India’s corporate funding market is what Winston Churchill might have described as a riddle, wrapped in a mystery, inside an enigma.
The riddle, according to India Ratings and Research Pvt. Ltd, a unit of Fitch Ratings Inc., is that borrowers’ credit metrics aren’t likely to worsen from here. And yet in the financial year starting 1 April, their borrowing costs may rise even if the Reserve Bank of India (RBI) cuts policy rates further.
India Ratings’ researchers Arindam Som, Priyanka Poddar and Soumyajit Niyogi have attempted to solve the puzzle by looking at demand and supply of funds. There’s likely to be a sizable mismatch, they say, as pumped-up government borrowings—as well as debt issuance by public agencies—crowd out private borrowers. Besides, investors are parking less money with mutual funds. Any shrinkage in their assets under management will compound the financing challenge.
There’s a further mystery on the supply side of the funding equation. Household financial savings have languished between 9% and 11% of gross domestic product (GDP) since 2012. Brokerage Kotak Securities Ltd can’t pinpoint why Indians aren’t saving more despite real interest rates of more than 5%. It might, the analysts say, have something to do with a 1%-of-GDP surge in their liabilities, combined with tepid job creation and the weak bargaining power of labour, which has become a global phenomenon. Those who don’t have enough cash after servicing loans for mortgages and two-wheelers can’t take advantage of high interest rates on bank deposits.
Then there’s the enigma of mistimed regulatory tightening. Starting 1 April, capital market regulator—the Securities and Exchange Board of India—wants large firms to issue corporate bonds to meet at least a fourth of their borrowing needs. This will help create a more liquid debt market, improve the pricing of credit, and reduce the outsize role of banks in project finance. Still, the requirement, if adopted in full, could exacerbate next year’s demand-supply gap in the capital market to around ₹1 trillion, India Ratings estimates. Starting 1 July, RBI wants banks to convert 60% of working capital limits above a threshold into loans with fixed maturities. It’s a sensible move. Overdrafts seldom test the true liquidity position of a borrower who pays interest but never returns the principal. Loans, meanwhile, give lenders a better handle on the cash flows of a business.
Yet firms may find it challenging to roll over around ₹1.9 trillion of maturing loans in FY20. This funding will mainly be needed by sectors such as gems and jewellery, property developers, construction firms and farm-commodity businesses, among others.
How can India get past its corporate-financing hump? The answer may lie in the general election to be held between 11 April and 19 May. A market-pleasing outcome on 23 May and higher stock prices could encourage businesses to bring in more equity, something many have been loath to do because of a narrowing gap between return on capital and borrowing costs. New capital expenditure—especially when it’s not merely for maintenance of existing facilities—will create jobs, thus boosting households’ financial savings. Companies will get financed.
Keep an eye on the latest decision by State Bank of India, the nation’s largest lender, to link some savings deposits and working-capital loans to the central bank’s repurchase rate from 1 May. Other banks will follow suit. As the use of the policy rate expands to cover retail loans and time deposits, borrowers who got only a token 10-basis-point benefit of a 25-basis-point reduction in the repurchase rate in February should see faster drops in their cost of capital.
The ongoing, simultaneous easing of fiscal and monetary policies may help, but only so far. The tempo for India’s corporate credit is going to be set by the next government. bloomberg