Credit magazine: Why Indian issuers don’t need to go offshore

Credit magazine, June 2010

Bankers hoping to entice Indian companies into offshore bonds face a number of challenges. Regulation creates a few hurdles, but that’s not the real impediment: instead, the biggest problem is that conditions are so good for borrowers in the domestic markets there’s scarcely any point going overseas.

“Indian issuers have relied a lot on the domestic markets in the last year or two, and those markets have lived up to it: in pricing, amount and tenor, it has been pretty comfortable,” says Maneesh Malhotra, director and head of debt finance, India, at HSBC. “Even now the cross-border markets have opened up, the domestic market has remained vibrant.”According to Dealogic, 117 issues had raised the equivalent of U$12.31 billion in the domestic market in the 12 months to April 14, compared to US$2.04 billion from six deals in the offshore markets.

There’s a lot to be said for it: liquidity, tenor, pricing. “Liquidity is probably $500 million to $1 billion for most of the top rated credits, those rated domestically triple A through double A,” says Ashwini Kapila, managing director at Barclays Capital. “There’s more flexibility in terms of being able to use the funds when you issue locally. There is a credit market available for those below AA, and there is tenor available for higher rated bonds up to 15 to 20 years, particularly for public sector issuers.”

This point on tenor is widely noted: in a region where few local currency markets bar Malaysia offer the opportunity for truly long-term financing, India’s rupee debt market stands apart. “We’ve seen 20-year issuance in the past, and there are a few public sector companies which do 15-year money two or three times a year,” says Malhotra. “Ten to 12 years is easily available. And you can raise up to US$400 million equivalent in these tenors.”

It’s also likely to grow from here. Fergus Edwards at UBS draws a comparison with China and ponders what it tells us about the direction India’s market will take. “If you look at the domestic market for RMB bonds and Indian rupee bonds, you can draw one of two conclusions: either there’s massive scope for absolute growth in the domestic Indian bond market, or the funding is currently being provided to Indian companies through other routes, such as domestic loans,” he says. “Either way there’s got to be massive capacity for growth.”

All of this presents a challenge for international investors who want to get exposure through offshore deals. “If you are an international investor, you want to buy the biggest names and the sector leaders to build up benchmarks,” says Edwards. “But if that’s who you are as a borrower, then you have the best access domestically. The international market just hasn’t seen a real benchmark borrower coming from India with frequency.”

There have been offshore deals, but they have tended to follow a pattern. Apart from Indian Oil Corp, most offshore borrowings have been for banks who have specific reasons for needing offshore capital. “All these borrowings have essentially been for offshore branches: using the funds for on-lending overseas,” says Malhotra. “The funds are not coming back into India but supporting clients of these banks such as large or medium Indian companies with operations overseas who require foreign currency funding.”

So why isn’t there more? Apart from the relative appeal of local currency markets, there are also clear regulatory restrictions that are off-putting when an Indian issuer looks to overseas bonds.

“Investors naturally would like to get more exposure to the best corporate names in India, but there are a number of structural issues in the market that have so far pushed Indian corporate to look at other forms of finance, chiefly domestic bonds or loans,” says Alexi Chan, managing director of debt capital markets in Singapore for HSBC. “In order to unlock that pipeline one of two things needs to happen: the structural issues need to change so there is more of a level playing field for a borrower considering which instruments to use; or conditions in the international credit markets, with a significant tightening of credit spreads to make offshore bond markets more compelling.” The demand is there, Chan says. “The overwhelming reception we got for Indian Oil demonstrates that pent-up demand is there.”

The structural issues Chan refers to are things like the RBI’s guidelines on overseas borrowing. This sets things like a minimum tenor, maximum pricing, and also conditions on end use. “They’ve worked well,” acknowledges Malhotra. “I don’t think there has been a stifling at any point of time.” But they do complicate the picture for issuers. Another issue is withholding tax, which depends on tax treaties India holds with each corresponding countries. This can be as high as 20% if you don’t know the domicile of each investor, something that doesn’t apply with syndicated loans, where the domicile of the participant banks is very clear. “That is an issue in terms of why Indian corporates do not borrow so much in the Indian bond markets,” Malhotra says.

The maximum pricing is 7.5%; any higher and the RBI won’t approve it. And it’s not likely to change much in the near future. “Don’t expect too much liberalization in the next one or two years,” says Rakesh Garg, Director, Barclays Capital.

Still, as one banker points out, “in a low rate environment it does become easier to hit pricing thresholds which minimise withholding tax. That’s an improvement, but it’s because of the market, not regulation.”

Although the domestic market clearly offers better all-in pricing, that doesn’t deter all issuers, even those who don’t need the funds offshore. “Although most Indian issuers use their offshore funds for overseas operations, issuers such as Indian Oil have used the cross-border market and brought the funds back into India,” Rakesh says. “Their objective was to diversify and enlarge their investor base, even if the cost may have been relatively higher.”

One oddity of India’s capital markets is what isn’t there. “What we don’t have is a sovereign benchmark internationally for India,” says Chan. And there isn’t likely to be one anytime soon. Ashwini says: “There’s no stated policy that India will ever issue or not issue a sovereign, but we all know on the ground there is big resistance from decision-makers in the government.”

In its absence, investors have instead hunted for a suitable alternative. “The State Bank of India is seen as a proxy to raise money for the government,” Ashwini says. “Effectively investors have taken it as given that there will not be a sovereign bond and see State Bank of India as the closest equivalent.”

The market was most grateful for SBI when it launched a vital issue in October 2009, a $750 million deal that was the first Indian offshore issuance for the better part of two years, and yet which priced agreeably at mid-swaps plus 190 basis points. “It reopened the market for Indian borrowers,” Edwards says. “You hadn’t seen anything remotely like it for 18 months, so it helped make clear the degree to which India’s pricing had changed over that period. That was very material. The size of the trade also demonstrated the volume of cash available for Indian borrowers.”

UBS was a bookrunner on that deal, as were HSBC, Barclays, JP Morgan and Citi. All consider it a landmark: Chan at HSBC calls it “A very helpful deal for establishing a benchmark for the country post-crisis,” and Ashwini adds: “Given that there had been no primary issuance by an Indian financial institution in nearly two years, the SBI bond issue reopened the international markets for Indian borrowers by creating a new benchmark.”

Subsequently, several Indian issuers – particularly banks – met with investors and priced at the first opportunity after the SBI deal. But banks like Axis and Bank of Baroda ended up postponing their deals in light of uncertainty around Dubai World and heightened sovereign risk, before coming back for a second attempt in a flurry of issuance in March. In the space of a week, Bank of India raised US$500 million, Axis Bank $350 million and Bank of Baroda $350 million; Deutsche, HSBC, Barclays and Citi appeared on all three deals. “In the end, all issuers successfully priced their transactions, and met with strong investor demand,” says Ashwini. “All the bond issues were well oversubscribed.” The Bank of India book, for example, was said to be close to $4.5 billion.

When deals like this do come they have tended to be Regulation S rather than targeted at the US, and are often underpinned by Asian demand. “It’s been a very good mix but you always notice Asia is a bit of an anchor,” says Malhotra. “It has closer physical proximity; Asian investors understand Indian names far better than someone sitting in Europe.” That said, Europe has shown strong demand too, while a recent 144A deal from ICICI shows the interest of funds in the US. By type, Malhotra reports a good mix of investors with private banks particularly strong over the last year alongside the fund managers.

They have good macro reasons to want to take part. “There is a general interest from emerging market investors to get more exposure to India,” says Chan. “There’s a general feeling that the Indian sovereign credit environment should be improving, India will undoubtedly continue to develop as one of the world’s largest emerging markets, and as this happens the number of companies that would wish to tap international markets would naturally increase.”

And it’s likely that if Indian borrowers ever ventured to the US, they would find just the same enthusiasm there. But by and large they haven’t been tempted to try. “The market is disappointed that more Indian borrowers haven’t gone down the 144A route, because US accounts are keen to increase Indian exposure,” says Edwards. “But that doesn’t make the 144a pricing necessarily cost competitive against a local loan market that is flush with cash.”

There is an exception, though: ICICI, which raised $750 million in November. “ICICI was quite different to the rest of the Indian bank borrowers because it has for some years done its international bonds issues in the 144A format, whereas most Indian borrowers have launched Reg S Eurobonds predominantly targeted at investors outside the US,” says Chan. ICICI has focused on 144A bonds sold to qualified institutional buyers (QIBs) in the US. “We saw tremendous demand from the US for Indian paper but there is very limited supply to the US from India. That’s another theme that will develop as Indian borrowers want to raise a larger quantum of funding: they will look at the 144A QIB market and tap into that investor base.”

If US-targeted bonds do prove to be a new theme, what else should we expect? “The next question is when do those borrowers that have come in a senior format start to consider sub debt,” says Edwards. “At that point, you start to see interesting transactions with longer term strategic benefits,” Edwards says.

18 months ago, India was considered a hotbed of convertible bond issuance. Could we see that come back? “You need to have a view that there is material upside in the share price,” says Edwards. “So as Indian equity market valuations have increased, so you would expect to see fewer CBs.” That suggests no room for a revival in issuance, but the regulatory challenges to straight dollar bonds may yet cause some issuers to consider it. “The international CB may still have attraction compared to regular bonds if keeping the headline cash yield low to pass some of the regulatory and tax hurdles to issuance matters.”

Domestically there is room for development in structure too. While onshore deals have mainly been somewhat plain vanilla, there are examples of more complicated structures. One was ETHL, an issue of zero coupon non-convertible debentures in January pledged against Essar’s 10.97% stake in Vodafone Essar with a put option on the shares. This deal, which effectively pierced the sovereign risk ceiling since Vodafone is rated three notches higher than the Indian sovereign, raised Rp42.3 billion – almost US$1 billion equivalent – from the domestic market.

Deals like this show that apart from being full of cash, investors in India are prepared to consider more complex stories. “It showed the market is willing to look at clearly structured deals,” says Ashwini. “The investor base is maturing.”