The Indian debt market can be divided into two segments: Indian currency denominated debt and foreign currency denominated debt. Anand Rathi speaks to Lyndon Driver
In terms of Indian currency denominated debt, the total size of the market as of March 2010 – as per the national Stock Exchange of India (NSE) – was just over $705bn. Of this, government debt – including public sector undertakings and local government bodies such as municipals – accounted for 88 percent ($38.5bn) of the total national debt while corporate debt amounted to just seven percent ($25.8bn).
There are a number of reasons behind the relative underdevelopment of the corporate debt market in India.
Apart from the conspicuous absence of borrowing facilities against corporate bonds, there is also a variation in the various corporate bonds issued. For example, different issues by Power Finance Corporation (a frequent borrower) have different day counts for periodic interest payments. While most bond issues have a minimum denomination of Rs 10 lakh (Rs 1,000,000), that of Power Grid Corporation is Rs 12.5 lakh (Rs 1,250,000).
Finally the standards of disclosure and transparency in India are relatively poor compared with the western benchmark.
Turning to foreign currency denominated debt, the total size of External Commercial Borrowings (ECB) – including Foreign Currency Convertible Bonds (FCCB) – made by the Reserve Bank of India (RBI) was just over $80bn as of March 2010. Of this, FCCB accounted for 15 percent ($12bn) of the total.
Driving the growth of Indian FCCBs are a number of factors, including interest rates that are lower than than of traditional debt, the option to convert debt to equity upon the maturity of a loan, the easy transferability of debt between non-residents outside India, and the fact that average term of a loan is approximately five years.
The Indian debt market grew from $342bn in 2006 to just over $705bn in 2010, representing a Compound Annual Growth Rate (CAGR) of 20 percent. However, as we have seen, some 88 percent of this debt is composed of government securities and just seven percent of private debt. As such, the availability of debt to fund transactions in India is low. By comparison, in the US, some 75 percent of total debt comprises private debt, while the figure stands at 65 percent for the Eurozone and 35 percent in China.
In 2006, India’s total financial assets totalled $1.8trn, equating to 202 percent of the country’s GDP. This compared well with other emerging economies but was significantly low compared with developed nations such as the US and the Eurozone, where the financial assets where 424 percent and 356 percent of GDP respectively. China’s financial assets stood at $8.1trn; 307 percent of GDP. Under the Indian financial system most of the capital is channelled back to the government, and state owned enterprises and the public sector absorbs nearly 70 percent of the nation’s savings. As a result, there is inadequate capital available to fund successful private enterprises.
Private Equity (PE) deals have shown a decline both in volume and value since January 2007. The total private equity investment since 2007 to 2010 till date is $27bn. The global financial crisis has changed the PE landscape altogether, resulting in fewer deals and even fewer exits. Allocations to PE funds by Limited Partners (LPs) were down in the first half of 2009, with some LPs even requesting a rescheduling of existing commitments. In response, some PE funds – most notably the international players – have reportedly reduced their management fees and reduced their commitment to the asset class.
Given the current economic situation, global LPs are likely to invest in fewer funds than they would have done three years ago, and today they are picking those funds with management teams which have a genuinely sound track records and exceptional operational experience. In addition, going forward, the emergence of domestic LPs investing from family and corporate accounts are expected to offset – at least in part – the reduction in capital from overseas.
In terms of exit activity, the majority of exits in 2009 were made by funds that made their initial investments between 2004 and early 2006. In addition, many of these divestments have only been partial exits. Exit multiples have been varied, with ChrysCapital making an 8.5x return on its investment in Shriram Transport Finance, whereas the majority of other divestments have seen more austere returns, for example Citi Venture Capital International (CVCI) recorded returns of 1x on its sale of Techno Electric & Engineering Co.
Traditionally in India, there has been a reluctance among privately-owned family companies to share ownership or surrender control of their business. However, this scenario is changing, as family businesses are becoming increasingly larger entities, and as such their need for funds has increased. Private equity firms present a distinct advantage over traditional methods of fundraising as they take a more active advisory role and have a greater ability to raise growth capital – a combination that business owners and promoters are finding more attractive. In this way, there is a growing openness to private equity by Indian businesses and this is likely to increase further in the coming years.
There is a growing trend for global funds to seek domestic LPs as they acknowledge their superior knowledge of the local market, in particular on regulatory issues and in their understanding of the mechanisms of the Indian private equity industry. This expertise, therefore, helps protect the interests of both GPs and LPs alike.
IPOs and FPOs
The appetite for IPOs and FPOs in India seems to have increased despite the current economic climate. In the first three months of 2010, some 30 Indian companies raised a combined $6.9bn through initial share sale offerings (including both IPOs and FPOs). This is slightly surprising, as over the same period the total value of IPOs globally was $53bn. With 20 IPOs in the first quarter of the year, India had the third largest number of IPOs globally, after China and the US. Global IPO activity witnessed five-fold growth during the period with a total of 267 IPOs valued at $53.2bn in the quarter ending March 2010, compared with 52 deals, which raised $1.4bn, in the same quarter the previous year.
India’s leading sectors in terms of IPO and FPO activity were infrastructure (including logistics, real estate and construction) as well as retail and IT. In addition, as of the beginning of April 2010, there were a further 117 more IPOs in the pipeline.
The fast-growing Indian economy offers huge opportunities for cross-border M&A, which has the benefit of bringing in the necessary skills, expertise and resources that are presently not readily available in India. In the resources sector, Indian companies are actively seeking to acquire energy and mining assets in the CIS and Africa. Also, the IT, Manufacturing and Healthcare sectors present the strongest growth opportunities for cross-border M&A. Over the last three years, one-third of all deals has been in these sectors.
As to the location of India’s partners, both in terms of volume and also the value of deals, India engages most with US and Northern Europe for cross-border M&A. Even in Northern Europe, the UK is the dominant country. Other regions of good activity are Western Europe and South East Asia. Based on the number of deals concluded over the last three years, India has completed the majority of its transactions with the US. In value terms, however, over the same period, India has been most actively involved with African nations. Having said that, India’s involvement with Africa is principally the result of the 2010 Bharti Zain deal, bearing a transaction value of $10.7bn.
India’s financial services
Financial services in India are not well recognised and there is not much demand for financial services products such as insurance. The exceptions to this rule are Unit-Linked Insurance Plans (ULIP), which are viewed mainly as tax-saving instruments. Demand for non life insurance such as automobile insurance has been present in India for some time as it is a mandatory government requirement, but the situation is not the same for life insurance.
In recent times, however, there has been a growing awareness of the financial services industry and the products on offer to individuals. India’s growing economy has also bolstered this awareness. Financial services offered to individuals range from banking and insurance to investments in equity markets and mutual funds.
Financial services’ future
An increasingly affluent middle class is one of the most important factors spurring the development of the Indian financial services industry. A relatively stable economy and a consistently-high GDP growth has also fuelled this development. The social fabric of India – which is increasingly encouraging individuals to save their money – has also created a need for further financial services. Gross financial savings is expected to rise from $2bn in today to $6.6bn by 2017, creating growth opportunity groups such as banks, insurance providers, mutual funds, the stock markets and wealth management firms.