A widening current-account deficit and faltering growth has prompted credit agencies to downgrade India’s sovereign rating outlook. But despite fears that an increasing threat to its sovereign rating could shut out Indian issuers from the international bond markets, economic reforms, government support for banks and the continued hunt for yield may continue to fuel demand for India’s dollar-denominated bonds.
Standard & Poor’s ranks India ‘BBB-’ which is the closest investment grade level to junk status, and revised its outlook to negative from stable in June. The credit agency said there is a “significant chance” that a downward trend could eventually hurt its political, economic, fiscal and external factors, according to an October 9 report citing credit analyst Kim Eng Tan.
Despite these factors, some bankers believe that pricing ranges for dollar-bond deals may remain relatively intact. For example, Syndicate Bank priced a US$500 million bond at 355 basis points over US Treasuries on October 9, the tightest spread for an Indian bank according to Dealogic. A benign global economic environment will help state-owned Indian banks continue to price in the 300-plus area over US Treasuries, according to a Hong Kong-based senior debt syndicate banker.
“I think in the end of the day it’s not just ratings driven. It’s a lot more complicated than that,” said the banker. “People are not just looking at their ratings, people are also looking at what the government is doing, the trends for industry consumption, GDP. If you’re talking about the banking sector it’s going to be NPLs [non-performing loans] and interest margins and bank capitalisation and bank liquidity. There are a lot of things that investors take into account. It’s not just the ratings.”
S&P on October 10 cut State Bank of India and Union Bank of India’s stand alone credit profiles to “moderate” from “adequate,” stating that their asset quality will remain weak because of high credit costs and slippages in restructuring loan books until at least March 2014.
Still, unwavering government support for issuers especially in the banking sector and GDP growth of 5.5% in the last quarter will be difficult for global investors to bypass amid a search for yield. The government’s commitment to an 8% Tier I ratio for government banks underpins the capital positioning of the banking system, according to a Fitch report dated October 8.
In addition, the common equity Tier I ratio of most of India’s banks are above 7%, which also shows that their capital positions are “well protected” and should be able to absorb stressed credit costs, added the Fitch report.
“The issuers, for the most part, are state owned. And you’re talking about a major Asian economy, one of the most populated nations in the world and you can’t ignore it,” said the senior banker. “A lot of people are already invested [in India.] The yields are pretty attractive relative to the rest of Asia credit. Basically it’s rated the same as Indonesia but it trades 100-plus spreads over Indonesia. Some of the state owned banks, in some people’s minds, are better relatively.”
Bank Negara Indonesia (BNI)’s 2017s trade 240 basis points over US Treasuries, while government-backed State Bank of India’s 2017s are trading at 270 basis points and Axis Bank’s 2017s are at 340bp over USTs.
Indian banks have issued US$5.1 billion worth of dollar-denominated bonds so far this year, according to data provider Dealogic. The remaining US$2.3 billion was issued by Reliance Holdings, NTPC and India Railway Finance Corp.
Barclays is also positive that India’s bonds will strengthen as the Reserve Bank of India and market’s demand for government bonds and T-bills will outweigh net supply. Kumar Rachapudi, the bank’s rates analyst, forecasts that shorter supply will drive yields for the benchmark 10-year government bond down to 7.75% by the end of the year and reach 7.5% by the end of March 2013 from its current level of 8.16%. He also said the RBI may cut interest rates by 100 basis points by the end of the first half next year.
Yet a downgrade to junk will mean that investment-grade bond portfolios will have to cut their holdings of Indian credit. But that does not mean previous oversubscription rates of nine times book for IDBI Bank’s US$500 million deal on September 17 or ICICI Bank’s August 14 deal that attracted over seven times its order book for its US$750 million deal will become symptoms of the past.
“Is there a market right now for double ‘B’-rated sovereigns, or double ‘B’-rated credits? Absolutely there is,” said another senior debt banker. “This [the downgrade] doesn’t make the demand go away. It does create a different price, potentially it does require a different kind of people that would look at what measures are being taken by the country and by those particular companies in order to continue and exist and grow in that new rating environment and subject to all of that, emerging market funds are pretty strong and there is demand for non investment grade as well.”
Still, some bankers are more cautious about bringing Indian bonds to international investors amid a heightened credit alert, as their appetite for yield may wane if India were to be hit with a downgrade.
“I think the chase for yield has been a good run. Whether it can keep up, I think we’ve seen a good rally and I don’t think investors are really that keen to add additional paper on the back of the news from S&P.”
Even if continued demand lures Indian issuers to the global bond markets, banks may be faced with the possibility of having to pay higher interest costs and lenders may not be able to pass the additional spread to end-consumers. Fitch estimates that India’s gross NPLs will reach 4.2% in the financial year ending 2013.
“If they borrow at a higher cost they must be able to lend at a higher cost as well,” said the debt syndicate banker. “The likelihood is even if they can afford it the other borrowers can’t afford to take out loans at that kind of spread.”
In order to prevent a downgrade from hurting Indian issuer chances from reaching for global capital offshore, the government should increase its interest cap of 500 basis points over Libor on 5-year bonds, clean up non-performing loans and inject capital into the banking system to shore up investor confidence especially in Indian bank bonds, said the banker.
The Indian government defied political opposition to open its retail sector to foreign investment this month and cut energy subsidies to help encourage overseas inflows into the country and narrow the deficit.
“A lot of people are getting encouraged by the steps the government is taking so we would focus people on those steps, the potential upside and many times the ratings agencies are out of sync with the market,” said another debt banker. “They’re too slow to upgrade too slow to downgrade, particularly too slow to upgrade many times. They’re reactive not proactive so that’s another thing we can convincingly tell people.”