The re-emergence after seven years of Indian borrowers in the international capital markets in 2003 created high hopes among debt capital markets bankers that the country would become one of Asia's bigger sources of supply. Although volumes have inched up, the expected flow of deals has not materialised. There is still a sense of optimism, however, as Adam Harper finds out.
Indian issuers are still failing to meet investment bankers' high expectations. Just four public bonds deals and total issuance of only $1.5bn between last September and this September is hardly representative of the size or rapid growth of the Indian economy.
When they have come to the market, Indian issuers have tended to eschew paying premiums for benchmark sized deals and have preferred smaller, tightly priced bonds. But, as 2005 continues, bankers are nonetheless confident that India will steadily become a more and more important part of the Asian bond market.
Debt capital markets readily list the reasons that Indian issuers have stayed away from the international fixed income markets: Reserve Bank of India regulations are onerous, the convertible bond market is red hot, Indian borrowers have access to cheap loans from highly liquid markets both onshore and offshore, Indian companies are cash-rich and so on.
But Mark Leahy, head of syndicate for Asia at Deutsche Bank in Singapore, says that Indian companies will naturally gravitate towards the bond market as the country's economy continues to open up and thrive.
"The first time for any borrower can be complicated and there is some viscosity in the decision-making process," says Leahy. "Companies need to reach a material stage of development and growth before it makes sense for them to diversify their investor base. Even then the basis between loans/domestic funding sources and the offshore markets can be a hurdle. To take the leap issuers have to be convinced that their business has changed fundamentally and not just cyclically."
Perhaps the only Indian issuer to come to the bond market over the last year because it wanted its business to change fundamentally was Vedanta Resources, the London-listed aluminum, copper and zinc producer.
Vedanta raised a very successful $500m five year deal in December last year and re-opened it for a further $100m in January. The biggest Indian deal of the year was led by Barclays Capital and Deutsche Bank.
The metals firm stood out, though, as the only private sector company to access the market in a year otherwise dominated by familiar public sector issuers. Of these, State Bank of India was able to notch up some milestones when Citigroup, Deutsche Bank and HSBC led a $400m five year deal in late November.
SBI milestone
At the time, bankers said it was the biggest ever institutionally targeted bond from an Indian issuer. It also made use of a Moody's Baa2 rating that pierced the sovereign ceiling by one notch to achieve the tightest ever pricing for an Indian benchmark deal at 117.5bp over Treasuries, or 77bp over mid-swaps.
Many Asian bonds bankers believe that Indian borrowers can achieve remarkably tight pricing, considering the sovereign is rated Baa3/BB+. "With low Treasuries and Eurozone yields, there has been significant compression in spreads over the last two or three years wherever you look in Asia," says one head of syndicate in Hong Kong. "There are a lot of people who believe that Indian spreads are ahead of the credit, but — frankly — that is driven by the lack of supply and is part of a global supply and demand imbalance."
Despite this tight pricing, Indian issuers are faced with the extra cost of a 26% withholding tax on the coupons of offshore fixed income instruments. The state owned Indian Railway Finance Corp was able to minimise this by tapping the Euroyen market in March. Finance Corp's ¥13bn five year deal, arranged by ABN Amro, Daiwa and UBS, paid a coupon of just 1.43%.
"Yen is attractive because the withholding tax," says S Balachandran, managing director at IRFC in New Delhi. "There is also a correlation between the rupee and yen, which move in the same direction up to 75% of the time."
John Keith, regional head of debt capital markets at Nomura in Hong Kong, believes the Samurai market could also be a logical source of funding for Indian borrowers.
"For market reasons of both demand plus supply, underpinned by an increasing investor appreciation of India's actual and prospective growth, there is little question that Indian issuance should work well within the Samurai market.
"Greater international participation in Samurai plus very visible Japanese lender participation within syndicated loan facilities should couple well with prospective institutional investor demand for new issues. The return of Indian issuers after a decade long absence, presupposing well structured and executed transactions, will quickly ensure the validity of the Samurai market as a compelling and competitive source of financing."
A need beyond loans
Although there is an abundant supply of cheap bank credit, both onshore and in the international loan market — and withholding tax on offshore loans is only 10% — a handful of Indian issuers recognise that loans cannot meet all their needs.
"If we are looking to raise $300m or more, the syndicated loan market may not be able to give that much, so we go to bonds," says OV Bundellu, executive director at Industrial Development Bank of India in Mumbai. "It is also our strategy to widen our investor base, tap new investors and strengthen our perception in the market." IDBI was in the market in December with a $250m five year Reg S deal led by Barclays and Merrill Lynch.
Bundellu believes that the Indian issuer base will expand beyond state owned credits, though. "The loan market is simpler to enter," he says. "With bonds you need much more preparation — you have to get a rating, do due diligence, get to know investors and sell your story. But — slowly, slowly — Indian corporates are looking and there is an increased appetite to go to the bond market."
And there does indeed appear to be an improving corporate pipeline in India. Vedanta is planning to return to the market and has mandated Deutsche Bank, Merrill Lynch and Morgan Stanley to arrange a rumoured $500m-$1bn five year issue. If it does get completed at the top end of that range, it will easily be the biggest ever Indian offshore corporate bond.
The restructured Essar Steel has mandated Barclays, Credit Suisse First Boston and UBS for a $200m deal while Essar Shipping has named Deutsche Bank and HSBC for a $150m-$200m bond. Bankers also expect a deal for Tata-backed Haldia Petrochemicals. Furthermore, there are persistent rumours that Reliance Industries, India's largest private sector company, may come to the market.
With assets worth more than $18bn in operations including oil and gas, communications, telecoms and financial services, Reliance is a mouthwatering prospect for the international debt capital markets. The conglomerate is not short of money, having recorded gross profits of $1.73bn in 2004-2005, but some bankers believe its investment needs and possible acquisition funding may be too great for the balance sheet and loan market.
"The possibility of continuous macroeconomic growth translating into corporate capital expenditure makes the prospect of increasing funding needs from the sector more realistic," says Florian Schmidt, head of emerging markets debt capital markets for South East Asia at Bank of America in Singapore.
"Once these candidates discover the advantages of duration borrowing in a low interest rate environment, possibly supported by a more level playing field tax regime, we could see more international bond issues," adds Schmidt.
One of the factors restraining companies from accessing the market is the Reserve Bank of India's limit on the rate paid for external commercial borrowing. There are RBI ceilings at 200bp over Libor for between three and five year debt and at 350bp for tenors over five years — equivalent to a yield of 7.85%, bankers say.
This limitation, an onerous approvals process and Indian issuers' preference for loans and convertible bonds makes India a rather dour part of the Asian market for the time being in the eyes of some bonds bankers. "There's not much going on right now," says one. "There will be in a year or two so we had better invest. But — put it this way — I am not in India every week."
But others feel the expansion of the Indian market is closer at hand. "In 2003 there was one deal, in 2004 there were four, this year there could be seven or eight by the end," says Leahy at Deutsche Bank, who expects some $3bn in new issues from India this year.