The answer to India’s nascent corporate bond market

IFR India Report 2009
10 min read
Emerging Markets

On the back of their recent election victory, India’s United Progressive Alliance led by the Indian National Congress delivered a clear message: to develop India’s sub-par infrastructure with an ambitious stimulus package. The Eleventh Five-Year Plan has earmarked US$500bn to achieve this, while the previous five-year plan committed US$250bn.

The government now has the right people in the right positions,” says Anup Maheshwari, head of equities and corporate strategy at DSP Blackrock. “There’s ownership of infrastructure projects. There’s a commitment to deliver and to attract more foreign investment, so the days of political divergence are, hopefully, in the past.”

Project financing is the mechanism the government hopes will facilitate India’s infrastructure growth. Of the US$500bn tabled, the central and state governments will provide US$350bn in a 37.2 % and 32.6% weighting, respectively,with the remaining 30.2% (US$150bn) expected to come from private investment.

That’s the theory, but how realistic are these figures? Vinay Minon, executive director of equity capital at JPMorgan Mumbai, is cautiously optimistic. “I’m not completely sure if this US$500bn commitment can be fully realised. The government’s intent is positive, which is important, but the figures are high and if we are to achieve them, we need solid execution capabilities.”

Total required debt financing has been estimated at Rs9.88trn (US$202bn), with Rs1.86trn in equity financing flowing into the private sector. But this still leaves two-thirds (US$100bn) to be raised as debt. How then, is India’s capital market responding?

Equity growth augurs well

Unsurprisingly, following the US$500bn stimulus package announcement, India’s stocks have been among the best performing emerging market equities in 2009. In early March the Sensex slumped to a three-year low of 8,160.40. However, by August 3, it had closed at a 14-month high of 15,924.23 – a staggering 95% rebound – while the NSE Nifty had reached 4,711.10 points.

“We should see a fair bit of upside in the market, certainly compared with last year, but my belief is that the market will only begin to show signs of growth in the third quarter of 2010; that’s the real indicator,” said Minon. “I expect to see growth of

5%-5.7% GDP, down slightly because of the weak monsoon.”

Infrastructure projects have increased demand for raw materials, especially steel, which posted a 5% increase last quarter as production rose to 12.8m tonnes. S K Roongta, chairman of Steel Authority of India, was quoted as saying “the company expects infrastructure spending to boost demand as much as 8% this financial year”.

Bharti Airtel and Reliance Industries are top-ten-ranking stocks as telecom and power projects spring forth across the country. “We’re long-term bullish on equity performance: 10% annualised returns are expected for 2010, reaching 15% by 2012,” says Anup Maheshwari, whose TIGER fund, launched in 2004, is

one of India’s largest infrastructure funds with US$680m of assets under management. ”All of which suggests India’s equity market has a lot of bottom-up potential.”

Total investment by foreign institutional investors amounted to US$5.4bn during April-May, while more than US$199m was pumped in during the first week of June.

These capital inflows need to continue for India’s infrastructure growth to be realised. Government ministers are travelling the world to attract overseas institutional investors, but it’s the likes of India Infrastructure Finance Corp (IIFCL) and Infrastructure Development Finance Co (IDFC) – government-backed special-purpose vehicles – that hold the key to making project finance a viable option.

They operate by providing infrastructure companies with cheap, long-term debt, as well as assist India’s banks through takeout financing. This helps banks transfer existing loans off their balance sheets and ease the burden they’re under to finance such massive projects. With the imprimatur to raise capital through issuance of bonds, IIFCL had, as of March 2009, sanctioned Rs187.6bn for 107 infrastructure projects totalling an estimated Rs149bn.

Ultra mega debt

Some of the biggest projects are in road expansion and power generation. Some 30.5% (US$152bn) of the stimulus package goes to power generation, while 15.4% (US$77bn) will go on roads. In both sectors the government wants US$40bn to come from private investment. “I think capital investment is moving ahead faster in power than other areas of infrastructure growth,” says Maheshwari.

Reliance Power is a key player, having recently won contracts to build three ultra mega power plants (UMPP), each capable of generating 4,000MW. “We raised US$3bn for SASAN UMPP – the single largest debt raised for a project in India to date,” said Reliance Power CEO J P Chalasani. “It also represents the first integrated power and mining project closed with project financing. External markets were slow so we focused on the domestic market on the proviso that we always have the option to raise further finances outside the country if necessary.”

SASAN and ROSA UMPPs will cost US$4bn and US$1.2bn, respectively, with SASAN already attracting interest from US investors and the company is also contemplating possible debt raising through bonds in China.

Another large beneficiary is Tata Power. “We’ve had a good year so far – year-on-year results for Q1 FY10 have more than doubled,” said Tata executive finance director, S Ramakrishnan.

Having won the tender to build Mundra UMPP at a cost of US$4bn, the preferred route for Tata to raise debt has also been through bank loans. “We have secured overseas loans close to US$1.8bn and US$200m-equivalent domestically. IIFCL contributed 10% of the financing,” says Ramakrishnan. “Of the loans secured, State Bank of India has been the lead bank. A syndicate of national banks will provide the rest.”

Improving India’s road network represents a huge challenge. At over three million kilometres it is the world’s second-largest network. Some 20km per day of roads are to be built – compared with 2km currently. To tackle the problem the National Highways Authority of India has launched the largest ever highway project: the National Highways Development Programme involving the construction of more than 13,000km of four and six-lane highways at a cost of Rs540bn. Earlier

this year, IIFCL raised US$2.1bn to help finance 60 highway projects. The Asian Development Bank granted US$100m recently to widen sections of the East-West Corridor. IDFC is also in talks with the state government in Kerala to set up India’s first State Road Fund.

Aviation sector taking off

The scale of the infrastructure task is obvious, as is the success of large liquidity-rich companies like Reliance and Tata. “We think we’re well positioned to capitalise on the government’s US$500bn commitment and close more projects,” says Reliance Power’s Chalasani. However, the biggest challenge to stimulating infrastructure growth is how to get smaller companies engaging with the behemoths in the tender process.

Hence the need for IIFCL, which will provide refinance of up to 60% of bank loans approved for infrastructure projects at an interest rate of 7.85%. It has already raised Rs100bn this year in tax-free bonds to refinance India’s banks, as well as successfully negotiate with the World Bank for a 28-year US$1.2bn loan. So there’s plenty of government debt being raised for takeout financing. If this helps lower bank lending rates, it could encourage smaller corporates to win big contracts and elevate their profile, in turn boosting their stock price. One area of infrastructure that seems particularly well suited to PPP projects is aviation.

Airport construction is a genuine growth area with 100% FDI now permissible for building greenfield airports. Passenger numbers have soared in recent times, from an estimated 39m in 1999–2000 to 117m in 2007–08. By 2017, Airports Authority of India expects the figure to reach 420m. Air cargo volumes have similarly increased, recording a 10.5% increase last year.

All of which is creating a lot of private investor interest, to the extent that of the Rs309bn earmarked for airport investment, Rs216bn is expected to be raised privately. The PPP mechanism seems effective. Previously only one airport (Cochin) was privately managed, now there are four: Delhi, Mumbai, Hyderabad and Bangalore. Given that India is hosting the Commonwealth Games in 2010, further growth and upgrading of India’s airports is both critical and realistic.

Credit market development

Although India’s government bond market is well developed, accounting for nearly 40% of its GDP, its credit market is yet to take off. As of 2008, it accounted for just 3.2% GDP – Malaysia’s, by contrast, was roughly 20% of GDP.

Clearly, India’s credit market is still not liquid enough because of too many FII restrictions. Currently, India limits foreign investment in corporate debt at US$1.6bn. Besides regulatory reform, a change in corporate mindset is also needed. Rather than reverting to traditional methods of reinvested capital, equity raising or bank loans, corporates could look to raise the debt themselves. Only US$750m (US$500m in foreign currency) in debt allocation has come from IIFCL to fund Reliance Power’s power projects – a relatively small percentage.

“For infrastructure growth to be realised it needs a lot of international investment,” says Maheshwari. “I believe the GCF target of 9% of GDP is achievable. There’s access to capital in India right now so it can be done. But it needs innovative thinking.”

Deepening its credit market will enable India Inc. to facilitate fundraising for infrastructure and provide an incentive for FIIs to remain invested in the country even when the equities market slumps. Project financing could provide a timely fillip. But as Ramakrishan concludes, “funding is not the whole story. Problems also exist with land allocation, environmental clearances and fuel linkages.”

Duncan Wood