Since the beginning of the year, Indian capital markets have kept one glaring event in sight — the general election which will take place between April and May. The election pits the incumbent government of prime minister Narendra Modi against Rahul Gandhi’s Congress Party.
Whatever the result, a big shift in government policy seems unlikely. India has already pulled off some stark, and occasionally controversial, reforms during Modi’s administration, including the introduction of sales tax and the demonetization of 500 and 1,000 rupee banknotes. It is hard to envisage policy changes on that scale.
The greater risk is that Modi wins the election, but with a reduced mandate. One Indian banker tells GlobalCapital Asia that his firm predicts only a 22% chance of Modi’s Bharatiya Janata Party (BJP) winning a majority.
What difference does this make to capital markets? Quite a lot, it turns out. Many investors have decided to reduce their exposure until the election is over, says Sanjeev Prasad, institutional equities strategist at Kotak Securities. Corporations are also hesitant.
“Many companies that are waiting in the wings will launch their trades [post-election],” says Mangesh Ghogre, head of equity capital markets for India at Nomura. “Nomura is working on eight IPOs which have filed [a prospectus] and will target to launch when the window opens.”
Should BJP retain power and continue the status quo, market sentiment should remain strong, says the Indian banker. But if another party takes power — and that would almost certainly be Congress — it will take a few months for the market to digest the result, says an Indian banker. It does help that Congress has plenty of experience of government, he says. It ran the country for 49 years.
The good news is that the second half of the year should be wide open for issuance, in both the debt and equity markets. As the election nears, the pipeline for both debt and equity deals is growing.
The second half of 2018 was all but shut for international fundraising from the country, and Indian companies are eager to make up for lost time, particularly in the equity market.
“There is a long pipeline of IPOs that want to hit the market in 2019,” says Nomura’s Ghogre.
Many of the concerns that plagued India in 2018 will continue throughout this year— including fears over the trade war between China and the US, exposure to oil prices and wider worries about emerging markets.
But Avinash Thakur, head of debt origination for Asia Pacific at Barclays, says: “People will be less concerned about these issues in 2019. The prospect this year is looking much better compared to last year.
“If these issues stay in the market, they cease to be an unknown and the market factors them in.”
Others agree. “The last three months have been great for the market,” says Kotak’s Prasad.
“You still see some trade tension, but it has come down a bit. And central banks seem to be more dovish.”
India’s central bank has been particularly helpful in another way, too. The Reserve Bank of India (RBI) doubles as the country’s bond market regulator and, in that capacity, it has taken an increasingly liberal approach.
The RBI has typically kept a tight grip on exchange rates. India’s currency is not freely tradeable — speculators must use non-deliverable forwards to take bets on its direction — and offshore fund-raising is subject to myriad regulations. But “the outlook of the regulators has changed over a period of time,” says Manan Lahoty, partner at L&L Partners.
Regulators have been busy this year, opening new parts of the market and boosting the economy ahead of the election.
For instance, the Securities and Exchange Board of India (Sebi) amended the minimum investor allocation for InvITs and real estate investment trusts (Reits) in March in the hope of giving the lagging market a boost.
The RBI also made a number of reforms to its external commercial borrowings policy in attempts to loosen and simplify offshore debt raising activities.
This included combining all international borrowing and lending transactions into two categories, replacing the former four-tier structure. It also simplified the minimum average maturity period requirements, allowing borrowers to access shorter dated funds.
Loan and bond bankers were immediately optimistic that the changes, which were announced in January, would provide a fillip to offshore volumes.
With such changes helping start the year, things are looking up for India’s debt market, and international bond issuance has started 2019 with a bang. Borrowers returned in force in January, and the pipeline filled up quickly from there. Shriram Transport notably sold its first dollar bond in late February, making it the first Indian high yield borrower to sell an offshore note in more than year.
The market is already on track to outpace last year’s issuance. In 2018, just $6.38bn worth of notes were sold internationally, a big drop from the $16.47bn raised in 2017. By contrast, Barclay’s Thakur expects 2019 G3 bond issuance volume to be double that of last year.
“The issuers themselves seem to be in a better place right now,” says Thakur. With the US Federal Reserve rolling back on the number of rate hikes they expect this year, investors are feeling a bit more confident.
The offshore bond market is also being helped by tighter conditions in the rupee bond market. While there is always a smattering of new issuers, such as Shriram Transport, Indian bonds tend to come from repeat borrowers. In January, for instance, there were notes from government-linked names like Oil India.
“The rupee market has not been at its best, so some of these issuers are keen to explore dollars,” says Thakur. “If the market continues to be challenging, then we will see more issuers coming to dollars.”
India’s issuers have been helped in part by the increased appetite for duration since the start of the year, as they tend toward the longer end of the curve. “What was happening last year was that the five year was getting much more expensive,” says Thakur. Now that international investors are eating up five and 10 year paper again, issuers are seeing more appeal in the dollar market. “Duration is one of the reasons they were back in January,” he says.
Stock market rebound?
Like the bond market, stocks took a beating in 2018, but investors and sell side bankers are feeling more positive about the coming year. Equities also suffered a sharp drop in new issuance, with just $14.979bn raised in 2018, compared to $30.749bn in 2017, according to Dealogic.
The Nifty 50 index dropped sharply in the latter half of 2018, and has fallen more than 7.5% between start September and the end of February.
Medha Samant, investment director at Fidelity International, says much of the volatility in the Indian equity market is due to political noise. She says that India has continued to demonstrate a long term growth trajectory, despite the ups and downs in the markets. “It’s the fastest growing key economy in the world,” she says.
That does not mean investors have no reasons to be wary. “What worries investors is that the rise in Indian stock prices has been driven by valuation multiple adjustments rather than actual earnings improvements,” says Ghogre.
Valuations in small and mid-cap companies ran up in 2017, but have been hammered in the last six to nine months.
The S&P BSE small cap index dropped by more than 20% between the start of September 2018 and the end of February 2019, while the S&P BSE midcap index fell by nearly 15% during the same period. That leaves some valuations looking attractive, but in the long-run it will mean little without visible gains in earnings growth, cautions Ghogre. “That’s the challenge for investors,” he says.
Prasad says valuations have become very expensive. “You have a bunch of stocks that people want to buy, but probably can’t buy because of valuations … It’s a very, very weird market here, honestly,” he says.
The run-up in valuations is partly down to foreign investors putting more focus on the market, says Sumit Jalan, co-head of India investment banking and capital markets at Credit Suisse.
Given a fall in primary market activity last year, with just $5.515bn raised from IPOs versus $11.749bn raised in 2017, foreign and local accounts alike have turned to the secondary market, fuelling a rise in prices.
This all makes for a tricky environment for Indian capital markets bankers. But they can at least take comfort in the fact that the market still allows room for structural innovation. Indian investors are looking forward to the prospect of the country’s first Reit. The sector has lacked activity so far, but Embassy Office Parks Reit, the country’s first, was launched as GlobalCapital Asia went to press.
“Once that launches, that will bring another product to the capital markets suite,” says Ghogre. “Investors will have another product to play real estate.”
Lahoty agrees that the deal will be a milestone. “The Reit has been much spoken about for the last four or five years,” he says. The first Reit has been ready to go, but was reportedly waiting for an appropriate market window. Once it is done, Lahoty expects plenty of other such deals to follow.