Big-ticket foreign acquisitions by Indian companies may slow this year on the heels of the turmoil in European debt markets that is increasing borrowing costs and inducing more volatility in the foreign exchange markets.
Two of the biggest foreign acquisitions in 2007 by Indian companies have relied on overseas borrowings: Tata Steel Ltd’s acquisition of Corus for $12.2 billion and Hindalco Industries Ltd’s acquisition of Novelis Inc. for $6 billion.
“The increasing credit spreads (in overseas market) will impact incremental borrowing (by Indian companies). The cost of borrowing will go up,” said Ajay Mahajan, group president, financial markets, YES Bank Ltd.
Together with the recent policy measures taken by the Indian government, this is expected to trigger a sharp drop in external commercial borrowings (ECBs), slowing foreign capital inflows and easing the pressure on the appreciating rupee.
“The potential slowdown in capital inflows through ECBs could be $15 billion this year (2007-08),” added Mahajan. The net inflows through ECBs in 2006-07 were a record $16 billion, which prompted the government to initiate measures to choke ECB inflows and help the central bank’s currency management operations.
The rupee, which has gained 9% against the US dollar since January, closed at Rs40.63 against the dollar on Monday, marginally higher than the 10 August close of Rs40.635.
Several large foreign acquisitions by Indian companies have been helped by a favourable overseas debt market. The interest rate on ECBs, for instance, is fixed at a premium to the six-month London interbank offered rate (Libor), a daily reference derived from the money market in London.
The spread over Libor has started widening as investors turn risk averse in a time of uncertainty. The interest rate on the last medium-sized five-year ECB issued in end-May was about 6%. Since then, no major offering has been made by Indian companies.
But signals of a tight money regime are already apparent. The European Central Bank, the US Federal Reserve and other central banks injected $135.7 billion on 9 August and $154 billion on 10 August into the money market amid fears that the fallout of the trouble in the US subprime market would adversely impact lending in Europe. Financial institutions have begun to invest in government securities in Europe, driving up yields on corporate paper.
Not all executives familiar with Indian companies’ borrowing abroad are of the opinion that the increased cost of borrowing will be temporary.
“I expect this to subside in the near future because there’s is a lot of inherent strength operating in the Indian economy,” said Anil Ladha, senior vice-president, debt capital markets, ICICI Securities Ltd.
Credit default swap (an instrument that allows the buyer cushion in the event a company defaults on its debt obligations) rates on Indian debt have widened by about 75% in the recent past on account of global factors, but this is not likely to have a long-term impact, said Ladha.
But some other disagree. The developed world’s debt market has already begun to see an increase in risk premium on all kinds of securities issued by emerging markets fir-ms, said Bidisha Ganguly, ch-ief economist at BRICS Securities. “ECB funding is going to be more difficult,” she added.
If the rupee begins to weaken against the dollar, it might have a negative impact on companies that want to borrow overseas. “Volatility does impact decision making even if they have hedging mechanisms,” said Raman Uberoi, senior director, ratings, at credit rating agency Crisil Ltd.
The combined impact of all these factors could last up to two years, added Uberoi.
Data collected by consultancy Grant Thornton showed outbound deals initiated by Indian companies in the first six months of 2007 increased significantly. Outbound deals in 2007 was $27.9 billion, almost three times the $9.9 billion worth of deals registered in all of 2006.
Uberoi did not rule out the possibility of overseas deals by Indian companies, but said everybody would have to contend with higher costs.