Mumbai: Debt private placements touched a record high of Rs. 2.6 trillion in calendar year 2012, according to market research firm Prime Database. Indian corporations rushed to raise money from the market to take advantage of the interest rate differential between bank loans and such bonds.
Indeed, the corporate bond market has been growing over the years but the immediate trigger for higher debt private placements could be the greater interest of foreign institutional investors, or FIIs. The limit on investment in debt by FIIs has been rising over the years as India seeks to broaden and deepen its bond markets.
FIIs can currently invest up to $65 billion (around Rs.3.5 trillion today) in debt. Out of this, $20 billion is meant for government bonds, another $20 billion for corporate bonds and the rest, $25 billion, for infrastructure bonds. Apart from the interest rate, a weak local currency is another incentive for FIIs to invest in debt instruments as they can earn more if the currency depreciates against the dollar. The Indian rupee is among the three worst-performing currencies among emerging markets in 2012, losing 3.46%.
According to investment bankers, companies prefer private placements because it helps them raise money faster than public debt offers. The time and cost involved in holding road shows and fulfilling regulatory formalities for public issues nullifies the cost benefit that a company with high credit rating enjoys. “For public offers, the listing and disclosure formalities are cumbersome and that makes them relatively unattractive for smaller, frequent issuances. For large companies, any interest cost benefit is significantly reduced due to the administrative and distribution cost,” said Siddharth Suri, assistant director for debt advisory at Rothschild India Pvt. Ltd.
Suri also said that the easing of listing norms by the Securities and Exchange Board of India (Sebi) and disclosure norms for private placements of debt have also increased the popularity of private placements among large and higher-rated firms. In October, Sebi allowed companies multiple rounds of fund raising through debt within 180 days by filing the prospectus only once.
Another reason for increasing debt placements is the considerable arbitrage opportunity between the interest rate charged on loans by banks and prevailing yields on corporate bonds. Banks cannot give loans at a rate lower than the so-called base rate, or minimum lending rate. Currently, the base rates of most banks are around 10% or more while corporate bond yields are around 9% for both five- and 10-year triple-A rated bonds, according to Bloomberg. State Bank of India’s base rate, 9.75%, is the lowest among banks.
“For highly rated firms, private placements are cheaper than bank loans,” said Suri.
Typically, banks keep a margin on their base rate while fixing the actual loan rates and this depends on banks’ internal rating of borrowers.
Balesh S.J., senior director, treasury, at IDFC Ltd, said: “The debt private placements may continue to be high in 2013 as well unless the Reserve Bank of India (RBI) goes for sharp rate cuts. Even if the central bank cuts its policy rate, the impact on base rates of the banks will be with a lag. Corporate bonds will be a preferred route for fund raising as this market reacts quickly to any interest rate movement.” Banks are also big buyers of corporate bonds. Such subscriptions are shown as investments on banks’ books and when interest rates drop, they can book appreciation benefits as treasury income. Bond yields and interest rates move in opposite directions.
Suri of Rothschild said banks are keen to invest in bonds and make treasury gains as they expect interest rates to fall. Another reason behind banks buying corporate bonds is RBI’s red flag regarding bulk deposits. Banks used to mop up bulk deposits, offering relatively higher rates but the regulator has asked them to pare their exposure to them. (Bulk deposits are typically high-cost deposits that can hurt the profitability of a banks in case there is a sudden withdrawal.) Banks are investing in corporate bonds as an alternative strategy.
“RBI has asked banks to limit their bulk deposits up to 10% of their term deposits. Banks have a huge appetite for AAA, AA+ corporate bonds as they give decent returns and are readily tradable in the secondary market,” said M. Narendra, chairman and managing director at Indian Overseas Bank.
The central bank has also encouraged the development of the corporate bond market in India. It has allowed banks to offer such bonds as collateral to borrow from its repo window as well as the interbank call money market.
Yet another trigger for a spurt in the corporate bond market and private placements could be Indian companies increasing their focus on infrastructure development.
The corporate bond market was a key element in facilitating investment in infrastructure, RBI deputy governor Subir Gokarn said recently at a conference.
That’s significant in the light of India’s plans to invest $1 trillion in infrastructure development in the next five years.
In November, Reuters had reported that the government would raise the FII investment limit in corporate bonds by $5 billion. However, there hasn’t been any official notification on this as yet.
According to P.R. Kalyanaraman, managing director at Centrum Capital Ltd, banks have considerably reduced their exposure to the infrastructure sector and this could be one reason why debt private placements have seen an increase.
Laxman Kumar Nasarpuri, partner at Financial Pundits, a Mumbai-based financial advisory firm, also said that large infrastructure finance companies such as Power Finance Corp. Ltd, Rural Electrification Corp. Ltd and Srei Infrastructure Finance Ltd have been resorting to debt private placement to raise long-term funds.