Restarting the engine

What happens next will determine the direction of India’s economy over the next five, or even 10, years. If Modi’s government can follow through on its promises to energise Indian business, the potential is clearly enormous. But India’s bureaucratic red tape is world renowned, and even a powerful public mandate risks becoming bogged down by vested interests and byzantine regulatory structures. In many ways, the capital markets are on the front line of this intriguing battle. Improving the flow of capital to underdeveloped sectors such as infrastructure will be key to lifting economic growth, but the scale of the challenge is daunting. India’s banking sector is running dangerously short of capital, with estimates calling for another Rs200bn of Tier 1 equity by 2019 to meet the latest Basel rules. Since committing to the Basel III standard, India has begun to realise that the measures risk starving some sectors of the economy of important growth funding. Given the state of the country’s finances, India needs to bridge that gap without resorting to government handouts for banks or borrowers – no easy task in a financial market so reliant on state support. The banking sector’s inadequacies pose some immediate problems for Modi’s task force. In particular, bank risk weightings threaten to leave some promising young companies without access to capital as lenders focus on borrowers with higher ratings and longer track records. Dysfunctional debt capital markets also make it hard for banks to lend at the long tenors required by infrastructure developers without facing a dangerous maturity mismatch with their own short-term liabilities. Many positive steps are already in progress. Indian banks are now allowed to sell long-term senior debt – a simple measure towards solving a problem that previous regimes, unbelievably, had neglected to fix. Clarity on tax and foreign ownership rules have reinvigorated the equity markets, allowing banks and their borrowers to improve their balance sheets. The key, however, is lifting India’s profile on the global stage. Although regulators have tried to insulate India from foreign forces, the slump in the rupee in the second half of 2013 revealed the fatal flaw in that strategy. Like it or not, India’s future depends on international capital now more than ever, and the country needs to work hard to win investors’ confidence – and maintain it. Modi knows this, and has done a good job of courting overseas Indians on recent missions abroad. There is, however, more convincing needed. To see the digital version of this report, please click here. To purchase printed copies or a PDF of this report, please email gloria.balbastro@thomsonreuters.com.

“It is like the critically ill patient in hospital. You never give up hope until the last minute,” said KR Kamath, chairman and managing director of Punjab National Bank, in referring to efforts to prevent stressed loans from becoming non-performing assets, a hot-button topic for India’s capital-constrained banking sector. “Revival of an asset is always desirable,” he said. Yet, Kamath, as head of one of India’s largest lenders, knows banks cannot afford to wait forever to recover their investments. Stressed banking assets are now one of India’s biggest macroeconomic challenges, with the potential to threaten government finances and weigh on already fragile economic growth. Over the last few years, as India’s growth has faltered from high single digits to around 5%, stressed assets on the balance sheets of Indian banks have risen sharply, partly due to the weak economic environment, but also due to systemic issues. Policy logjams, the cancellation of 2G licences and coal-mining concessions explain some of the blots on the banks’ books. “It was a perfect storm for us, where payments from several state-owned companies were stuck for a long time and the overall macroeconomic environment was bleak. Nobody wants to be labelled as sick. Yet, when there is a sickness the best thing is to go to hospital.” That, however, is only part of the picture. Among other reasons are high corporate leverage, especially in asset-heavy industries, and questionable risk judgements of many Indian banks. As a proportion of assets, the deterioration in asset quality has been largely confined to the state-owned banks, and the true picture may be even more dire. The recent high-level panel on bank reforms headed by former Axis Bank chief PJ Nayak was bald in its assessment: “The financial position of public sector banks is fragile, partly masked by regulatory forbearance.” The same panel pointed out that nearly 79% of total bank provisions are held by public sector banks. As of December 2013 Indian banks collectively held loan provisions for Rs985.93bn (US$16.03bn), with the SBI group alone holding nearly a third. Unfortunately, that is not the only bias in the stressed-asset story. The credit profile of banks is skewed towards riskier sectors that yield the highest amount of impaired assets. “While the CAGR of credit between 2009 and 2012 for the banking sector was 19%, segments like iron and steel, infrastructure, power and telecom witnessed much higher credit growth, despite the impaired assets ratio for these segments being significantly higher,” said former RBI Deputy Governor KC Chakrabarty in an analysis of Indian banks’ credit management last year. RBI’s half-yearly Financial Stability Report in December 2013 also acknowledged the problem: five sectors, namely infrastructure, iron and steel, textiles, aviation and mining, together accounted for 24% of commercial bank advances, but 53% of their stressed assets. Governance Banks’ credit appraisal and market analysis skills are under the spotlight. Most Indian banks only started collecting granular data on asset-quality metrics, such as segmental NPAs, write-offs and recoveries, in 2009, in response to regulatory requirements, and, for years, have preferred to kick the can down the road through the refinancing of stressed assets in a practice known as “evergreening”. Governance issues exacerbate these credit-risk challenges. Undeserving and unviable businesses may still be able to access credit due to collusion between bankers, politicians, businessmen and middlemen. A couple of months ago, the head of state-owned Syndicate Bank was arrested in a bribe-for-credit scam. In February, United Bank of India’s chief was forced to resign after bad debts reached more than twice the paid-up capital of the Kolkata-based lender. The asset qualities of Indian banks need more careful scrutiny. “A clear picture of asset quality across the banking sector can emerge only if restructured accounts and write-offs are

Credit rating agencies operating in India are accustomed to surprises, having faced court injunctions over negative rating actions and countless disputes over unpaid bills. Even in this ultra-competitive industry, however, state-owned Bank of India’s landmark capital market fundraising in July 2014 caused a stir. BoI’s debut Rs25bn (US$406m) offering of Basel III-compliant Additional Tier 1 securities came with a Triple A rating from domestic agency Brickwork Ratings, with zero notching to reflect the risk of loss absorption or coupon deferral under the Basel III standard. BoI increased the deal from a Rs12.5bn base size, and the instruments are in great demand in the secondary market. “If BoI fails, then the entire Indian banking sector will go down. Such an event will never happen.” How much of BoI’s success was down to the top credit score is unclear. In a falling interest-rate environment, the 11% coupon offered on the non-call 10-year AT1s was partially responsible for sparking the demand for the paper. The Triple A rating, however, also worked as a catalyst, DCM bankers said. The deal played a big part in introducing Indian investors to the AT1 structure, where investors will be written down if the bank’s capital falls below a certain level. Many are barred from investing at levels below AA+, or have struggled to decide whether the hybrids are dealing with debt or equity, and the takeup of earlier Basel III-compliant bank capital issues had been disappointing. Brickwork’s peers, such as Crisil, Icra and India Ratings and Research, responded fiercely to the development, issuing press releases and frequently asked questions on AT1s – highlighting the embedded risk in these perpetual instruments. India Ratings, the local arm of Fitch, was most vocal on this issue, calling the BoI AT1 sale a weak start. According to the agency, the 11% coupon, which is about 175bp higher than other Triple A yields, implies a rating in the range of A–/BBB+. The agency said the pricing had distorted BoI’s yield curve. “The rating on BoI seems improper, but we should praise the bank for taking the bold step and opening the Indian AT1 market,” said an official from another state lender, mulling an AT1 sale soon. The official, however, said his bank was in favour of notching down AT1s. The August 6 press release of Brickwork stated that the agency considered coupon discretion, probability of the breach of the higher trigger for CET1, financial performance and capital adequacy levels of BoI, but did not explicitly state the reasons why it did not see any risk in these loss-absorbing instruments. Nevertheless, these rivals stuck to their stand of notching down the AT1s at least two to four levels, depending on the issuer. Brickwork does state on its website that it will notch down AT1s zero to four levels below the issuer’s senior rating. India has never allowed a state-owned lender to go bust, and the rare opportunity to earn high yield from a Triple A-rated state lender appealed to investors, including a charitable trust. “If BoI fails, then the entire Indian banking sector will go down. Such an event will never happen,” said a DCM banker, ruling out the chance of any state lender becoming non-viable in India. The government holds a 66.7% stake in BoI. While such a response is typical in the Indian investor base, the rating action of Brickwork was against the global practice of rating agencies, which, typically, knock at least four to five notches off the standalone rating of a bank as a signal to investors of the potential risks of an AT1 bond. Basel III capital bonds are designed to force subordinated creditors to absorb losses if banking authorities declare any issuing bank to be no longer viable, and it is far from clear whether the government will step in protect subordinated investors in the future. Even at home and, prior to BoI’s issuance, Indian markets had a precedence of a local AT1 instrument getting notched down. In December 2013, pr

Offshore loan volumes from India are rebounding as positive sentiment among foreign investors allows borrowers to push for lower pricing. The momentum generated following the installation of a new government led by pro-business Prime Minister Narendra Modi spells great promise for the Indian economy and the business environment as a whole. India Inc is enjoying better equity valuations, with the Bombay Stock Exchange Sensex index regularly testing all-time highs, and foreign bond investors have warmed to US$15.52bn of international new issues so far this year, with the pace accelerating since Modi’s victory. It is a familiar story in the world of loans, too. India-focussed loan bankers have been kept occupied for the best part of the year and the pipeline of deals continues to bulge. “Pricing for top-tier Indian borrowers will continue to grind lower. Lenders expecting a greater yield would have to either move down the credit curve or look at structured transactions, which in turn would give a fillip to dealflow from the second and mid-tier credits.” For the first three quarters of 2014, offshore loan volumes were already at US$17.5bn from 46 deals compared with US$24.98bn from 91 transactions in all of 2013. Judging by the run rate and the deals in the market currently, 2014 is already within touching distance of the US$28.87bn raised from 78 deals in 2007, an all-time record. That is a remarkable turnaround for an economy that was in the doldrums for the last couple of years with the Indian rupee plummeting to historic lows of Rs68 to the US dollar in late August last year. At the time, all signs pointed to a difficult environment for Indian borrowers as lenders shied away from taking exposure amid a deteriorating macroeconomic environment. Even amid the confidence crisis, a sustained rise in pricing for Indian transactions did not materialise. Liquidity among foreign lenders, particularly the Taiwanese banks, has ebbed and flowed. Regulatory scrutiny of Chinese exposures in the early part of this year led banks in north Asia to hunt for assets and yield in other parts of the region, thus benefiting Indian and Indonesian borrowers. That, combined with the positive sentiment for the Indian economy following the elections in May, has restored the appeal of Indian credits for offshore lenders amid expectations of a resultant rise in loan market activity. “We expect [offshore loan] volumes to pick up in 2015 on the back of the positive economic and political environment,” said Birendra Baid, head of loans origination for Asia (ex-Japan, ex-Australasia) at Deutsche Bank. “Among the major contributors to the rise in volumes would be the restarting of capex cycle, which was stalled for the past few years. M&A activity and related financings should also see a boost as there is a lot of interest in India from financial sponsors,” he added. High-grade and state-owned borrowers have dominated the action, with the Tata Group at the forefront. Since November last year, Tata entities have raised US$1.56bn with US$5.64bn more to be added to that tally with a deal in the market from Tata Steel. Given the range of businesses in its stable, Tata Group is to a large degree representative of the Indian economy. Borrowers from the group raising money in the past year include companies in sectors such as automobiles, chemicals, communications, power and steel. All-in pricing on the loans for Tata entities ranges from 208bp to 324bp on recent deals. Another closely watched credit is Reliance Industries, a frequent offshore borrower. Its telecom unit Reliance Jio Infocomm is in the last lap of syndication of a US$1.5bn dual-tranche loan that pays top-level all-ins of 155bp and 171bp, respectively, on the 5.5- and seven-year tranches (average lives of 5.25 and 6.5 years). Those levels are well inside the top-level all-ins of 218bp and 223bp the borrower paid on a like-sized loan signed in January 2011 that had tenors of five and 5.5 years (avera

From the launch of electronic trading platforms to the first global rupee bonds, India’s local currency debt market has taken on new breadth this year. Yet, it still appears to be caught in a trap. While foreign interest in the Indian debt markets has surged, corporate bond volumes remain stunted. From January to September, net foreign investment in local debt amounted to a record Rs118.3bn (US$19.3bn), a marked turnaround from 2013, when foreign investors sold a net Rs50.8bn of Indian debt. Total corporate bond volumes between January 1 and October 9 this year, however, stood at a flat US$26bn-equivalent versus US$35bn for full-year 2013, according to Thomson Reuters data. Industry experts say proactive measures need to be taken to retain the interest of both foreign and domestic investors if the rupee bond market is to reach its true potential. The Indian corporate bond market is only three decades old and stands at around US$900bn, fourth largest in Asia behind Japan, China and Korea. Its growth has long been a priority for the government, but supply-demand issues have put a cap of the potential. “Channeling of the savings to the right assets, a proper electronic-trading platform, change in trading culture from hold-to-maturity to active trading are some serious gaps that need to be fixed for the rupee bond market to grow.” On the supply side, private placements from a handful of issuers, mostly state-owned companies, continue to dominate the market, indirectly impacting the growth of the secondary market. As bond sales remain restricted to private placements – limited to 49 investors – new issuers also typically either toe the line or just turn to the more familiar, albeit costlier, bank market. Instruments with AA+ or higher ratings continue to dominate rupee bond issuance, and innovation is sporadic. “Lack of supply of innovative debt instruments, such as step-up bonds, index bonds and dual-currency bonds, and missing markets, such as bond derivatives, are other supply side factors that have prevented the development of a robust corporate bond market in India,” said a study paper published on the Reserve Bank of India’s website in March 2014. On the demand side, the participation of key investors, such as pension funds, provident funds and insurance companies, remains restricted due to their investment guidelines, which limit many from buying bonds rated below AA+. Participation of retail investors also remains abysmal. “India has one of the largest bond markets in Asia with a savings rate of around 30%, which is reasonably high, but not as much as in China, where it exceeds 50%,” said Vijay Chander, executive director, Asia Securities Industry & Financial Markets Association, or Asifma. “However, the unfortunate part is the savings in India get invested in unproductive investments, such as gold and real estate partly because the country is under-banked or there is a cultural affinity towards certain asset classes “Channeling of the savings to the right assets, a proper electronic-trading platform, change in trading culture from hold-to-maturity to active trading are some serious gaps that need to be fixed for the rupee bond market to grow,” Chander said. “As India’s is structurally a high interest-rate economy, the hold-to-maturity trend suits investors because, if you sell a bond, it will result in mark-to-market losses. However, such an approach is not good for the market.” Electronic trading platforms for corporate bonds at the Bombay Stock Exchange and the National Stock Exchange were introduced earlier this year, but these have been barely active since becoming operational. Highlighting another structural flaw, Chander said the clearing and settlement mechanism too had gaps as the counterparty risk was not covered in every trade. He pointed out that the entity clearing and settling these trades (the Clearing Corp of India) assumes counterparty risk on government bond trades. “This facilitates greater liquidity

The general election victory of Narendra Modi and his BJP party in May delivered the promise of reform in Indian politics and the lifting of the policy gridlock that had stymied growth over the final years of the Manmohan Singh administration. Offshore Indian debt issuance has picked up, as a result, and the hope is that a new era for Indian bond markets has begun. An impressive US$6.8bn has printed in the offshore India market since Modi’s victory, according to data from Thomson Reuters, with a signal achievement arriving in the form of Tata Steel’s jumbo US$1.5bn offering of 5.5-year and 10-year bonds in July and Bharti Airtel’s US$2bn-equivalent Global that printed in May just after the BJP’s victory was flagged in election exit polls. It is not all about the political tailwind, however. The reduction of withholding tax on offshore issuance in the infrastructure sector, as well as the lowering to 5% from 20% of tax paid on bonds issued to fund infrastructure, promise to add spice to the Indian G3 debt market, even though, as this report went to press, it had yet to be formally signed. “To have gotten a majority government, with the stability that implies, was a very important result, and the S&P ratings outlook upgrade to stable from negative also underlined the change in perception. These developments opened the door for potentially a major pick-up in offshore issuance from India going forward.” “There was much anticipation among investors ahead of the election, with the entire India credit complex looking undervalued versus the broader Asia credit curve. To have gotten a majority government, with the stability that implies, was a very important result, and the S&P ratings outlook upgrade to stable from negative also underlined the change in perception. These developments opened the door for potentially a major pick-up in offshore issuance from India going forward,” said Alexi Chan, head of DCM, Asia Pacific at HSBC in Hong Kong. Gathering pace Standard & Poor’s was the only large credit agency to retain India on negative outlook and its decision in September to bump up the country after Modi’s victory added momentum to the India credit turnaround story. “Our outlook revision reflects our view that India’s improved political setting offers a conducive environment for reforms, which could boost growth prospects and improve fiscal management,” the agency said soon after publishing the ratings move. Prior to Modi’s victory, Indian credit had progressively widened versus the Asia credit complex, with the country’s credit perception among international investors stung by sluggish growth versus the previous three years prior to the global financial crisis, when India basked in the BRICS miracle growth story. That, and a precipitous fall in the rupee last year, which created fears that the country’s companies saddled with offshore debt would run into default, explains the drift north of Indian credit over the previous year prior to Modi’s victory. State Bank of India five year CDS traded at around 250bp at the wides, when the rupee was in the middle of its around 20% decline last year. Last week, it was at around the 125bp mark. In the aftermath of the Modi win, Indian credit spreads snapped in as much as 40%. “One good example was the Bank of Baroda 5.5-year deal that came back in January at Treasuries plus 325bp and which we tapped in July post election at plus 203bp for something like a 40% spread compression, highlighting the re-rating of India as a credit proposition,” said HSBC’s Chan. “This was reinforced by the Tata Steel bond, which, at US$1.5bn, represented the biggest high-yield debut issuance out of Asia, and the earlier Bharti Airtel dual-tranche issue on which the euro tranche successfully priced through the issuer’s dollar curve.” The Tata and Bharti (a dollar/euro combination of US$2bn-equivalent) deals take up a large lump of the Indian offshore debt issued since May, although the pipeline is rumoured

Having set an ambitious target of mobilising US$1trn of infrastructure investment in 2012–17, India has been busy expanding its range of financing options in the last two years. Among measures already taken to strengthen infrastructure financing are the establishment of Infrastructure Debt Funds (IDFs), credit enhancements of corporate bonds for infra projects, deepening of the local bond market, expansion of debt limits of foreign investors to buy long-term infra bonds and changes in the archaic Land Acquisition Act. However, these have not yielded desired results. “Financing infrastructure has never been an issue in India. The key challenge is getting projects off the ground and implementing efficiently,” said Anita Nandi, chief representative of the City of London in India, citing key findings of the organisation’s in-house research paper that had inputs from market practitioners. The entity provides local government and policing services for the financial and commercial heart of Britain.Development of the corporate bond market, infrastructure financing and international use of the rupee are some of the focus areas of the City of London in India. “The new government has started rolling out a number of policies, which may improve the efficiency of the bureaucracy and strengthen the investment climate. However, lifting GDP growth to substantially higher levels would require large productivity gains through implementation of far-reaching reforms.” “Investors are eager to invest in India, but are concerned that they don’t have a clear exit route. A faster and effective judicial system will definitely attract and retain investors” she said. “India must understand that foreign investors have options to invest their money elsewhere. India should make itself competitive for doing business on a global scale.” Like many, Nandi expressed confidence in new Indian Prime Minister Narendra Modi, but insisted his government would need to show results sooner rather than later. Since May, the pro-reform Modi government has introduced some key long-pending and crucial measures to boost infrastructure financing. These include introduction of senior bonds to promote long-term infra lending, investment trusts, real estate investment trusts and reduction of withholding tax on bond offerings. The most crucial measure among all has been allowing Indian banks to issue onshore senior bonds as this provides access to a key source of long-term funding for the country’s lenders. These bonds will also help fix a key anomaly of the Indian banking sector- the huge asset-liability mismatch. Fixing demand-supply imbalance India’s mostly state-owned lenders have shied away from issuing senior bonds in the local market simply because the Banking Regulation Act of 1949 does not explicitly allow them to do so. Nevertheless, lenders supported the pick-up in infrastructure lending since 2002 with short-term deposits. Almost half of all-bank funding in India matures in one year or less. As of May 30 2014, Indian banks had a combined infrastructure loan book of Rs8.57trn (US$140bn), according to Icra, the local associate of Moody’s. The infra lending of Indian banks registered compound annual growth rates of 25% in the last five years (2010–2014), Icra said. The rating agency also estimates Rs2.7trn to Rs3.5trn (3%–4% of estimated deposits as on March 31 2015) of onshore senior bonds can be issued to fund infra and low-cost housing sectors. This issuance can increase significantly to Rs24trn to Rs29trn for a six-year period from 2015 to 2020, it says. However, such a deluge of supply may not find adequate demand from local investors. As domestic investors like provident funds, insurance companies and pension funds can only buy around Rs1trn of such bonds, it is crucial that foreign insitutional investors also take a part of these sales. So far, the interest of the foreign investors in infra bonds have been muted. The FII limit of US$51bn for corporate debt was only

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 firm

The rush to raise new-style bank capital picked up globally in 2014, as more countries began to phase in Basel III capital regulations. In India, the first Basel III-compliant capital instrument was sold within the first three months of the new regulations coming into force, but a promising start has since given way to some tough questions. India began the transition to Basel III on April 1 2013 and, in June the same year, state-owned United Bank of India printed a Rs5bn (US$81.68m) 10-year Tier 2 bond, the first to come with contractual loss-absorption language, a requirement under the new global standards. UBI’s bonds pay a coupon of 8.75% and were entirely sold to state-owned Life Insurance Corp of India. There have been some positive developments since, but progress pales against the scale of the challenge. At the time of writing, Indian banks had sold Rs147bn of Basel III-compliant T2 bonds and just Rs52.8bn of Additional Tier 1 securities. These make little dent in the US$200bn of additional capital that Indian lenders have to raise before the full capital requirements of the Basel rules are enforced in March 2019. “Raising capital will be challenging for Indian banks, particularly state-owned banks, because of concerns around their asset quality, governance structure and ability to provide sustained value to the shareholders.” Market participants say lenders, mostly state-owned banks, which form 80% of the Indian banking sector, are most likely to struggle to raise the new capital needed. According to Fitch Ratings, nearly 41%, or US$82bn of the total US$200bn new capital requirement, will be from common equity T1, while 46%, or US$92bn, will be in the form of AT1 perpetual securities and the remaining US$26bn will be T2 capital. “Raising capital will be challenging for Indian banks, particularly state-owned banks, because of concerns around their asset quality, governance structure and ability to provide sustained value to the shareholders”, said Naresh Takkar, managing director and CEO of Icra, the local associate of Moody’s. Equity-market valuations remain low, and only four lenders have sold new shares to the public in the last 12 to 18 months. High risk, slow beginnings Basel III rules seek to reduce the need to use taxpayers’ money to bail out troubled lenders. New-style bank capital instruments need to carry loss-absorbing and/or equity conversion features, which make them riskier for investors. International investors expect a premium for that additional uncertainty and, as a result, price-sensitive Indian lenders have turned to the domestic market. However, whether or not the rupee markets alone can make up the shortfall remains unclear. “Today, the PSU banks not only need new capital, about 85% of the total requirement, but, given weak valuations and low earnings, their ability to raise capital is also impacted”, said Saswata Guha , director, Financial Institutions, Fitch Ratings, India. In the past, Indian banks have relied on heavy equity infusions from the government, rather than subordinated bonds or the public equity capital markets. Given the country’s fiscal deficit, however, the government’s will and ability to continue those injections is set to be sorely tested. AT1 instruments, which rank only ahead of common equity in the capital structure, are a particular focus for lenders wishing to raise capital without diluting their ordinary shareholders, including, in most cases, the state. Just how risky these securities are, however, remains a matter of intense debate. Bank of India is one of the three state-owned lenders, alongside IDBI Bank and Indian Overseas Bank, which decided to sell its first Basel III AT1s securities in the domestic market, even after mandating seven banks for an offshore AT1 offering. The bank sold Rs25bn of AT1s with a call after year 10 at 11% in August. “We highlighted a year ago that there are likely challenges in raising AT1 instruments as these non-equity T1 capital instrume

The India of late-2014 is almost unrecognisable from the morose, abject country of a year ago, when high inflation and elevated twin deficits were sapping international confidence. Today, the national capital, Delhi, hums with political change, while the country’s economic fulcrum, Mumbai, is infused with confidence for the first time since the financial crisis. Investment bankers, lawyers, and accountants busy themselves for a new rush of blockbuster stock offerings. Domestic share prices regularly touch record highs. Has India’s luck finally turned? Growth, once increasingly elusive in Asia’s third-largest economy, is firmly back on the agenda. In October, International Monetary Fund chief economist Olivier Blanchard revised up his forecast for GDP growth in the Indian fiscal year to end-March 2015 to 5.6% from 5.4%, and to 6.4% the following year. “Modi has re-energised India. Wherever you look, from relations with neighbours to overall economic and financial sentiment, he has taken a stumbling country and given it fresh impetus and belief.” The country’s once yawning current account deficit narrowed sharply to US$7.8bn in the three months to end-June 2014 from US$21.8bn in the same period a year ago, according to the Reserve Bank of India. Even inflation, long the bane of policymakers, is moving in the right direction. Consumer price growth weakened to 6.5% year on year in September, having topped 11% just 10 months earlier, with wholesale inflation hitting a five-year low of 2.4%. In search of a single reason to explain the country’s remarkable turnaround, many point to the energy and actions of a single man, Narendra Modi. Since taking office following a landslide general election win in May, the country’s 15th prime minister has embarked on a bold reform drive that has penetrated virtually every crack and fissure of India’s creaking economy. An anti-corruption campaign, no less vigorous and far-reaching than the one Chinese President Xi Jinping is waging in Beijing, is tackling endemic graft. In August, Indian stock regulator Sebi finally gave the go-ahead for the creation of real estate investment trusts (REITs) after six years of foot-dragging – a major boon for a recession-plagued property sector crying out for capital. The nation’s dysfunctional energy sector, a huge strain on public finances, is also being transformed. In October, Modi’s left-field pick as finance minister, Arun Jaitley, announced that the price of natural gas would rise by a third, bringing it in line with market forces, with diesel prices also being deregulated. Economic supporters, for now, are universal in their acclaim of the man vested with giving the country a new head of steam. “Modi has re-energised India,” says Anjan Ghosh, head of corporate ratings at Gurgaon-based ratings agency Icra. “Wherever you look, from relations with neighbours to overall economic and financial sentiment, he has taken a stumbling country and given it fresh impetus and belief.” IMF chief economist Blanchard implicitly praised Modi’s pioneering agenda to issue the Fund’s first genuinely sunny outlook on the country in years. Commending the decision to embark on “much-needed structural reforms”, he added that effective policies and a welcome injection of confidence had enabled India to “recover from its relative slump”. It is easy, given the speed of Modi’s rise to national political prominence, and his record as the reform-minded governor of Gujarat, to make the mistake of viewing him as a free-market proponent in the guise of, say, Margaret Thatcher. The reality is rather more nuanced. True, India’s new premier may have campaigned on a ticket of hope and change, much as US president Barack Obama did in 2008, but insiders say Modi’s worldview is also predicated on a belief that the public sector can be retained, so long as it is retrained to serve the people rather than – as has been the case in India’s long history – itself. Gujarat model His makeover of the civil