International ambitions versus local restrictions
Indian corporations are at the forefront of the growth of one of the biggest economies in Asia, but the amount of international bond issuance from the sector remains small, not just compared to the supply from other Asian countries, but also compared to the amount of issuance from Indian banks.
This is partly because these Indian companies have good access to local liquidity, but offshore borrowing rules are a bigger factor.
Indian companies face strict borrowing limits when they go offshore, and are forced to pay withholding tax on their international bonds. These factors can often make the administrative cost of moving to the offshore market and the time involved appear prohibitive. But this scarcity helps ensure big international demand from overseas investors.
At the time of writing in September, Reliance Industries was the only Indian company to have turned to dollar bond investors so far in 2012, selling a $500m 10 year deal in late February. But more corporations have turned to the international loan market, and bankers think there is huge demand for Indian companies to tap offshore funding sources in both senior and hybrid format.EuroWeek sat down with two of the best-regarded companies from India, and two senior bankers in the market, to discuss the outlook for Indian corporations, the chances of a big increase in international funding and the way regulations can hinder, and sometimes help, these companies appeal to investors.
Note: this interview was conducted before Indias finance ministry announced it would cut withholding tax on overseas borrowing from 20% to 5%, a rule that covers both loan financing and infrastructure bonds.
Participants in the roundtable were:Ashish Garg, head, corporate finance, Vedanta ResourcesR Govindan, vice-president, corporate finance and risk management, Larsen & ToubroManeesh Malhotra, head of debt finance, India, HSBCManmohan Singh, head of debt capital markets, India, Royal Bank of ScotlandMatthew Thomas, Asia Pacific editor, EuroWeek
EUROWEEK: Can you give an overview of your funding plans, and how you approach both offshore and onshore markets?Ashish Garg, Vedanta Resources: We have access to a diverse pool of funding sources. Our holding company has been listed in London since 2003, and Sterlite Industries, one of our subsidiaries, is listed in both Bombay and New York, so it is clear that we have access to a lot of different equity investors. Most of our debt funding needs are in US dollars, and we raise around 70% of our funding in the international market.
We are not very active in the domestic bond market, since turning to bank lenders for project finance deals proves cheaper for us. But that may change over time. We would like to become a more active issuer in the domestic bond market, as long as pricing makes sense.
When we look at the offshore markets, we tend to fund through a mix of bonds and convertible bonds. We get a very good reception in the international bond market. That is why we were able to close a $1.65bn deal last year, which was one of the largest deals in Asia at that point. We have not sold convertible bonds since 2010, but that is a market that we know is open for us.R Govindan, Larsen & Toubro: We are essentially a construction conglomerate, and over the last 10 years or so our parent company, which is listed in Bombay, has changed the financial profile quite a lot. We have done quite a lot of transactions in India over this period.
Broadly speaking, we require capital at three levels: the parent company, a listed subsidiary, and a subsidiary that we are planning to list at some point in the future. We typically raise debt on a non-recourse basis, and primarily fund in the domestic market, through a mix of bank loans and bonds.
We have issued convertible bonds in the past, but we tend to primarily be loan market-driven when we go offshore. We want to work with people who know us well, because the nature of our business means assets are slightly longer term than other companies. We have not yet issued international bonds in conventional format, either in private placements or a public deal.
When we look at the needs of the business and the profile of the company, as long as domestic regulations allow us, we would like to work on more innovative ways of raising capital, both inside and outside India. But right now, we tend to work with relationship banks.
The challenge of the international bond market is that it can create volatility for your enterprise. For instance, rating changes can have a big impact, and whether we want to subject ourselves to that process is something we need to consider. It is tough to work with rating agencies when some of our projects have a 60 year timeframe.EUROWEEK: How many Indian corporations are reluctant to go into the global bond market in this way?Manmohan Singh, RBS:There are a number of Indian corporations that do look at the international markets for funding, but there are a number of challenges, especially regulations on how the proceeds can be used and withholding tax, which makes international funding more expensive. Those institutions which are global in nature and have large commitments outside of India dont provide a challenge. They are active already. But there are a lot of companies that are growing, and they weigh up the global bond market in a different way.Govindan, L&T:We look at the global bond market on a fully-swapped basis, because a lot of our businesses tend to be in India. But that does not mean we will swap the deal, since we have a lot of international businesses too, it just means that is the pricing comparison for us.
We want diverse funding sources, and we want to leave the domestic market to our subsidiaries that only operate in India, to the extent that this is possible. But the regulations are definitely a bit challenging today.EUROWEEK: What are the key regulations holding Indian corporations back from accessing the international market?Maneesh Malhotra, HSBC:The key issue is withholding tax on bond investments. There is no doubt that bond markets are much more efficient than bank lending markets, but there are advantages in the loan market for a lot of companies. The bond market does not give you the chance of flexible drawdowns, for instance, and without that you can have a huge negative carry.
There is some debate about withholding tax now, but if it is reduced down to 5% [from the 20% rate for offshore bonds now], there is very little doubt that a lot of companies will start creating MTN programmes and issuing smaller deals as and when they need them. It will then be possible to get $20m or $50m chunks from the private placement markets. That overcomes the problem of big public bonds, which give you that negative carry.
Restrictions on the use of proceeds have blocked some international fundraising in the past, but the Reserve Bank of India is allowing more flexibility on this point at the moment. It is the withholding tax issue that is really holding Indian companies back from the international market, unless they are using offshore subsidiaries.Govindan, L&T: There are a lot of restrictions on the end-use of proceeds, and they can have a big impact on the economy. For example, the government is looking for a public-private partnership that over the next five years will fund infrastructure projects worth around $1.2tr. The government is not going to pay a single dime into this, so the private sector needs to provide around $350bn of equity and $850bn of debt. The Indian banking system is just about able to meet the incremental needs of the domestic financial system. There is not enough spare capacity to fund the projects that the Indian government envisions.
Foreign companies can come and raise their own debt and equity to help fund these projects. But the rules on the end use of proceeds mean they cannot raise capital and infuse that capital into their subsidiaries, even if they are using the money to fund these infrastructure projects. That is a critical constraint.
Most of those companies that raise bonds outside India keep the money outside the country. Indian regulators do not mind that, although they put some limits on the amount domestic subsidiaries can support sister companies that are issuing international bonds. But either way, this money is generally being kept offshore.
This means we are relying on the domestic banking system to fund these infrastructure projects, but they do not have the capacity to fund these projects.
There are also restrictions on refinancing. Even if you are a well-developed company, you cannot turn to the markets to refinance your outstanding debt. The proceeds of your deal need to go to capital expenditure. That is restrictive for big companies that know they can access the capital markets, and do not want to hoard cash to pay for debt that is maturing. There are a lot of regulations that affect the way a company can structure its capital position. It easier if you have a business that is operating outside the country, but for each industry there are a lot of specific nuances that make it difficult.Garg, Vedanta: Most of our capital requirement is in India, despite the fact we fund a lot outside India. We face a lot of restrictions on the use of proceeds, irrespective of whether we are funding inside or outside India. There is a lot of room to relax the regulations, which would help corporations fund a lot more in the international bond market. That can not only give you a better cost, but it can give you more flexibility over tenors.
The withholding tax issue is definitely the biggest issue on the bond side, but there are other things that need to be relaxed, including minimum maturities. Indian companies are not able to fund offshore with maturities below five years, although there are exemptions. This is a hindrance to us. The offshore renminbi market, for example, is very attractive, and the ideal maturity for that market still appears to be three years. But we cannot exploit the cheap pricing available there because of the rules.
There are also inflexibilities in pricing. The RBI imposes a cap on pricing, and Im not sure how many corporations are able to borrow without paying more than that. That is something that needs to be considered.
In terms of foreign investors coming into the rupee bond market, it is still not attractive for them. The absolute return you can get is good, but after it has been swapped back and youve paid your withholding tax, the returns are not enough to entice a lot of foreign investors.
It will take time to solve these issues.Govindan, L&T: It is difficult to plan strategically at the moment. There is some uncertainty over the economy now, so what do we plan for, a slowdown or economic growth? We need as much flexibility in our funding options as possible to ensure we have a good risk management framework in place.
When we swap a dollar bond into rupees, we can swap it back, but only once every 10 years. Once you have reversed the swap on a particular deal, you are stuck, which limits your ability to change your risk profile as your business profile changes. Some of these accounting and regulatory challenges on risk management have an impact on your choices. You really need to be conscious of these problems.EUROWEEK: There is an obvious sense in which Indian rules are too strict. But some of these rules have a benefit. Some offshore lenders, for instance, actually support the tightness of external commercial borrowing rules, because they force Indian companies to be able to pay back debt without relying on taking on more debt. How much do these rules make lenders and investors more happy to take exposure to India?Singh, RBS: These regulations we have talked about are constraints, but they have served us well in the good times. The Indian economy survived the global crisis of 2008 relatively unscathed, and not a single domestic deal suffered because there was sufficient domestic liquidity. We havent seen the kind of defaults that weve seen in other parts of the world.
We talk about these constraints as challenges, but they have not stopped any deals from happening, whether we are talking about capital formation or M&A. I take Govindans point that, when we go to the next stage and infrastructure requirements become very significant, we have to start to think differently.
Most Indian companies are looking at the bond market from the perspective of their own growth projections, and their desire to reduce their reliance on bank lenders. Some of these companies have even turned to the offshore market to refine their capital structure, issuing hybrid bonds. There are options available. There are constraints, of course, but the regulator is flexible.Govindan, L&T: Lenders will definitely be happy that there is a specific use of proceeds of their loans, but that is between the lender and the company. The regulator does not need to play a role.
We have not opened the banking system or the financial system fast enough. Look at the Asian financial crisis. Some people say that the fact we are not open helped us survive that, but actually they have it the wrong way around. Those countries that were affected had a lot of growth first, and then one year of pain. We did not have the growth, so where is the benefit? It is better to grow, and take the occasional pain.
The legal system in Indian is transparent, which is a benefit for companies. There are a lot of good companies that have been operating for 30 years or more, so as long as these companies can get approval from their stakeholders, they should be allowed more flexibility. There should not be so much regulation in terms of access to capital. Lenders and investors can make the call over whether your use of proceeds makes sense. They may be happy that there is a strong regulator, but that is not necessarily fair on companies that are well managed.Singh, RBS: Lenders do their own research on a company anyway. This is obviously common practice in the international loan market; a major portion of your time is spent studying a company. Lenders tend to know the company very well. Bond investors also make their own credit assessments, beyond the rating, so whether there is a restriction that needs to be in place or not, it does not necessarily need to be imposed at the regulator level. Malhotra, HSBC: The pricing restrictions that the RBI has put in place mean that not many corporations can go to the overseas market. They cant fund at levels within these levels. There are some specialised high-yield investors that want to get exposure to Indian credits, and Vedanta has managed to tap that demand. But companies that dont have the overseas architecture of Vedanta cannot always access the market, and their funding needs are left in the hands of Indian banks.
As well as moving away from the withholding tax, the regulator should do something about the all-in cost ceilings. That is a key change that could really have a good effect on Indian companies. They need more access to the overseas market.Govindan, L&T: The domestic bond market is entirely open to high-grade issuers. It seems almost anything is possible, although the size may not be that big. But for slightly lower-grade issuers, it is a huge challenge to fund in the domestic market. Pension funds and insurance companies have relatively strict limits. Some of that comes from the regulators, but pension funds and insurance companies will always take a relatively conservative approach to the market anyway.Garg, Vedanta: The regulations increase the cost of capital for everybody. It is like closing the entire highway because one person drives on the wrong side.
It is not just restrictions on companies borrowing that are a problem. There are some issues for banks that have already been able to lend to Indian companies. It is very difficult for banks to declare a company has defaulted before a loan has been outstanding for five years, even if the company has breached a covenant during that time. That is a big issue for project financing, in particular.
Global investors include these inflexible rules in their pricing estimates. There is room for Indian banks in the dollar market, for instance, to compress their spreads, but that is purely from a credit point of view. When the regulations are included, the pricing starts to look more fair.Govindan, L&T: I agree that global bond pricing has, over the last few years, been relatively fair. There is some differentiation that has been happening over the last few years, so everyone is not paying the same level. But everyone still has to pay up for the regulatory risk.Singh, RBS: It might help Indian companies if there was a sovereign curve. This would set a benchmark for other issuers, and would allow investors to calculate real relationships between country risk and individual credit risk. Without this sovereign curve, you need to price over the state-owned banks. Is the starting point of that pricing correct? Nobody knows. But if you have the sovereign, there is no question about the benchmark.Malhotra, HSBC: In principle, there should be a sovereign benchmark. But Im not sure whether or not this is the right time to do it. There are some questions over India sovereign ratings at the moment, and that might stop the sovereign getting the value it should get in the international market. They should have entered the market a few years back, but if they go now, they may not help Indian borrowers too much on account of the public, and negative, comments ratings agencies have been making. But I fully agree there should be a sovereign benchmark.EUROWEEK: How attractive are hybrid bonds for Indian corporations, domestically and internationally?Govindan, L&T: Hybrid instruments are always useful. If you are at the edge, and you need flexibility from an accounting or a rating point of view, hybrids make a lot of sense. They give you a buffer in your balance sheet, and we would look at the structure seriously to give us some flexibility to consider future acquisitions, for instance.
There should not be much of a difference between international and domestic hybrids. The structure can add a lot of value, and as long as you have communicated it well to your stakeholders, it can reduce the perception of risk in your company. But you need to be careful. It does not replace your need to hold a strong equity base, and it should only be used as a small percentage of your overall equity capital.Malhotra, HSBC: The hybrid market is clearly open for Indian issuers, but it is really only an option for truly high-grade companies, whether we are talking about offshore or onshore issuance. But hopefully, over time the access to the market will increase.Garg, Vedanta:The hybrid product is a good product for increasing your funding options, especially when you have a constrained balance sheet. But the convertible bond market is also attractive for the same reason, and the liquidity you can get in the convertible market is attractive. We get back to the same points, however, in that a reduction in withholding tax would help, but right now the convertible market certainly makes sense for us.Govindan, L&T: Indian companies that took a call to expand their businesses over the last few years will now find their balance sheets a bit stretched, and the hybrid market is a nice development for them. EUROWEEK: We have only seen two Indian rupee hybrids so far, from Tata Power and Tata Steel. Is there a big enough investor base for hybrids, or even for high yield, in the domestic market? Singh, RBS: The domestic bond market is there for investment grade issuers, and the hybrid market is only open for a subset of those issuers. It is not a market than can be accessed by every company.Malhotra, HSBC: The domestic bond market is large, but it is not deep. We do not have the investor diversity and depth to ensure that all types of issuers, and all types of structures, can be absorbed. We are not seeing steps the government should be taking to deepen the investor base with respect to allowing various investor classes to invest in lower rated bonds. They are more focused on improving the secondary market, rather than adding more investors to the primary market. There is basic reform required in certain investor categories, and the hybrid format is certainly not at the top of the agenda.There are occasional high yield deals, and there are some niche investors. But these things are the exception, rather than the rule.