It appears to have shied away from issuing a debut offshore bond in its own name, but the Indian government has certainly made it a lot easier for the country’s high yield credits to access the international bond markets this year.
Liberalisation measures enacted by the Reserve Bank of India (RBI) in January and July have resulted in a seven-fold jump in issuance compared to 2018 according to Dealogic data (see Table 1). But the $7.6 billion total is still very small relative to the size of India’s $2.67 trillion economy and China’s $57.4 billion dollar-denominated high yield issuance during 2019 (again according to Dealogic data).
Should the RBI flex the issuance boundaries a little wider, or is its decades-long fear of systemic risks relating to capital flight, hot money flows and foreign exchange imbalances justified?
One thing is clear. The offshore drive is about offsetting the ongoing onshore funding drought. This is especially true for non-banking financial companies (NBFCs) following the implosion of IL&FS in September last year
The government wants to open up an escape valve from onshore pressures and tap into global capital pools at a time when European investors, in particular, are looking for higher yielding investments. What it doesn’t want to do is push up overall debt levels when public debt stands at 70% of GDP and it is targeting a reduction to 60% by 2025.
Getting the balance right is all about what level the RBI sets the pricing cap at under its External Commercial Borrowing (ECB) regime. This currently limits offshore bond issuance to a price ceiling of 450bp over Libor, equating to up-front yields with a 6% handle on a fixed rate basis.
In the past, the cap has been 500bp over Libor and some debt capital markets specialists believe that the RBI may widen it to 550bp. If it did so, the regulator would pave the way for deals with upfront yields around the 7% mark.
This might enable some of the market’s newly minted borrowers potentially to avoid maturities bunching by providing them with more leeway to extend their offshore curve beyond three years and allow a few more lower-rated credits to make their international debuts.
One constraint is the scale of the changes the RBI has already made this year. Chief among these has been: widening the offshore bond market to any borrower eligible for foreign direct investment, lowering the minimum maturity threshold from five- to three-years and allowing Indian borrowers to refinance rupee loans in foreign currencies.
At the moment, rupee refinancing is subject to a minimum seven-year tenor; something the RBI might also tweak to five years.
Sameer Gupta, head of Indian debt capital markets at Deutsche Bank, notes how, “the RBI’s progressive relaxation measures have really opened up the offshore market for Indian borrowers and enabled them to diversify their funding sources.”
Table 1: India High Yield Bond Volumes
| Priced Year | Deal Value USD (m) (Proceeds) | No. |
|---|---|---|
| 2004 | 996 | 3 |
| 2005 | 1,997 | 3 |
| 2006 | 250 | 1 |
| 2007 | 235 | 1 |
| 2008 | 1,250 | 1 |
Historically, the market’s supply/demand imbalance has helped India’s high yield borrowers to achieve cost-effective pricing relative to where they could price onshore and against global peers.
Bharat Shettigar, head of Asia ex-China corporate credit research at Standard Chartered, told FinanceAsia that: “The scarcity factor means that Indian names trade relatively tight compared to similarly rated Asian and emerging market names. They’re attractive to Asian bond funds keen to diversify away from the Chinese high yield credits which account for such a huge proportion of the region’s issuance.”
NBFCs HIT THE OFFSHORE TRACK
Nevertheless, international investors have exhibited a high degree of caution and that is expected to continue in 2020. A number of prospective deals have consequently not seen the light of day after investors’ requested pricing premium pushed them the wrong side of the RBI cap.
And even then, one of the three maiden offshore NBFC borrowers – Indiabulls Housing Finance –has had a pretty immediate and spectacular fall from grace.
Indiabulls was the second NBFC to access the international bond market this May following Shriram Transport Finance’s pacesetting debut in February. Its $350 million 6.375% 2022 deal started to trade down as soon as it hit the secondary market and has continued that way ever since.
An eruption of fraud allegations, which reached the Supreme Court this October, has resulted in Moody’s slashing its credit rating from Ba1 to B2 in the space of just five months and its bonds sliding to 74 cents on the dollar.
Yet for most investors, the biggest risk is the NBFC sector’s liquidity crunch. Many onshore funding sources remain frozen, although the government is improving distressed asset and bankruptcy resolution procedures to flush bad debt out and get the whole system moving again.
As Standard Chartered’s Shettigar noted: “When IL&FS blew up it came as a big surprise to everyone, including probably the regulator. But there’s a better understanding now and the authorities appear to be in better control of the situation.
“That’s providing some reassurance, which should, in turn, ease the overall stress on the sector,” he added.
As a result, India’s best NBFCs have found a willing international audience within the RBI’s pricing cap.
Shriram Transport has traded in line with the overall Asian high yield sector. Its BB+/BB+ rated $400 million 5.7% February 2022 bond is currently quoted around the 4.76% mark.
Perhaps more impressive is Muthoot Finance’s ability to debut in October after Indiabulls’ issues came to a head. Its Ba2/BB+/BB-rated $450 million 6.125% 2022 deal has traded up to 5.036%, demonstrating investors' openness to credit stories in which they believe.
Deutsche’s Gupta says investors are highly selective but still receptive to new paper, particularly from higher-quality retail-focused NBFCs.
Top of the pipeline is Manappuram Finance, which lends against gold and jewellery. It was assigned BB- ratings for its $750 million MTN programme from S&P and Fitch last week.
It has also just finished roadshows for a $250 million three-year offering via UBS as global co-ordinator and Barclays as bookrunner. The group's one notch rating differential with Muthoot Finance, on the Fitch side, suggests fair value at least 30bp back.
An eagerly awaited deal from Bajaj Finance is also said to be at the top of the pipeline. It set up a $1.5 billion MTN programme under Deutsche and HSBC this June and has an investment grade rating of BBB- from S&P.
Other issuers in the pipeline include Piramal Capital & Housing, which set up a $1 billion MTN programme via HSBC and Standard Chartered in July, plus Hero FinCorp, Mahindra & Mahindra Finance and Cholamandalam Finance.
So far, a growing pipeline does not appear to have caused an overhang. Nomura, for one, does not believe it will stay this way.
In its 2020 credit outlook, the Japanese securities house says the "risk-reward is skewed to the downside" and has an underweight on the NBFC sector. It cites valuations that are "quite expensive" and says "stress in the sector is likely to persist, notwithstanding recent indications from the government that it intends to provide support."
This, however, is unlikely to deter supply. A second factor that attracts all of India’s high yield credits offshore is the cheaper pricing they can achieve versus onshore, even after the costs of hedging are taken into consideration.
The current rules state that borrowers have to hedge 70% of their offshore borrowings. Most do this using out of the money call options, which typically add about 150bp to 200bp to the all-in cost.
For a borrower like Shriram, this is still 300bp to 400bp cheaper than the 9% to 10% levels it currently has to pay onshore for three-year paper.
RENEWABLES OVERCOME ONSHORE HURDLES
In addition to the NBFCs, there has also been a wave of deals from the Indian renewables sector over the past couple of years. As Deutsche’s Gupta commented, “This sector has grown from nothing in 2014 to a flourishing complex of deals stretching right across the curve.”
It is one area where India has really been able to populate Asian green bond portfolios given the relative scarcity of green fixed income investments from elsewhere around the region. This may be one additional reason why Indian renewable credits have benefitted from a particularly wide onshore-offshore pricing differential.
International investors have been comfortable to accept pricing around the 6% mark. For example, Greenko Energy Holdings executed a $350 million 6.25% four-year non-call two-year deal in August. Its Ba1-rated paper currently yields about 5.297%.
Domestic investors, on the other hand, expect double-digit yields according to credit analysts. They typically prefer “mainstream” high yield credits like Tata Steel.
The Ba2/BB-/BB-rated industrial credit’s rupee-denominated 2022 paper is trading around the 7.4% level. Its dollar-denominated 2024 paper is currently quoted around the 4.8% level.
So who has valued the renewables sector correctly?
“Offshore investors appear to be more comfortable than onshore investors,” said Standard Chartered’s Shettigar. “Domestic investors appear to attribute a lot more weight to regulatory risk since they’re well aware of how infrastructure projects have got de-railed in the past.”
Their caution is backed up by HSBC research. Analysts Pranjul Bhandari, Aayushi Chaudhary and Deep Nagpal examined the Centre for Monitoring Indian Economy (CMIE) database.
They found that “about a third of the projects that have been stalled are due to policy-related problems such as land acquisition, access to raw materials such as coal and environmental clearances.”
And then there is the state governments’ tendency to delay supplier payments: one of the reasons why Jain Irrigation experienced cash flow difficulties and is now entering a debt resolution plan.
But its problems also underscore the additional caution that international investors should have displayed in the middle of the decade when they were offered bond deals from companies that had set up offshore entities to bypass the RBI’s ECB regulations.
The companies were able to offer tantalisingly high up-front yields because they had got round the RBI’s price cap. A number have since come unstuck.
Jain Irrigation’s unrated $200 million 7.125% 2022 bond is currently quoted at 30 cents on the dollar. Macrotech Developers (also known as Lodha) $200 million 12% March 2020 bond is trading at 80 cents.
BREAKING RECORDS
The RBI’s caution and historically limited supply have created an offshore pricing advantage of which plenty of companies are keen to take advantage. There is plenty of pent up supply.
Both Gupta and Shettigar are confident that offshore issuance levels will continue to climb whether the RBI institutes further relaxation measures or not.
“I do think there’s been a structural change,” Shettigar concluded. “And because growth is coming off a low base, we could see issuance rates climb by about 10% to 20% next year, more if the RBI makes a big change to the pricing cap.”
One entity that will not help India’s outstanding dollar borrowings is the sovereign. Its plans to access the dollar-denominated market for the first time are said to have hit the back burner after running into domestic opposition.
Moody’s downgrading of its Baa2 ratings outlook from stable to negative early this November will not have helped to revive the plan. In many ways, however, Moody's is moving towards ratings equalisation with S&P and Fitch, which both rate India one notch lower at BBB-.
The move has also not really had much impact on the trading performance of India’s high yield credits. Investors seem buoyed by glimmers that India’s corporate debt levels are inching in the right direction.
As HSBC concluded in a recent research report, debt service capacity is rising and overall corporate debt levels are falling. The key will be how quickly or slowly this feeds back into economic growth.
Yet many believe that India's "growth recovery will be delayed and remain sub-par" as Nomura puts it. As ever, structural reforms will be the key that unlocks the door to getting growth back above 6%.
