The long-awaited PFC-REC merger, which won board approval late Sunday, creates a stronger balance sheet and a larger lending institution. But the merged entity could face higher borrowing costs in the near term, as investor exposure limits would narrow its bond investor base, market experts said, also calling for a diversified funding basket.
The merger combines two of India's largest bond issuers into one. That will leave mutual funds, insurers and other domestic institutional investors with less room to buy fresh bonds under single-issuer exposure limits.
“Overall borrowing requirements are unlikely to change because the underlying funding needs remain intact. The merged entity will still have to raise money from the market,” said Ajay Manglunia, executive director at Capri Global Capital.
“The main impact is on investor appetite. Earlier, investors could buy bonds issued by two separate entities. After the merger, exposure gets concentrated in a single issuer, so the appetite could reduce,” he said, adding that the merged entity would need to diversify its funding sources and could see yields “harden slightly” till that happens.
As of 31 March, domestic bonds accounted for 56% of PFC's total outstanding borrowing of ₹4.9 trillion. Foreign currency borrowings comprised 20% of borrowings followed by real time liquidity (RTLs) from banks and financial institutions, as per data from PFC's investor presentation for FY26.
PFC and REC together accounted for over half of India’s corporate bond market in FY26, with domestic bond borrowings of ₹2.75 trillion and ₹2.77 trillion, respectively. Individually, PFC’s borrowings were equivalent to 25.4% of the FY26 corporate bond market, while REC’s represented 25.6%, taking their combined share to about 51.1%, according to data from Primedatabase.
“There will be some impact on demand. Earlier, there were two issuers but now there will be one. That means exposure limits get exhausted faster, creating some pressure on demand,” said Killol Pandya, head of fixed income at JM Financial Asset Management.
The Securities and Exchange Board of India (Sebi) has capped mutual funds' exposure to a single issuer at 10% of a scheme’s net assets, whereas the Insurance Regulatory and Development Authority of India (Irdai) has a single exposure limit of 15% on the net controlled funds of an insurance scheme.
Some experts believe the government could allow some leeway to the existing debt of PFC and REC, including exempting them from exposure limits to allow the two companies to consolidate their balance sheets and borrowing profile without hurting access to capital.
The companies are engaging with the government and regulators to smoothen out these things. The regulators may allow some exemption to enable them to borrow from banks sufficiently to meet the business needs,” a senior industry official told Mint. "In terms of pricing, I don’t think the market is rewarding them as such for now. Going ahead, things (yields) could only become tighter for them," he added.
Shobit Gupta, chief investment officer of Generali Central Life Insurance, expects the insurance regulator to allow grandfathering of existing holdings. However, since insurers are required to invest minimum 15% in the housing and infrastructure sector, this will lead to "paucity of good credit quality names and end up in compressing credit spreads for other eligible companies in the sector".
This will also limit insurers’ ability to invest in incremental bonds of the merged entity, leading to lower appetite for the NBFC’s bonds and higher borrowing costs, Gupta said, adding that these costs should realign as PFC’s balance sheet expands and absorbs REC.
Diversifying funding
Investors who earlier held exposure to two separate issuers will now have exposure to a single issuer that could constrain fresh buying, a senior fixed income expert said on the condition of anonymity, adding that the merged entity will be forced to diversify its funding sources, including increasing bank borrowings, instead of relying only on the bond market.
“Banks are not as tightly constrained by issuer-level norms, so the merged entity can continue issuing, and banks can absorb more of the supply. On the margin, yields may need to be slightly higher initially to attract demand,” said JM Financial’s Pandya.
The Reserve Bank of India has capped banks and non-bank financial companies' (NBFCs) exposure to a single company at 25%.
Another source of funds could be higher overseas borrowing, according to some market participants. However, overseas issuances could be muted till there is more clarity over the treatment and classification of such bonds. Last week, PFC raised $300 million via five-year overseas bonds, becoming the second company and first CPSE to raise funds under the RBI's special swap window.
Both PFC and REC are ‘Maharatna’ central public sector enterprises under the power ministry. PFC had acquired government's 52.63% holding in REC for ₹14,500 crore in March 2019. Since then, REC has been operating as a subsidiary of PFC, making the latter the largest government-owned NBFC.
In addition to financing solutions tailored to power generation, transmission, and distribution, including renewable energy and sustainable infrastructure, PFC and REC also finance non-power infrastructure projects under roads and highways, railways, airports, ports, etc.
Despite the possible short-term funding constraints, PFC’s credit rating is expected to remain unchanged, given its government-backing and key role in power financing, according to Borhan Lin, director—International Public Finance, Fitch Ratings.
"We view PFC as a reference issuer of the Government of India (GoI), as its access to funding is important for supporting policy lending to the power sector,” Lin said, adding that this comfort supports the ‘stable’ outlook on the rating of the company. Fitch has a ‘BBB-’ rating on PFC’s debt. “It will continue to perform this reference issuer role and maintain adequate financing access, including the cost and availability of both onshore and offshore funding, to carry out its policy role under the government’s control and oversight.”
As per the merger scheme document, PFC will become government's principal institution for implementing power sector reforms and flagship programmes. The merged entity is expected to benefit from improved balance sheet strength, stronger capital base, and higher operational efficiencies, enabling large-scale funding and improved credit flow across the power sector value chain, including supporting next-generation technologies such as green hydrogen, energy storage, small modular nuclear reactors, and grid modernization, the document said.
The merger proposes a share-swap ratio of 88 PFC equity shares for every 100 REC shares. PFC shares ended 1.7% lower at ₹425.50 on the National Stock Exchange on Monday, while those of REC ended 0.1% higher at ₹365.