India Inc’s junk bond issuance hits RBI pricing cap hurdle

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MUMBAI: India Inc may be raising massive amount of equity from foreign investors, thanks to strong inflows, but in the dollar bond market, activity remains muted, especially for high-yielding bonds or the so-called junk bonds.

Only four companies – REC Ltd, UPL Ltd, Adani Ports, and Vedanta Resources – have tapped the dollar bond market post March, when covid-19 upended markets. Except for Vedanta, the other three have an investment grade rating, above BBB-.

Meanwhile, since March, the equity markets have seen around 1 trillion raised by several companies, across sectors, including Reliance Industries Ltd, HDFC Ltd, ICICI Bank, Axis Bank, and Mindspace Business Parks REIT.

The subdued activity in the dollar bond market, however, is not an indication of lack of interest on the part of foreign investors or Indian issuers, said investment bankers.

“In comparison to the domestic market where investor appetite in credit has largely been limited to the AAA and AA space, investors in the offshore market have the appetite for Indian paper across the risk spectrum,” said Arun Saigal, managing director and head of debt capital markets, Barclays Bank India.

While foreign investors flush with liquidity are keen on picking up debt papers of Indian corporates, restrictions on pricing these bonds under the Reserve Bank of India (RBI) guidelines have left several companies, especially those which are rated below investment grade, unable to tap this pool of capital.

“What’s constraining the Indian issuers from raising USD bonds is the pricing cap that is applicable for borrowings under the ECB (external commercial borrowing) route, where issuers can’t pay beyond LIBOR plus 450 basis points cap. Given the overall macro environment and the yields available in the secondary markets, investors want the appropriate returns for the risk that they are taking,” said Saigal.

“If the RBI were to relax the pricing cap by even 150 bps, one would see a significant increase in the volume of bond issuances by Indian companies,” said Saigal.

A major factor that saw issuers from India falling outside the RBI pricing cap was the rise in yields in the secondary markets due to the pandemic.

“When covid-19 happened, in the initial period yields widened significantly. Lot of the Indian papers saw yields widen by 300-400 bps. In March and April, there were very few issuers who could have raised bonds within the regulatory caps,” said Ganeshan Murugaiyan, managing director and head of investment banking at BNP Paribas India.

The drop in interest rates in the developed markets was another reason that resulted in lowering of the pricing cap and pushing high yield issuers out.

“The thing to note is that raising the cap would not increase the overall coupon or fixed rate cost of borrowing by much, because of the fall in US treasuries. The 5-year treasury rate has fallen from 150 bps to 25 bps. Effectively a company which could earlier pay up to a cap of 6%, can now only pay 4.75% thus making it difficult for them to tap the offshore market,” added Barclays’s Saigal.

To be sure, while bankers do believe that with the secondary markets yields slowly stabilizing, Indian high yield issuers should be able to tap the markets, they caution that these issuers will find competition from those in developed markets offering attractive yields to investors.

“The rates have stabilized now, but on a relative yield basis some of the high yield papers in developed markets are offering attractive yields at this point. LBO (leveraged buyout) activity has again restarted and large deals are coming to the market. On a risk adjusted basis investors are not fully back in the emerging markets, said BNP Paribas’ Murugaiyan.

So, bonds will take a little more time, but in the second half you will see more bonds from India, he added.

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