers.

Anuj Puri, head of property consultancy Jones Lang LaSalle, expects to see around US$12bn of REITs come to market over the next three years. The introduction of foreign portfolio regulations, which help to simplify ownership rules, are also a step in the right direction.

However, more could and should be done. Bankers point to a host of rules that continue to crimp the development of India’s capital markets. Overhauling the IPO process will make stock sales more “time and cost efficient”, notes Citi’s Kapoor, who also points to the need to make the structure of REITs more tax-friendly for property investors.

Indian banks, he adds, should be encouraged to issue dollar-denominated Additional Tier 1 capital in order “to meet their capitalisation targets”, while regulators should “make it easier for international investors to participate in rupee-denominated bond issuances without having to come onshore.”

Neil Atkinson, Asia Pacific head of depositary receipts at BNY Mellon, points to the importance of approving over-the-counter American-depositary-receipt programmes on all forms of securities, helping to “broaden and diversify” the range of available investors, while lowering the cost of capital.

Finally, there is the pressing issue of India’s capital markets. Activity slumped in recent years, as the country’s economic prospects dimmed. Equity capital market volumes totalled US$8.4bn in the current year to October 16, the second-lowest rate of issuance since the financial crisis, while debt capital market issuance slumped to its lowest levels since the dark days of 2008.

Still, most are optimistic that the worst is now behind them. Investment bankers in Mumbai are working flat out to prepare a host of stock sales in the months and years ahead.

“IPO activity will seriously start to pick up from the start of the next fiscal year, as companies, long starved of capital, look for fresh funding to benefit from a new era of growth,” said S Subramanian, managing director of investment banking at Mumbai-based Axis Capital.

Citigroup’s Kapoor sees a solid “pipeline of potential capital raising” taking place across sectors from metals and mining and industrials to financial services and infrastructure. A second surge of activity will come from buyout firms finally managing to exit holdings through private placements and IPOs, with new consumer, insurance and healthcare plays also looking to tap India’s resurgent equity markets.

India has had many moments of bullish optimism since the country began to unshackle itself from its socialist past in 1991. Many have proven either false dawns or false starts. However, there is a sense under premier Narendra Modi that India has found the right man for the job: a politician determined to give the private sector its head, to encourage capital formation, and to drive through even the most painful reforms.

“The system was in a logjam for a long time,” said Nomura’s Awasthi. “Under Modi, India’s business community finally has its confidence back, and the country is headed in the right direction.”

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Public promise
A member of the cleaning staff walks outside a department store advertising a sale at a shopping mall in Mumbai