Bond Markets Threaten to `Unfriend' India

The wrong mix of spending and borrowing could push up companies' interest costs.

There are growing apprehensions about where the Indian government will take bond markets this year, and where bond markets will take India Inc.

Flirting with Fragility?

Indian bonds have had a bad start to the year*

Source: Bloomberg

*Year-to-date returns on local-currency sovereign bonds, data as of Feb. 24, 2016

The first question will get at least partially answered as early as Monday, when Finance Minister Arun Jaitley announces his administration's spending and financing plan. For now, the mood is pessimistic. Out of the five economies that Morgan Stanley identified as fragile during the 2013 taper scare, only India's sovereign debt has failed to make money for investors so far this year. (Local-currency Brazilian, South African and Indonesian bonds have returned 4 to 6 percent while Turkish debt is up 1.5 percent.)

Bond markets are more than a little anxious about India, and it's not hard to see why.  The median estimate in a Bloomberg survey is for a 13 percent increase in federal government borrowing to a record $99 billion for the fiscal year that will start on April 1. In addition, India's state governments will be tapping the market to replace the high-cost bank debt on the books of their struggling power utilities with subnational bonds. That's another $48 billion of required financing over two years.

No Motivation

Low capacity utilization at Indian manufacturing companies reduces their incentive to invest

Source: Reserve Bank of India

But what does a nervous sovereign bond market mean for Indian companies? That's a little trickier to answer.

It's expected that the thrust of government spending in Jaitley's budget will be on boosting incomes for farmers, government employees and pensioners. While this expenditure might push up consumer demand to some extent, it won't be enough to persuade Indian companies to make new investment, given that the existing capacity utilization level for manufacturers is less than 71 percent.

To boost private investment, there'll most likely be an increase in public spending on roads, railway and irrigation. Maybe the market will view the overall package as supportive of faster GDP growth and higher future tax collections, and give it a thumbs up. But if bond investors get spooked by the mix of spending and borrowing, rising sovereign yields will push up corporate borrowing costs.

Consequently, the 100-odd companies that are supposed to benefit the most from the twin emphasis on farm incomes and infrastructure could see their interest costs rise faster than their operating profits. And that might force them to scale back on investment plans. The risk of that is quite high considering corporate balance sheets are already stretched. Back in 2006 and 2007, when the economy was growing rapidly, these companies had a high margin of safety -- their Ebitda-to-interest ratio was about 5 to 6 times. Now, that cover's halved:

A Growing Interest Burden

The ratio of Ebitda-to-interest costs has plunged for Indian companies

Source: Bloomberg

*For 101 Indian companies engaged in road, rail, irrigation and power infrastructure and equipment manufacturing

Stories of distress abound. Take an engineering and construction company like Punj Lloyd, which had an operating profit five times its interest cost in 2007. Last year, its interest bill was $135 million, and it had an annual operating loss of more than $76 million.

In the short run, equity markets might be easier to please. Shareholders, for instance, would react positively if Jaitley starts implementing his plan to reduce the corporate tax rate by a total of 5 percentage points to 25 percent by 2019.

Fixed-income investors, though, would be both more discerning and harder to placate. They would rather see the finance minister keep a tight control on spending and borrowing, so that the central bank has more room to cut policy rates. For India Inc., a lower cost of capital would be far more useful right now than tax sops. Conversely, if bond markets decide to ``unfriend'' India, companies will hurt more than the sovereign.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Andy Mukherjee in Singapore at

    To contact the editor responsible for this story:
    Katrina Nicholas at

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