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Rating fears hit issuance, but more deals expected

01 Oct 2012

Sagging economic growth and threats of a sovereign rating downgrade plagued Indian borrowers in the first half of the year, resulting in a drop in new issue supply from the country. But with spreads having narrowed, some bankers are now hoping for around $3bn of volume by the end of the year, writes Jun Ebias.

Indian borrowers had a tough start to 2012. The global bond market rallied in the first six months, as investors flush with cash built up their portfolios after staying away for most of the fourth quarter of 2011. But Indian issuers were mostly absent, with only two deals during the period.

Reliance Industries, a conglomerate, was the first to test investor appetite for Indian bonds, coming in February after a six month period in which there were no international bonds from India. Reliance raised $1bn from a 10 year deal and quickly tapped it to raise another $500m.

The previous issuer from India had been Ballarpur International Graphic Paper, which raised $200m from a perpetual transaction in August 2011.

Reliance certainly demonstrated the pent-up demand that existed after such a long break, getting a combined $11.8bn of demand for the original deal and the tap. That inspired Axis Bank to follow with a $500m 5.5 year issue, although unlike Reliance, Axis had to pay a new issue premium — of about 10bp.

But with the country’s economic outlook worsening — official statistics announced on February 29 indicated that the fourth quarter of 2011 had seen the slowest pace of expansion in two years — spreads widened and new issues dried up.

Rating agencies got nervous, too. Standard & Poor’s became the first of the three major international raters to sound the alarm bells, when it cut India’s sovereign rating outlook to negative from stable in April. Fitch followed in June, downgrading its outlook to negative and putting India at further risk of being relegated to the sub-investment grade universe. Both agencies now have India at BBB-, the lowest investment grade rating.

"The credit warnings kept investors away from Indian dollar bonds," says Rajeev de Mello, head of Asian fixed income at Schroders. "Economic issues also put an increasingly high premium on Indian corporate bond spreads, prompting Indian issuers to wait for better market conditions."

Narrowing spreads

Luckily, they didn’t have to wait too long. An opportunity came in late July, when bond spreads narrowed to around 420bp over Treasuries from as high as 550bp over in the early part of the year, fuelled by hopes that the European Central Bank was considering new ways to address the eurozone’s debt crisis. In the US, the Federal Reserve was seen to be getting closer to launching a third round of quantitative easing.

State Bank of India was the first out of the blocks, reopening the market on July 25 after it had been shut for five months. The bank sold $1.25bn of five year bonds that drew $6.8bn of orders.

Five others followed: Export-Import Bank of India, ICICI Bank, Indian Overseas Bank, Union Bank of India and Axis Bank, which did a $250m tap of its September 2017 bond sold in February.

Together, the six banks raised $3.6bn from July 25 to August 21, defying expectations of a lull in the primary market due to the summer break.

Investors flocked to Indian bank bonds because of the juicy premium they offered against their peers in Thailand and Malaysia. According to bankers and debt traders, Indian banks paid around 175bp-190bp over the secondary prices of Thailand’s Siam Commercial Bank and Malaysia’s Hong Leong and RHB Bank, rated two to three notches higher than their Indian counterparts.

After the heavy supply from Indian lenders, bankers are now anticipating offerings from Indian companies and government-owned entities, including the state-controlled India Infrastructure Finance Co, which is reportedly looking at a $1bn global bond by the end of the year.

"We expect Indian issuers to continue to tap the market in the remainder of the year," says Joep Huntjens, senior investment manager for Asia at ING Investment Management in Singapore. "The busy summer in the primary market reflects in part investors’ search for yields."

Indian issuers have sold a combined $5.583bn from the dollar bond market so far this year, 30.5% lower than in the whole of 2011, according to data from Dealogic. But with $3bn more issuance expected before the end of the year, total volume this year will probably match or even exceed last year’s $8.035bn.

New markets

Nonetheless, the unpredictability of the dollar bond market — with windows shutting down as quickly as they open — has driven some Asian borrowers, including Indian issuers, to explore other avenues to raise funds. Borrowers tested dim sum, Swiss franc and Singapore bond markets successfully.

IDBI Bank was one of them. While its peers were busy in dollar bonds, IDBI closed its first deal in Singapore’s domestic market, where it was able to raise a decent amount at a more attractive price.

It raised S$250m ($202m) from a three year bond that was priced at 3.65%, the lower end of price guidance, and around 25bp tighter than where the comparable existing 4% July 2015 notes from Russian lender VTB Bank were trading in the secondary market. The deal saved IDBI around 8bp-10bp over its dollar funding costs, say bankers.

But IDBI was not the first Indian lender to tap the Singapore bond market. Rival ICICI raised S$60m from a five year bond in April last year through a private placement.

IDBI’s deal attracted S$3bn of demand mostly from domestic investors and fund managers, and bankers are hopeful that given the success of the deal, more Indian borrowers will consider issuing in Singapore.

"The Singapore dollar deal for IDBI will be a game changer," says Clifford Lee, head of fixed income at DBS Bank, one of the three bookrunners of the transaction alongside HSBC and Standard Chartered. "I would imagine that all the other issuers will consider broadening their investor base given the volatility in the dollar bond market."

This was not the first time that IDBI had ventured outside the dollar bond market. It also raised money in the dim sum bond market last year, as well as in the Swiss franc market early this year.

Borrowers are always looking for other markets to conquer outside the dollar bond market, says Schroders’ de Mello, and India is no exception.

Korean issuers, for example, have expanded into the Malaysian ringgit, Thai baht and dim sum markets in the last two years, after tapping the dollar, Swiss franc, Samurai and Kangaroo bond markets previously.

"The dollar bond market is the deepest, so for investors who want size, usually it is the first port of call," says de Mello. "Afterwards issuers will diversify into other markets. In the future, more Indian issuers will be trying other markets as well."

The fast growing dim sum market, which has attracted issuers from the Middle East, Europe, US and UK, is one market that a lot of Indian issuers are looking at seriously, say bankers, especially those with ambitions to expand in the booming Chinese economy.

So far there have been only three Indian issuers in the dim sum bond market — ICICI Bank, Infrastructure Leasing & Financial Services and IDBI Bank — which raised a combined $251m, according to Dealogic.

Export-Import Bank of India is interested in making its debut in the offshore renminbi market, says executive director David Rasquinha. The policy bank has sold three deals in Samurai before and now wants to diversify into the dim sum and other Asian local currency bond markets, he says.

Rating woes stay

For all the recent activity from issuers — and expectations of more to come before the end of the year — the risk remains that the country’s debt rating will be downgraded. S&P analyst Takahiro Ogawa says the negative outlook on India’s ratings signals at least a one-in-three likelihood that the country will be downgraded within the next two years.

"A downgrade is possible if the country’s economic growth prospects dim, its external position deteriorates, its political climate worsens, or fiscal reforms slow," says Ogawa.

Some economists forecast that India will expand below the central bank’s 6.5% estimate this fiscal year. A weaker growth will contribute to the widening budget deficit already under pressure due to the lower tax revenue and the higher subsidy on petroleum products.

India’s budget deficit is likely to reach 5.6% of GDP in the current fiscal year ending on March 31, 2013, says Gaurav Kapur, senior economist at the Royal Bank of Scotland in Mumbai. That is well above the government’s estimate of 5.1% of GDP by the end of the fiscal year.

India first earned an investment grade rating from Moody’s in January 2004, which was followed by Fitch two years later. S&P was the last to elevate its rating to investment grade, doing so only in January 2007.

If a downgrade comes, taking the country into sub-investment grade territory, investors will have to react. "There will be some sell-off of dollar bonds without a doubt," says Avinash Thakur, director, DCM Asia at Barclays. "It’s not just an ordinary downgrade. It’s a big shift from investment grade to non-investment grade."

Spreads on Indian dollar bonds would probably widen by 25bp-50bp in the event of a downgrade, says Thakur.
01 Oct 2012