Will corporates change their resource raising strategy as rates rise?

ISSUE

Foreign borrowings out

ASHOK SUD
Regional Head,
Standard Chartered Bank

Why are corporates today increasingly thinking about raising fixed rate funding through rupee term loans? There are three major factors.

Firstly, a widely recognised bias towards high interest rates going into the future, driven on the back of developments in international markets and the inflationary spike in India.

Secondly, a gradual increase in capacity creation after a four-year lull when excess capacity across various sectors was getting sweated out of the system. Finally, a huge liquidity overhang.

With increasing dollar interest rates and high cost of forward covers - borrowing in foreign currency is temporarily on the back burner.

We hope that this is temporary as in the long run it is a critical source of finance for an investment hungry country. In the absence of a credible floating rate benchmark in India, floating rate loans have not been necessarily appetising at the best of times.

These are now clearly even less so, given the upward interest rate bias. On the one hand, the non-rated bond market is no longer accessible with RBI guidelines preventing banks from subscribing to bonds unless they are rated and listed on the exchanges.

On the other hand, the rated bond market has at best been sputtering owing to a lack of clarity on disclosure norms in the absence of a listing agreement for debt securities.

A year and a half ago, when industrial recovery was in its initial phase, the RBI was keen to support this resurgence by cutting interest rates. Its easy monetary stance was made possible by low global interest rates, a strong rupee and low domestic inflation.

The view was one of still lower interest rates and an appreciating rupee - resulting in forward premiums plummeting into discounts. A strong exchange rate view and the resultant low forward premiums (creating conditions where the fully hedged cost of a dollar borrowing was lower than that of a Rupee loan) had the corporate sector keen on borrowing in dollars.

Additionally, in an economy emerging from a phase of low growth corporates were not willing to make big capital commitments, resulting in limited demand for long-term money.

Several companies had undergone significant financial restructuring and refinancing at low interest rates, thus, boosting profits and making them cash rich. As a result, the industry's reliance on external funds was low.

Therefore, the flavour of the moment, until recently, was borrowing in foreign currency with an aim to refinance at lower rates. Booming equity valuations meant that corporates were issuing FCCBs to get the debt-equity balance right.

The economic and financial conditions have changed in a short period of time. International commodity prices are booming. Oil prices have surged-- with Asian currencies bearing the brunt more than theUS dollar. The rupee's reversal is also a peg in the same story.

Inflation is now a global reality. In India, there are initial signs that the investment drought is ending. Business confidence has risen and companies are now investing in fresh capacity.

Today, the inflationary and flow impact of high oil prices dominate. This needs to be kept in mind as things can change fairly soon once the central bank starts attaching more importance to growth rather than inflation.

The need of the hour is for banks to provide borrowing solutions that would suit corporates in all possible scenarios.

Convertible bonds in vogue

Y M DEOSTHALEE
Director & Chief Financial
Officer, L&T

The rising inflation rate over the last two months, mainly attributable to a base effect, international prices and an liquidity overhang, has set off the alarm bells. The RBI did try to neutralise some of the increase in money supply through open market operations.

The approach otherwise seems to favour a wait and watch approach, especially in a rising short term interest rate scenario as it can dampen growth.

Sentiments in the debt market have been extremely bearish, reflected in the recent rise in G-sec rates from around 5.25-50 per cent levels to 6.50-70 per cent.

US bond yields are at four-month lows. The main reason behind spread coming down is too much liquidity flowing into the US after the Fed signalled the beginning of a rate tightening cycle.

Ironically, this led to a market flush with liquidity, pushing down bond yields in the US rather than firming up. Also for various reasons, the amount of corporate paper floated recently in the US and Europe has been lower, leading to too much liquidity chasing too few instruments.

Banks have generally had a preference for direct lending to corporate paper, both because of the scope for relationship building and also because of better yields.

Corporates too have had to resort to higher direct borrowings given the sedate debt market. The cost of short-term funds has not been impacted significantly since larger corporates have anyway been borrowing at Mibor-plus, which has not changed.

Long-term funds have become more expensive with five-year AAA yields having moved up from 5.8 per cent to about 7 per cent. But there's been an increase in the demand for floating rate instruments from the cash rich mutual fund industry, with a lower spread over government paper compared with bonds.

A rise in secondary market yields may not directly translate into a rise in rates for corporate borrowing.

From the point of view of absolute interest costs for India Inc, they might not be significantly affected in the short to medium term since corporates have just been through an extensive restructuring of debt and a reduction in interest payouts.

Hence, unless there is a significant hike in investment levels and resultant borrowings, the impact might be quite controlled. Companies may have to pay some attention to their working capital cycles though.

Over the last couple of months, trading in local corporate bonds has been lacklustre. Indian paper in overseas markets is also quoting at softer rates. This is an opportunity for corporates to borrow at fine rates overseas, especially since local interest rates seem on the verge of hardening.

The interest in convertible structures is increasing with demand mostly coming from outside investors. This is favorable for Indian companies for various reasons. One being that premier corporates now have low gearing levels and can factor in a debt increase.

Newer companies need risk capital which is more easily available from foreign investors who have a larger risk appetite than the local ones.

Moreover, the domestic scene is poised for large investments and participating companies will need both equity and debt, which favour a strong convertible bond market.