No Passage Out of India for Private Equity

The Indian state of Andhra Pradesh unsettled the world of microfinance in mid-October when it passed rules regulating debt-collection techniques and prompted some microlenders to agree to a target 24 percent cap on interest rates. On Nov. 23, India's Finance Ministry said it would introduce legislation that would also increase oversight of the industry and seek to eliminate such practices as forcing borrowers in danger of defaulting to take out additional loans and the seizure of household goods by debt collectors.

Since then the profit outlook for microlenders in India, the world's largest market for this sort of finance, has worsened. The credit ratings of a dozen local companies, including SKS Microfinance and Equitas Micro Finance India, may be downgraded over worries about their future profitability, the Indian unit of Standard & Poor's, Crisil, said on Nov. 22.

The shifting regulatory climate in India's 240 billion-rupee ($5.3 billion) microfinance market may be bad news for private equity and venture capital investors that have steered $565 million into Indian microlenders since 2006, according to financial research firm Venture Intelligence.

Until now, major global investors were making substantial profits. In August, SKS, India's biggest microlender, raised 16.3 billion rupees in an initial public offering. That share sale also generated a capital gain of 5 billion rupees for investors such as Silicon Valley private equity firm Sequoia Capital and Bangalore-based fund Unitus Capital, which sold part of their stakes, according to data compiled by Bloomberg. "Today nobody wants to invest in the sector because of the uncertainty over regulation," says Sumir Chadha, managing director of Sequoia Capital India.

In November, Share Microfin, which is backed by Dubai private equity fund Legatum, and Spandana Sphoorty Financial, whose investors include Singapore sovereign wealth fund Temasek Holdings, said they would delay IPOs that were expected in the first half of 2011 because of the new restrictions. "If all the big guys are facing the risk of not being around, you have to be very courageous or mad to invest," says Vineet Rai, founder of Aavishkaar Venture Management Services, a microfinance investor in Mumbai.

The practice of focusing on loans in poor areas largely shut out from traditional banking services gained prominence globally when Muhammad Yunus won the Nobel Peace Prize in 2006 for his role in founding Bangladesh's Grameen Bank. Microlending in India has expanded at an average annual rate of 62 percent over the past five years in terms of number of customers and 88 percent in loan volume, according to Micro-Credit Ratings International, a rating firm in Gurgaon, India.

The tougher regulations in Andhra Pradesh, a southern state that accounts for 30 percent of India's microlending market, arose from concerns about overlending to low-income borrowers, interest rates as high as 50 percent, and coercive debt-collection techniques that the state government claims have led to impoverishment and suicides by borrowers. There were 9.6 loan accounts for every poor household in the state, according to a report released on Nov. 15 by the nonprofit group Access Development Services. The upshot? "I don't think private equity investors will recover their money at the rates they thought they would," says Sanjay Sinha, managing director of Micro-Credit Ratings International.

The bottom line: A regulatory backlash against Indian microlenders is complicating the exit strategies of private equity and venture capital investors.

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