Historically accessing Indian rupee (INR) denominated corporate debt has been an arduous task for foreign investors but the government has slowly changed regulations to allow limited foreign investment.
The historic limitations were due to the Indian authorities desire to keep the INR partially convertible. Current account or trade flows are fully convertible, but there were strict controls on the capital account, i.e. when investing in domestic financial instruments.
The rationale for this is to prevent the flow of ‘hot money’ into financial assets resulting in a boom & bust cycle of asset inflation and deflation. These rules arguably protected Indian asset values from some of the excesses witnessed elsewhere in Asia and the rest of the world.
However, there is always a cost to such controls. In India’s case, the cost has been a lack of foreign debt available to domestic companies.
Again to control the currency and prevent ‘excessive’ borrowing of foreign debt by Indian companies, the Reserve Bank of India (RBI) imposes an annual external commercial borrowing limit, capping offshore borrowing by Indian companies.
Naturally, this then means people try to find a way round these caps using instruments like foreign currency convertible bonds.
Regardless of the rights and wrongs of these controls, India’s growing corporate sector is predominantly reliant on domestic banks for loans and domestic real money players such as insurers, mutual funds and pension providers.
The Indian bond market is still dominated by government bonds with domestic corporate bonds comprising only 1.6 percent of GDP in 2010, compared to 27 percent in Malaysia and 37.8 percent in South Korea in the same period.
However certain reforms, such as the clarification of the regulatory role of a variety of bodies and the increasing availability of credit ratings has facilitated growth in the Indian corporate bond market over the last few years.
Secondary market trading has also increased, from approximately $16 billion of trades in 2008 to $120 billion in 2013.
Thus by 2013, Indian corporate bonds represented more than 20 percent of the Indian debt market.
At the same time, the RBI has continued to tighten liquidity in the market by both reducing monetary issuance and increasing interest rates. Concurrently, certain sectors, such as real estate, have fallen out of favour with domestic lenders and the bond market. This has created a supply/demand imbalance for debt capital in those sectors.
Unsurprisingly, this has attracted the interest of private debt capital providers in India. Firms such as Religare or KKR are exploring whether to create products to allow foreign debt investors to gain exposure to the Indian corporate credit market.
The method proposed involves initially building corporate loan portfolios through either captive or partner non-bank finance companies. These loan portfolios then have non-convertible debentures (NCDs) issued against them, replicating the credit terms of the portfolios or even the individual underlying corporate loans. NCDs are domestically listed debt instruments in India.
These NCDs can be bought and sold by foreign investors once registered with the Indian authorities through a well-defined process. This then allows an offshore arm of the Indian private debt firm to create foreign currency debt instruments, which are backed by the underlying domestic NCDs.
The INR foreign exchange exposure may or may not be hedged, depending on the risk appetite of the foreign investor. So it is now possible for foreign investors to have effective direct exposure and pay-through from Indian domestic debt instruments.
Is this a good thing for the Indian corporate borrowers?
I would argue yes – there is an increasing need for corporate debt across the credit quality spectrum of corporates and current debt solutions are not meeting the needs of India’s growing private enterprises.
If these NCDs enable more speculative grade companies to access debt and fund growth then that is probably a good thing, as long as the excessive leverage seen elsewhere in the world is avoided.
How much investment goes through this route into Indian domestic corporate debt remains to be seen. And of course the biggest question is whether the Indian authorities will allow this route to remain open or seek to extend their controls, blocking much needed foreign capital for India’s less well known corporate borrowers.