Macro and Treasury – Country Analysis
India: Sebi rings the changes
India’s capital markets are finally getting the lease of life that bankers and issuers have long craved. Spurred on by political change that has put enterprise and investment firmly on the agenda, regulators are seeking to revamp an environment that has often appeared more designed to prevent progress than permit it. Hopes are high that the results will be seen in 2015, as Elliot Wilson reports.
Sebi has been busy. The Securities and Exchange Board of India, the country’s stock regulator, has been tweaking rules here and pruning them there, seeking to create a more streamlined capital markets structure that will be friendlier to institutional and retail investors alike.
It hasn’t been easy going. As with much of the country’s bureaucracy, India’s securities markets are cluttered with burdensome rules that muffle financial innovation. It takes too long to complete an IPO and still longer to get a stock up and trading on one of the country’s leading exchanges, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
Sebi wants this to change. In a discussion paper published on January 8, it proposed cutting the time it takes to bring a stock to market once an issue period closes, from 12 days to six, by shifting most of the IPO bidding process online. Investors can currently bid for stock allocations by cheque or by signing documents with bookrunners in person — outdated rules in an era of instant trading data.
And the regulator wants to push the envelope further. “Once the process gets stabilised,” Sebi said in its paper, “timelines can be further curtailed to [two or three] days.”
This is just one of a number of reforms being discussed at the highest levels. Some are major, others relatively minor. Aashish Agarwal, head of research at CLSA India, points to plans being circulated within the regulator about abolishing a tax on dividends.
“That would be a good move, appreciated by investors and the capital markets,” he says. “It would create value for minority investors and boost long term-valuations.”
Sebi also appears willing to moderate its own influence and power when a change is in the best interests of the investment community. One rule being mulled would allow listed corporates with market capitalisation of at least Rs15bn ($241m) to apply only to their immediate stock exchange partner when seeking to issue additional securities.
Before, smaller firms had to apply to Sebi (as well as the likes of the NSE or BSE) when planning follow-on equity sales, creating an additional cost burden for smaller companies. “The aim here is to create a more balanced playing field for all companies,” says S Subramanian, managing director of investment banking at Mumbai-based Axis Capital.
A host of other rule changes designed to streamline investing are also filtering through to the market. Some that have garnered little media attention still pack a serious punch, including rules designed to beef up corporate governance, clamp down on insider trading, and make it easier to delist a stock.
“These changes appear smaller, but they are all vital to the long term health of India’s capital markets,” notes Sanjay Sharma, head of equity capital markets at Deutsche Equities India. “What Sebi is doing in terms of trying to reduce the post-issue settlement period and to reduce the documentation involved ahead of capital market issuances — all these are positive moves designed to accelerate capital market activity.”
Other tweaks to existing rules are clearly designed to boost retail investor participation. In late January Sebi said it was considering a government proposal to extend the window on an offer for sale (OFS) — a process that lets the owners of a listed corporate dilute or sell their holdings — by an extra day. That would give retail investors more time both to gauge the value and health of a stock during a sale and, if necessary, to rustle up additional funds.
Retail participation in equity transactions remains woefully low, but government and regulator are determined to alter this mindset. In June 2014, Sebi drew up rules that forced issuers to set aside 10% of any share offering for retail buyers and to offer them a discount to the final pricing on a new stock.
But a newly burnished set of rules will only go so far. “These are positive steps for sure, but how impressed investors will be I don’t know,” says Anjan Ghosh, chief ratings officer at ICRA, a domestic ratings agency majority owned by Moody’s. “Retail investors are staying away from markets because they were burned in the past. They need to learn how to trust stocks and issuers again.”
All these rule twists and tweaks point to an activist government determined to inject passion and impetus into a market that had, in recent years, lost its way. To Rashesh Shah, chairman and chief executive officer of Mumbai-based Edelweiss Financial Services, the buck stops at the door of reform-minded premier Narendra Modi, whose Bharatiya Janata Party took office following a landslide general election win in May 2014.
“Modi isn’t just pro-business, he’s pro-investing. He knows that more investment creates more jobs,” Shah says. “He’s for a more meritocratic society, for playing by the rules, and for giving no special dispensation to anyone.”
So far, the best intentions of Sebi and Modi have garnered little more than glowing headlines. Most of the attention has in recent months focused on India’s resurgent stock markets. The BSE Sensex, India’s most tracked bellwether index, inched up in response to Modi’s election win last year, paused, then surged when he rolled out a list of clear reforms that spoke to the hearts and minds of the investor and business community. On January 28 2015, the Sensex hit a new record high, passing 29,600 in intraday trading for the first time.
Institutional investors have clearly bought into Modi’s message. Equity capital inflows by foreign institutional investors (FIIs) were $20bn higher in 2014 than the previous year, according to Sebi, with investments in Indian stocks by domestic institutions up $10bn.
“Institutional buyers like India for many reasons: lower oil prices, a stronger economy, a reform-minded government, and the promise of a current account surplus for the first time in many years,” says V Jayasankar, head of equity capital markets at Kotak Investment Banking. “You’re seeing a genuine structural shift in the Indian economy and how the country is being perceived. And that’s why we have seen a rising stock market ever since prime minister Modi came to power.”
Primary activity has been rather slower to take off. Indeed the market has in recent years shrunk in every conceivable way. A total of 63 IPOs were completed in 2010, at an average size of $131m, according to data from Dealogic. In 2014, just 46 initial stock sales were completed at an average size of $5.3m, the lowest and slowest rate of issuance in 13 years.
Many expect activity to pick up as 2015 progresses, with a flurry of deals hitting the market in March and April. Sizeable transactions on the immediate horizon include a $170m IPO from Sadbhav Infrastructure Project (a spin-off from Ahmedabad-based construction firm Sadbhav Engineering) and a $125m initial stock sale by SH Kelkar, a fragrance maker part-owned by buyout giant Blackstone Group.
Deal flow should accelerate in the second half of the year, bankers say. “We expect to see around $5bn raised in IPOs in the calendar year 2015, with a few high quality, mid-sized issuances coming to market each month,” says Kotak’s Jayasankar. “Once the market has really picked up speed, you’ll start to see some bigger transactions.”
A good omen comes from the rise in private equity exits in recent months: sales by buyout firms hit $3.5bn in 2014, according to data from investment house JM Financial, a seven year high. Most PE firms ploughed their money straight back in, betting on a new India boom, buying $10bn in new assets in 2014.
What about the data?
Others remain a little more circumspect about the prognosis for the country’s capital markets, preferring to wait for stronger economic and capital expenditure data. India’s investment ratio fell to 28.5% in 2014, government figures show, from 33% in 2008, as corporates shelved or pared back capex plans.
Even the announcement by India’s Central Statistical Office (CSO) that gross domestic product would expand by 7.4% in the year to end-March 2015 — a faster rate of economic growth than China’s — was met with suspicion at home and abroad. Modi’s own ministers downplayed the data, which came in two full percentage points higher than expected after the CSO switched to a modern methodology that reassessed the weighting of manufacturing and services.
Yet here too there is good reason for optimism. The CSO’s new methodology is based on international norms; under its aegis, India’s economy expanded by 7.5% year-on-year in the three months to end-December 2014. Capital expenditure is expected to rise in 2015 for the first time in five years, as leading corporates such as Tata Motors and Coal India, the world’s largest coal mining company, launch major expansion plans.
“I expect to see primary issuance and capex really start to rise in the second half of this year,” said Deutsche’s Sharma. And another Mumbai-based investment banker notes: “As the economy returns to full power, you’re going to see a renewed surge in capital expenditure, which will drive India’s economy and capital markets to the next level. Then you’re going to start to see the launch of blockbuster follow-on sales and IPOs.”
Bankers see most issuance being concentrated in a few key industries. “We expect specific sectors to drive activity, notably the consumer [and] retail space, e-commerce, and healthcare,” says Kotak’s Jayasankar. “We also expect to see more primary issuances later in the year and in 2016, in industries like banking, education and infrastructure.” Some capital raising has already kicked off in earnest. In the first week of February, HDFC Bank sold 22m ADSs on the New York Stock Exchange, raising $1.6bn, to fund growth and boost reserves.
Under Modi’s economic stewardship, the government has also pledged to sell slices of state-owned companies, beginning with dominant industrial groups. New Delhi aims to raise $10bn in the Indian financial year to end-March 2015, as it seeks to broaden the country’s investor base and trim its budget deficit. In late January, the state sold a 10% stake in Coal India, raising $3.7bn. FIIs subscribed to $1bn worth of the shares, with $2bn being bought by domestic insurers and mutual funds. The rest was shared out between retail and wealthy investors and another dominant state-run firm, Life Insurance Corporation of India.
Unwinding the state is a recurring theme of Modi’s administration. In his latest budget slated for February 28, finance minister Arun Jaitley was widely tipped to unveil plans to raise $11.25bn through state divestments in the year to end-March 2016. Prominent deals are likely to include the sale of 5%-10% in Hindustan Zinc and aluminium giant Balco, raising $3.2bn.
Insurance deals ahead
Another key sector will be insurance, for two reasons. First, the government is pushing ahead with plans to allow foreign corporates to own up to 49% of Indian insurance firms. That in turn will push more local insurers, their coffers swelled with foreign capital, to sell shares on domestic bourses.
“It will work as a loop, with insurers selling stock to investors, then reinvesting proceeds back into other listed securities, boosting primary issuance and deepening India’s investor base,” says Axis Capital’s Subramanian. He points to a slew of major sectoral IPOs set to hit the market going forward, notably by the insurance divisions of major lenders including HDFC Bank, ICICI Bank, and State Bank of India.
With interest rates likely to fall as the economic recovery deepens, and inflation inching down thanks to sharply lower oil prices, debt market bankers are also eyeing a solid year ahead. “We see a lot of pent-up demand out there for bonds, particularly among foreign investors,” insists Edelweiss Capital’s Shah. “FIIs helped kick-start India’s equity boom more than ten years ago, and we hope to see a similar injection of activity and liquidity in the debt capital markets space in the year ahead, helping the domestic bond market to really kick on.”
Liquidity should also be provided from deeper-pocketed domestic insurers as well as pension funds. “Originally, it was assumed that banks would be the biggest buyers of bonds, but that’s changing,” adds Shah.
Others also see mergers and acquisitions enjoying a timely return to form, with corporates, notably in the infrastructure space, looking to divest underperforming assets in order to focus on new, high-growth areas. Premier Modi continues to push ahead with plans to make it easier for companies to buy and sell land for industrial, residential and commercial land, replacing laws that have long hindered India’s manufacturing sector and constrained economic growth.
“M&A transactions tend to take off around six to eight months after a sharp rise in the value of stocks,” notes Edelweiss’s Shah. “We’re getting to that point around now.”
A host of other recent rule changes also point to the government’s newfound determination to boost India’s long-term economic potential, from a bold-but-imperative move to axe diesel subsidies, to the decision in February 2015 to launch the country’s first open coal auctions, open to 134 bidders. That process will prove fiercely competitive, with 100 licences spanning 23 mines set to be handed to the likes of London-listed Vedanta Resources and domestic groups such as Reliance Power, Adani Group and Jindal Steel and Power.
Other pending reforms include the roll-out of plans to permit the creation of real estate investment trusts, and the impending introduction of the GST, a long-awaited national sales tax aimed at balancing the budget and boosting the federal tax take, rules that have further heartened investors.
“The government has decentralised power, decluttered government, energised the state, and liberalised labour reforms,” notes ICRA’s Ghosh. “The policy paralysis that gripped the previous government is gone.”
For the first time in years, the short and long views on India both offer good reasons for investors to smile. This was an economy in the doldrums 12 months ago, overseen by a tired, dying government and dogged by stagnant stock prices and a virtually non-existent primary market. A year on, a new, driven, reform-minded government is selling down prime slices of powerful state firms, while bankers gear up to sell freshly cooked batches of stock to eager institutional and retail investors.
“Everything is in sync again,” says Edelweiss Capital’s Shah. “The gloom is dissipating and the confidence is back. India’s economy and capital markets are heading in the right direction again, thanks to the government, and to the reforms being pushed through by Sebi.”