Qantas The Australian Way, December 2011

In 1997, Arundhati Roy’s book, The God of Small Things, introduced the world to the southern Indian state of Kerala. In truth, it’s an odd sort of a cultural flag-bearer: it is a story whose key moments hinge on prejudice, betrayal and loss, and doesn’t always portray its community in a positive light. But its language is so evocative, from the “fatly baffled” bluebottles and the “nights, clear but suffused with sloth and sullen expectation” of the opening lines, that it has served as an incantation for millions of readers. Many have found it so seductive that they have come to see the place for themselves.

Today, the areas Roy wrote about scarcely need any help in attracting visitors. A few miles from the towns she described sits Kumarakom, where resorts are thriving to attract tourists to one of India’s most beautiful regions.

To see the article as it ran in Qantas: The Australian Way, click here: qa1211_Kerala.indd

Just two hours from the city of Kochi, which has direct flights from Singapore and the UK among other places, Kumarakom has become a leading place to enjoy one of southern India’s most compelling attractions: the Kuttanad backwaters.

It is impossible to discuss this place with anyone who has been here without the expression “god’s own country” turning up sooner or later – it’s part of state branding now –  but it is unarguably magnificent. On converted rice barges called kettuvallam, guests drift around a network of inland lakes and rivers, watching everyday life proceed on the banks: people bathing and washing clothes in the water; carpenters artfully chiseling Jesus and Virgin Mary statues for the Syrian Christian churches of the area; men standing in tiny boats and herding hundreds of ducklings up waterways toward dedicated farms.

The houseboat experience, while fully entrenched – around 500 of these boats ply the backwaters – is not (yet) ruinous or twee, and is simply one of the most relaxing and peaceful things one can do in India. Kumarakom, sitting on Lake Vembanad which connects to the backwaters, is perfect for exploring it: since the resorts back on to the lake, houseboats come straight to their door to collect them.

Kumarakom is also a starting point for boat trips through the more intricate and less visited networks of waterways that lead many miles inland between the paddy fields, where sometimes the rivers are all but invisible beneath the weight of surface duckweed covered with blossoming hyacinths. An hour or so in one of these boats will take you to Arundhati Roy’s home town, Ayemenem, in which most of the action of her book takes place; the house and factory are based on real locations (and the pickle factory is run by Roy’s uncle).

One Kumarakom location, the Vivanta, operated by the Taj group, is where the area’s tourist industry and Roy’s literature coincide. The resort’s centerpiece is a grand, 134-year-old house built by a missionary called George Baker, and housed four generations of his family before the last of them left in the 1970s, after which it passed first to the state, then to the Taj group. Fans of the book will know this as the secretive History House, in which the novel’s devastating climactic scenes take place; Baker, in the book, is kari saipu.  The resort has handled its heritage with some deference, and was strengthening the building’s roof and upper stories at the time of writing; it has built a limited number of guest villas between the house and the lake, among ponds designed to nurture local birdlife. Roy wrote of “cold stone floors and billowing, ship-shaped shadows on the walls, where waxy ancestors… with breath that smelled of yellow maps whispered papery whispers.” And, while it’s hard to feel that in the bars and hotels that sit in the former Baker family rooms, the place remains evocative and atmospherically decorated.

Roy was somewhat scathing about the tourist influx into Kerala. “Toy histories for rich tourists to play in,” she (or, more precisely, the book’s narrator) called it; “history and literature enlisted by commerce.” She bemoaned the compression of Keralan traditional kathakali performances, “collapsed and amputated”, and mocked the “old communists, who now worked as fawning bearers in colourful ethnic clothes, stooped slightly behind their trays of drinks.”

Nevertheless, Kerala and tourists do appear to have embraced rather well so far: the interaction is still friendly, the waves from the shore apparently genuine, the people engaging and not obviously cynical. As always, there’s a risk: in the backwaters, the impact of five hundred barges running daily on diesel cannot help but be felt eventually. And there are ever fewer children along the main byways who have not learned the ubiquitous: “One pen! One pen!” But tourism has been better planned along the backwaters than in many other places in India.

Kerala is a fascinating state, politically and culturally, and this too forms part of the texture of Roy’s book. Kerala and West Bengal are among the only places anywhere in the world to have democratically elected a Communist government, and both states have consistently voted them back in again ever since. Several side-effects of this are visible in the state today: high literacy; an orderly plotting of land; and, apparently, a higher representation of women in bureaucracy.

And, while local theatre and dance is no doubt compressed as Roy complained, it is at least made central to tourists in the resorts, along with many other local charms: the practice of ayurvedic medicine and massage, which thrives in the hotel spas as well as in local towns; and Keralan food, quite different to other Indian cuisines, with widespread use of the local bounty of coconut and mango.

Kumarakom is just going to get bigger. A Radisson has opened here now, and hoteliers report growing tourist numbers both domestic and foreign. British lead the charge, with Australians somewhat unrepresented: they tend to head further north. But not the least of Kerala’s attractions is that it offers the magnificence of India with a palpable dilution in the hassle involved in enjoying it. It’s a peaceful, calmer India, and those who overlook it for the tout-clogged riches of Rajasthan and Agra are missing a trick. There are certain places where you tell your closest friends to go there before it gets ruined, but you don’t tell everyone because you don’t want to be part of the ruining. This is one of those places.

BOX: Elsewhere in Kerala.

Kerala has it all. It is served by two international airports, in Kochi (Cochin) and Thiruvanathapuram (Trivandrum) – many travelers enter by one and leave by the other. Aside from the world-famous backwaters, attractions include:

• Kerala has some of India’s best beaches, although Australians will be disappointed by their cleanliness. Near Trivandrum, Kovalam is the most developed beach centre, with top-drawer resorts, though it has correspondingly lost much sense of local charm; those in search of a more Keralan experience instead head further north to Varkala, where the beach is flanked by laterite headlands and the hotels perch above it on a scenic cliff.
• Kerala also offers some of the best wildlife reserves in the south. Arguably the best, the Tholpetty and Muthanga reserves within the Wayanad Wildlife Sanctuary, take some getting to but offer wonderful scenery, good eco-resorts, and occasionally even sightings of tigers. Closer to the cities, Periyar, centred on an artificial lake, is a good place for spotting wild elephants; Thattekkad is a world-class bird sanctuary; and Eravikulam is famous for its antelopes.
• Munnar is a tea-growing town high in the hills with beautiful mountains and forests. It’s also close to the Eravikulam wildlife reserve.
• Of the cities, Kochi/Cochin is perhaps the most attractive, with a harbour and well-preserved colonial architecture embracing the Portuguese, Dutch and British eras. Its signature sight is the lines of Chinese fishing nets, a beautiful image at sunset.
• Kerala is the best state for experiencing Ayurveda – whether a massage or lengthy stays for holistic herbal treatments. It is also known for its kathakali theatre and the kalarippayattu martial arts. Kochi in particular offers a range of kathakali experiences, from a one hour introduction to (literally) all-nighters. One of the highlights, for many, is to get there early to watch the extravagant make-up being applied.

A senior Indian policy official has denied that a new definition of the poverty line in India will penalize millions of the country’s poor.

On Tuesday India’s planning commission filed an affidavit with the country’s Supreme Court to re-set the level at which people are considered to be poor: those in rural areas living on more than 26 rupees (around 50 US cents) per day, and more than 32 rupees in cities, will not be considered poor – and therefore ineligible for government assistance such as food subsidies. The figure is starkly lower than the World Bank’s definition of the poverty line, at $1.25 per day.

But Kaushik Basu, chief economic adviser to the government of India, told Emerging Markets that the government had not yet decided which definition of poverty to use, and that the final definition would allow assistance to as many individuals as possible. “We are inclined to use the most generous definition,” he said, “by which I mean a definition where more people will qualify as poor.” Asked if the definition would impact who would qualify for food subsidies, he said: “Who will qualify as poor will certainly depend on this.”

The move has been widely derided as an attempt to make India appear to have less people in poverty than it does, but Basu said it was instead related specifically to a new food security program. “There are three competing definitions of poverty that are used in India,” he said. “When we switch from one to another, we don’t want to the mistake of… having poverty going down just by changing the definition: of course we don’t want to do that. But now we are going into a new food security program where we are going to try to reach out to a very substantial portion of the poorer population, we have data on the new definition so we can do that job better.” Previously the main definition of poverty in India has been based on calorie intake rather than income or spending.

Amar Bhattacharya, Director of the G24 Secretariat – and an Indian national who was previously a senior adviser on poverty reduction at the World Bank – also defended the move. “As long as you are consistent in the measure, I think that makes absolute sense,” he told Emerging Markets.

India’s opposition has pilloried the move. At a press conference in New Delhi yesterday, the BJP party spokesman Prakash Javadekar said the new criteria were “like rubbing salt in the wounds of the poor.”

“Estimating the numbers of people in poverty is an exercise which often ends in number crunching for the sake of justifying the government’s miserly investment in food and services for people living in poverty,” said Avinash Kumar of Oxfam India. “This seems to be the case here. This will exclude a vast number of people from essential services, when what is needed is universal access to basic needs like food, healthcare and education.”

Kumar added: ”In the past few years, four different commissions set up by the government of India have come up four different estimates of the number of people living in poverty. This confusion within the government itself is a testimony to the government’s shoddy and often self-serving attempt to shy away from its real responsibilities.”

Basu also claimed that poverty was declining in India. “From 2005 to 2009, we know that poverty has gone down quite substantially no matter which definition you use.” Even based on the new definition, India would have more than 400 million poor, or around one third of the population.

India’s finance minister, Pranab Mukherjee, has warned there is a danger of currency wars as emerging market countries seek to avoid the pressures that come with their climbing currencies.

“If the crisis deepens further and there is greater volatility in financial flows, there is an increased risk of this happening,” he said.

“Our view is, if such tensions arise, they should be eased through dialogue, not through competitive devaluations.”

Mr Mukherjee argued that the rising level of emerging market currencies ought to be reflected in the mechanisms used to build special drawing rights, the international reserve assets created by the IMF.

“In the BRIC countries, as their contribution to world output and economy is increasing substantially, therefore the currencies used in these countries should have to be widely appreciated.” That, he said, “should have been taking into account while determining the ingredients of the SDRs.” He added, though, that India was not calling for that today because other factors, such as free convertibility of currencies, need to be taken into consideration. “But the importance of these currencies has increased.”

Reserve Bank of India governor Duvvuri Subbarao said that India was able to absorb the high levels of capital flows it has been receiving, and had no immediate intention of imposing controls upon them. “At the moment we have a current account deficit and are able to absorb the flows that are coming in,” he said. “We are quite unlike other emerging economies which are having a problem of excess capital lows.” He said the RBI would continue to use a range of “quantity and price instruments” to manage capital flows, “so that they bring foreign savings necessary for our development.” He said that using taxation to manage capital flows was “clearly not off the table,” but added: “the question of foreign controls is clearly outside any policy consideration at the moment.”

One of India’s most central challenges today is inflation, which logged a 9.8% (headline) and 7.6% (core) year-on-year increase in August, above consensus expectations. “The high inflationary environment is clearly not going away anytime soon, with underlying inflation pressures firmly in place,” said Leif Eskesen, chief economist for India at HSBC. “Moreover, there are further upside risks to the inflation outlook.”

The Reserve Bank of India has acted aggressively to combat inflation, raising interest rates 12 times and 500 basis points in (WILL CHECK), slowing growth as a consequence, without managing to bring about a decline in the headline inflation rate. But World Bank chief economist for South Asia, Kalpana Kocchar, said that momentum inflation is starting to come down. “The RBI has done a good job trying to put a lid on demand pressure,” she said. “A lot of these pressures are coming from a big increase in rural demand as a result of the push for inclusive growth,” such as a national rural guarantee scheme. “On one hand that’s a good story, putting more money in the hands of the poor, but it’s straining the resources of the economy and that’s causing inflation.”

She said India faces pressure as the only South Asian nation to be fully globally integrated, both on trade and finance, and noted that India’s main stock market index has fallen as much as or further than most developed countries, and more than emerging market composites. She noted “some home-grown problems with regulatory uncertainty and some policy paralysis in India,” and highlighted the need for investment.

Euromoney, December 2010

It is the very definition of a behemoth: the headcount of a decent-sized western city, an affiliation of nine companies, covering 471 separate coal mines. It faces 4,000 different law suits, powerful unions, and the threat of Maoist rebels around many of its mines. Yet when the books closed on October 21, Coal India became the largest IPO in India’s history, in a $3.46 billion deal that shot up 40% on its first day of trading and attracted US$52.5 billion of demand – most of it international.

How did this happen? The reasons stem from what one banker calls a “perfect storm” of circumstances: thirst for emerging markets, even more thirst for resource companies, buoyant markets and a company which, unlike many other state-owned leviathans around the world, proved both well run and able to communicate its story worldwide.

See also: Coal India Fees Go Up In Smoke here:  http://www.chriswrightmedia.com/euromoney-coal-india-fees-go-up-in-smoke/

But when 16 shortlisted investment banks filed into the offices of the Ministry of Finance’s Department of Disinvestment in New Delhi for pitch meetings in early May, it was not obvious that the deal would be such a runaway success. A previous state sell-down, a US$2 billion follow-on for mining company NMDC in March, had barely got across the line, ignored by both international institutions and local retail and only saved by domestic institutions – at the bottom of the range. It had swiftly traded down upon launch. It was not what the government, amid a galvanized program of divestments intended to generate wealth creation among ordinary Indians and tackle the budget deficit, had had in mind. And the omens for Coal India looked scarcely better: as the banks went through their pitches, European sovereigns appeared on the edge of default, and a second round of the financial crisis looked likely.

Still, the six mandated bookrunners were sufficiently enthused about the prospects of the float that they accepted a resplendently absurd fee of 0.000001% of the deal proceeds to be on the deal (see separate article).  They did so because Coal India represented something extraordinary: the largest coal mining company in the world, with the largest reserves, and a global leader in its sector. “One of the most significant things was not that it was the largest IPO out of India, but the largest company in its sector in the world out of India,” says Saurabh Sonthalia, managing director and head of capital markets at DSP Merrill Lynch. “We haven’t seen that before.”

So the six swallowed the cost – including a host of additional burdens lumped on them by the government, including document printing costs – and set about dividing up leadership for the tasks ahead. Citi, which bid lowest, was given the job of leading the prospectus (“it’s traditional that the lowest bidder gets that job, in return for causing us all so much pain,” says one banker, half joking, at most); Deutsche developed investor presentations; Morgan Stanley books settlement; Merrill set up the roadshows; Kotak Mahindra covered approvals; and Enam Securities led retail marketing.

Three different parties were involved in the sale: Coal India itself, headed by chairman Partha Bhattacharyya (see box for interview); the Department of Disinvestment, headed by Secretary Sumit Bose; and Ministry of Coal, headed by Minister Sriprakash Jasiwal. While Bhattacharyaa, who famously knows everything it is possible to know about Coal India, was the repository of all information on the sector and the company, Bose and his team had the clearest sense of what the deal needed to achieve for the country.

“The idea of the disinvestment program basically revolves around people’s ownership,” Bose says. It intends to get all profitable unlisted companies on to the market, and to increase the free floats of those with historically thin listings up to 10%, as well as other follow-on raisings. Doing so should trim the deficit and fund infrastructure, but that’s only part of the goal. “In all of this retail is very important,” he says. “Our budget estimates for the fiscal year are abut Rs40,000 crore [US$8.9 billion] and 15,000 of that has come from Coal India, so it was important in that context, but also in broad basing the ownership of companies to the people, giving them a chance to buy the shares.”

So the department sent its banks on the road with a clear mandate: make this deal work for everyone, get retail in, and get the price right. Another poorly performing deal could have been catastrophic for the state: if institutions and retail were disappointed in this deal as well as previous ones, there would be no way of coaxing them back in for vital subsequent deals like the forthcoming raising by Indian Oil Corporation. “You can stretch valuations and still get the deal done, but give a reasonably priced deal to the market and it will serve you well for the entire disinvestment program,” says Ravi Kapoor, managing director and head of global banking for India at Citi.

There were a few procedural matters to deal with, particularly around the powerful unions, before work started in earnest. For example, in Indian IPOs shares can only be reserved for employees in the company that is being listed, not subsidiaries, whereas in Coal India all the employees are in the eight subsidiaries and none in the holding company that was being listed. An exemption had to be sought from the Securities and Exchange Board of India – which was uncommonly swift and accommodating throughout.

Other questions and challenges were swiftly pre-empted. The certifier of coal reserves in India was not one that was widely known outside, so a new reserve engineer was appointed; the sprawling accounts of eight subsidiaries were brought into a palatable form that international investors would be happy with; and the fabulous amount of outstanding litigation – there are 4,066 separate cases mentioned in the prospectus, plus about 9,000 land cases and service matters – categorized and sorted in a 61-page chunk of the prospectus. (That prospectus, incidentally, was completed in 60 days, considered something of a record given its complexity.) “The idea was to get them prepared and up to speed in terms of what it takes to do an IPO,” says Kapoor. “No restructuring was needed, we just needed to make sure the story was correctly articulated.”

The toughest part was collating the sheer scale of the enterprise into one document. As one bookrunner puts it: “It’s not easy to do due diligence on 471 mines.”

As the banks hit the road, first in informal pre-marketing with their clients through July and then on a global roadshow with the company in August, it would quickly become clear that demand was not going to be a problem. But there were a lot of questions to answer. Some were about pricing and margins: why does Coal India sell coal at about a 50% discount to international peers? Others were about the company’s vast cash holdings: US$8.4 billion on the balance sheet. Still others were environmental. The government has declared certain areas of coal reserves no-go because of dense forestry above them; through the marketing process, it was still not clear how much of the reserves would be covered by this restriction, with numbers cited from 10 to 40%. Indeed, that’s still not clear.

If that wasn’t enough, by August questions started arising about Maoist rebels. Many areas in which Coal India operates mines – including much of the untapped reserves that support future growth – are in areas with Maoist populations, and prone to strike action, if not violence.

But for every question, Bhattacharyya had an answer that was equal to it. “He is very articulate,” says Sonthalia. “He has been with the company all his life. He knows every aspect of it intimately and never needs to consult notes.” Washeries would be introduced to improve coal quality and boost margins, he said. Environmental issues were not a problem because the company had a track record of returning more forestry to the government than it took away in mining, he said. Maoist communities like us because we give them jobs and schools: when they strike, they don’t hit the mines, he said.

The fact that the strikes do hit the transportation that moves the coal from the mines was ignored; the fervour for the deal was so strong by now, and international investors so enthralled by the story of the company, the country and the sector, that it was clearly unstoppable by the end of the pre-deal roadshow.

Indeed, by the time the company was readying to get on the formal roadshow in October, there was a new problem: too much demand. For the previous year, most Indian deals had included an anchor tranche, and the prospect of one in Coal India had institutions clamouring to be involved. “Nobody said no to the anchor tranche,” says one bookrunner. “There were a couple of sovereign wealth funds, almost all of the top 10 long-only funds globally, and at least eight of the top 15 hedge funds globally. Everybody wanted to be an anchor.” It is understood that the Government of Singapore Investment Corporation and Norges Bank were among them.

And then the government axed that tranche.

“What does an anchor tranche do?” asks Sanjay Sharma, managing director, equity capital markets at Deutsche Bank in Mumbai. “It allows you to allocate stock to sensible investors you want to lock in, and it gives you an early indication of value. But in this case demand was very clear and people were indicating what their valuation intentions were upfront. So from marketing perspective it wasn’t required.”

More than that, the government didn’t like the way it looked. With all of its ambitions about broadening the ownership base to the people, it didn’t want to be guaranteeing allocation to some distant pension fund while clawing back allocations to its own retail base.

There was another reason, too: practically speaking, it looked near impossible to get the anchor tranche properly signed off in the timeframe that regulations require. “An anchor tranche opens and closes on the same day and allocations have to be announced almost immediately,” says Sharma. Realistically, that leaves a few hours for six banks to reach consensus and get approvals through three levels of government, the top one a senior group of ministers. It was never going to happen.

While the would-be-anchors were disappointed, they simply joined the scrum for the institutional tranche. When the books opened on October 18, they were covered in a day; the institutional book would eventually be about 25 times covered. Most significantly, more than half of the institutional demand was from overseas.

This was quite something given the headwinds that they had to overcome to get in at all. Coal India was the first big equity deal to be done under a new rule from SEBI. Previously, retail and HNI (a sort of high net worth category) investors had to provide 100% margin, meaning that whatever they bid for, they had to provide the full amount of cash in advance, even if they were clearly going to end up being scaled back in final allocation. Institutions had got away with a 10% requirement, but with Coal India, they were asked to pledge 100% as well. Since it was evident early on that all would be scaled back, most institutions made very heavy bids, and had to shift the full amount of cash into India. That created a foreign exchange risk that is neither easy nor cheap to hedge, as well as taking out of action a huge amount of capital that was never used: for all the money they sent, institutions only got 4% of it to go into the deal, and then had to remit the other 96% back home again. “Lots of investors have written to us saying it cost them 30 to 35 rupees per share just to hedge the currency, bring it in and take it out,” says S Subramanian, managing director of investment banking at Enam Securities.

There was still the crucial retail bid to get over the line. But that worked too. Bose says there were 1.8 million applications. If you’ve ever seen the newspaper-sized forms that retail have to fill in to participate in a deal like this, it becomes clear what a feat this was. But retail found a connection with the stock. “If you speak to the man on the street, they will tell you Coal India is gold,” says one bookrunner. “It is the largest coal company, it has $8 billion of cash; to them, it’s like a fixed deposit investment. They can put their money in and forget it. They earn dividends and sleep peacefully at night.”

With that kind of backing, aftermarket performance was always going to be good, but the 40% first day performance surprised even the bookrunners. It has led some to conclude the deal was priced too cheaply, but those close to the deal reject that. “I would say that had we even priced it 10 or 15 rupees higher the whole thing could have got into a negative rather than a positive cycle,” says one. “It’s psychological, at the end of the day.” Having priced at a modest discount to its only obvious comparable, China Shenhua Energy, it is now at a premium.

The deal gives cause for optimism for a host of other deals that will follow it: the IPO of Manganese Ore, divestments of Hindustan Copper and the steel authority SAIL, an issue from Indian Oil Corporation that could be bigger than Coal India, and a host of others. “The knock-on effect is that India can do larger, $3 billion-plus deals,” says Sonthalia. “We have the confidence now, and a new set of investors who have woken up to the fact that India is a good story.”

Box: Bhattacharyya and the Coal India story

In the Coal India head office above a swarming, heaving Kolkata street, chairman Partha Bhattacharyya lives and breathes the company he joined as a management trainee in 1977, just two years after its foundation. There’s nothing he can’t recall about it, rattling off profit numbers from 20 years ago without resorting to notes. He has risen steadily through the ranks since the 70s, and many of the skills that were useful in presenting Coal India to the world this year were honed in difficult times decades ago. Because financially, for most of the last 35 years, Coal India was a mess.

Coal India came about as a consequence of the oil price shocks in the early 1970s. The government set up a high-powered committee to examine its energy options, and decided that coal should be given the thrust of providing energy security in the country. The coal industry at the time was growing at about 2.2% a year, whereas the country was aspiring for national growth of around 5%; it was lagging because of a lack of investment because prices were not remunerative. But the government couldn’t simply increase prices. “In those days coal was a domestic fuel, just to be used in the kitchens of houses,” Bhattacharyya says. “So it was not a socially or politically feasible alternative to increase coal prices.” The government decided the answer was to nationalize the industry and boost it with public funds, and after some restructuring Coal India was created in 1975: a holding company with five wholly-owned subsidiaries, later increased to eight.

The new company had more than 600,000 workers (compared to 400,000 today), all of them paid absurdly low wages, so as a first step the government increased wages by 80%. But since the increase was not compensated for by price revisions, it rapidly started losing money. About 40% of the equity that was pumped into the company was lost, roughly Rs25 billion. And since half of the government money was provided as long term loans, they required loan and interest repayments, which were frequently missed. The overdue liabilities eventually totaled Rs 22 billion. The company met its production targets, but at the cost of a hopeless balance sheet too weak to approach the capital markets with.

It was 1987, when he became a technical secretary to the finance director, before Bhattacharyya was in a position to see how bad things were. “It was an eye-opening experience,” he says. “Questions started coming into my mind: why are we making losses? What is it that needs to be done? We realized the losses were basically a product of the way the company was conceived and brought into being.”

Then the rules changed: the government decided to phase out budgetary support over five years from 1991. “An arm’s length concept was introduced: it was decided that you have to fend for yourself.”

The decisions made then would define the company that has proven so popular with global investors in the last few months. First, the idea of opening new loss-making mines was axed. “Financial viability has to be the cornerstone. No project will be taken up until it achieves an internal rate of return of 16% at constant prices.” Government debt servicing would be made on the due dates, with no more deferment. And the habit of shifting money from one company to another, using profits from one to meet losses or salary at another, was ended and a firewall was created between profitable and loss-making companies – a tough policy which would strike him as ironic when, having been instrumental in implementing it, he was later put in charge of one of the worst loss-makers and asked to reform it.

“This was basically a massive change of mindset,” he recalls. “The managers who were there when it was born were used to circumstances that coal has to be produced at any cost. They had the feeling: we have to do what the country wants, that is why we were born and why we are here. And to tell them the country’s demand is the country’s problem, that you and the country should not identify with each other – this was a huge task.”

But reforms like this turned the company profitable and allowed it to approach the World Bank and the Japanese Bank for International Cooperation for a US$1 billion loan, which they agreed to in 1998, although only half was taken up. With this, Coal India developed 24 world-class new projects which Bhattacharyya still sees as “like gold pieces” today. The World Bank loan would prove important for other reasons too: for example, all the projects had to have an environmental and social mitigation project (ESMP) component. These practices, too, would later prove crucial in the float, which was eventually marketed to retail on a green theme with posters of replenished forestry.

Other headwinds followed: deregulation, which came in phases from 1996 to 2000, exposed India to international quality coal, with which Coal India’s unwashed coal could not compete. “For the consumer, inconsistency of quality is a major pain. Therefore we don’t have a case for pricing it along the lines of imported coal.” To this day, Coal India sells coal at a 30% discount to international prices in most of the country, and as much as 60% in the country’s heartland.

However, because of imports, consumers are familiar with the quality and price of washed coal. “This leaves us with a corollary: a situation where if we can produce coal that is of comparable quality and consistency, there is a strong case for price convergence.” And so Coal India is entering coal washing, setting up 20 plants; by 2017, by which time the company is projected to produce 647 million tons of coal per year, 300 million of it will be washed. And although it’s more expensive per calorie of energy for the consumer, the freight costs reduce at the same time, in a country in which on average coal moves 600 kilometres by rail to get to the user. “By washing coal my margins get doubled straight away,” he says.

It is only in 2007 that this strategy was put in place; had the IPO been attempted any earlier, the story that the world investor community embraced so vigorously would simply not have existed. This disparate collection of more than 400 mines and a workforce with a higher population than Liverpool took more than 30 years to become palatable for investors, but having got there, it is not looking back. It has $8.5 billion on the balance sheet, has brought its debt to total capital ratio from 60% to 6% in eight years, and the next stage is global acquisition. “That money has to be well spent,” says Bhattacharyya, who says he wants equity stakes in coal mining companies in Australia, Indonesia, South Africa or the US, with offtake agreements better than spot prices. Three proposals are already undergoing due diligence.

It all seems some distance from multi billion rupee losses, unpaid government debts and mines that were opened with every expectation of losing money. “This kind of story,” he says, “you don’t get too many of those.”

$34 doesn’t go as far as it used to in Mumbai. It might get you a modest platter at the famed Peshawri restaurant, or a small round of drinks at one of the top new bars like Wink or Aer, but it certainly won’t cover a hotel car to the airport.

It will, however, buy you all six bookrunners on the largest IPO in Indian history.

Bookrunners on the Coal India deal received an eye-watering 0.000001% of the US$3.46 billion proceeds on this landmark deal – between them. And the extraordinary thing is, that’s not because it’s what the government offered; it’s what the banks pitched. Or, to be precise, one did and the rest were obliged to match it.

This is part of a broader article on Coal India: http://www.chriswrightmedia.com/coal-india-inside-the-behemoth/

“It has never been our intention to get banks to bid zero fees or near zero fees,” says Sumit Bose, Secretary of the Department of Disinvestment in India’s Ministry of Finance in New Delhi. “That’s their choice.” And what’s even more remarkable is that this was supposed to be a deal that ended the self-defeating low-balling of investment banking fees in Indian stock market deals.

Pitches for government share sales used to go like this. The government would put out a request for proposals (RFP), and then the banks would provide both a technical pitch – outlining things like their knowledge of the company and the sector, and their track record on execution – and a financial one, covering the proposed fees. The government would assess the technical pitches, and shortlist typically 10 banks that met the grade. The financial bids of those 10, hitherto sealed, were then opened, with the one with the lowest fee pitch declared the lead bank. Then the government would work down the rest of the list in order of fees and invite them to match the winning low bid, until however many banks were needed as bookrunners had agreed to the terms.

This has long led to absurdly low fee pitches, since under this system, your technical excellence only gets you onto the shortlist, not the deal. So with Coal India, a decision was made to do things differently: this time, a weighting was applied both to the technical pitch and the financial, with 70% of the weighting going to technical achievement. In other words, out of 100 marks available, the low level of your fee could only win you a maximum of 30.

But there was a flaw in this plan: the scoring given to the financial bid. The lowest fee bid would get all 30 points, and then the others would get marks in proportion to how their bid compared. So if the lowest bid is 0.5% and you have bid 1%, you get 15 points; if your bid was 1.5%, you’d get 10 points.

Following this through to its natural conclusion, banks realized that something odd would happen with particularly low bids. The difference between 0.001% and 0.0001% in cash terms is not that significant for an investment bank. But in the scoring system, one would get 10 times as many marks as the other: 30 marks versus 3 marks, plenty enough to knock you out of the running.

“So then,” one bookrunner notes, “it became a question of who could put in the most zeroes.”

Citi eventually wedged five of them after the decimal point, equating to about $34.60 – and the system remained that everyone else who wanted to come into the deal, including those who led the technical assessment, was obliged to match it.

After two days of pitching in the Department of Disinvestment offices in New Delhi in early May, the bookrunners found out their points on the second night, and also discovered what the fees would be. Some, who did not get on to the deal, were stunned. “My recollection is one of utter disbelief,” says a banker. “We went in with what I personally through was an absurdly low pitch. We didn’t even get close.”

Another, who did get on the deal, recalls: “We didn’t bid very fancy fees, but we bid at a level where we at least thought we would not be out of pocket. We may not make money, but we won’t lose money.” Doing so made it so much more expensive than the lower bids that the bank almost missed out on the deal completely.

But the other bookrunners are surprisingly magnanimous about it today. “We were angry for a day, maybe a week,” says one. “But, you know, these deals aren’t really about the fees.” Another adds: “It’s Citi one deal, it’s somebody else in another deal. I can’t blame Citi only. Everybody is part of this madness.”

So why do it? Citi’s managing director and head of global banking for India, Ravi Kapoor, declines to comment specifically on the fee structure but has no regrets. “It’s a path-breaking and landmark deal, India’s largest IPO from the world’s largest coal mining company,” he says. “How can you not be a part of the largest IPO in the history of the Indian capital markets? It was important to be part of such a historic offering, and it was a resounding success.” He adds: “You have to play by the rule book, which is transparently laid out for everyone.”

In fact, the situation for bankers was even worse than it looks, because part of the terms of the deal required them to take on many of the expenses, such as regulatory processing fees, stock exchange fees and even printing of forms. Based purely on the IPO itself, everyone lost money on it.

However, it’s easier for a bank like Citi to pitch a near-zero fee than some others, because they have many other ways of making money from the deal. Of the bookrunners, both Deutsche and Citi have extensive foreign exchange and custody capability: both very important in this deal. This was one of the first instances of SEBI requiring institutional investors to provide full margin coverage, which means they had to commit all of the money they were bidding for no matter how much allocation they expected to get. That created a need for foreign exchange and hedging capability, from which Citi and Deutsche benefited, while local bookrunners with big brokerage operations were able to recoup their money in the first week of trading.

But one didn’t actually have to be in the deal to do any of those things. As one bookrunner observes: “The people who probably made the most out of this deal were HSBC and Standard Chartered, the biggest custodians. And they weren’t even in the deal.” Merrill and Morgan Stanley, without major forex or custodian operations, must have had a harder time recouping the costs.

Still, none of the bookrunners talk of the deal with anything other than enormous pride, and believe it was absolutely worthwhile to be in there – not just for league table credit but prestige on being on such a landmark deal. And nobody is under any illusions that this is simply how deals tend to go in India.

“Lead managers have only themselves to blame for it and nobody else,” says Saurabh Sonthalia, managing director and head of capital markets at DSP Merrill Lynch. “It’s inexplicable. It’s the internal competition, and everybody talks about it: everybody agrees that this is something that we must desist from doing. And then we continue doing it, deal after deal. I can’t explain it.”

Another banker says that some years ago an agreement was reached that there was a point below which no banks would pitch. “And then somebody broke the consensus and bid zero. So we stopped trusting each other again.”

“The reality is, it’s the banks who are spoiling this,” he continues. “But nobody looks at fees in bidding for these transactions. There are a lot of franchises you want to be associated with, but not many can give you a cheque for $600 million of league table credit in one hit.”

From the government’s perspective, this wasn’t quite what they had in mind when they shifted to the 70-30 structure. Sumit Bose in the finance ministry argues that shifting to the new system meant that “at least two bankers” who, in the previous system, would have made it onto the deal on the basis of a lowball bid over technical ability, did not do so; the corollary is that two banks with technical strength but not a low bid, did get on the deal whereas they wouldn’t have before. (Bose won’t name them but it is understood one was Bank of America Merrill Lynch – which, in the end, had to match Citi’s bid anyway.) But it didn’t stop the low-ball bids? “No, it did not stop that, but it actually worked, to the extent that two banks came in on the basis of this new mix,” Bose says.

Local banks look on with some disbelief at the whole process, particularly when they find their own fees brought low as a consequence. “It was the international banks who skewed the fee to such low levels this time around,” says S Subramanian, managing director of investment banking at Enam Securities. “We were surprised at that number.” Still, Enam could have said no; but decided it needed to be on the deal.

In theory, this is all going to change. When the RFPs came out for the next big deal, for Indian Oil Corporation, the government had set a floor of Rp600,000 for the minimum fees. That’s still not much, particularly seeing as it will be split six ways, and it’s already blindingly obvious to everyone that nobody will pitch above the minimum.

“As long as the government puts fees as part of the criteria for selection of the banks, there will be one or two who are so keen to do the trade that the fee levels are not going to change,” says Sanjay Sharma, head of equity capital markets for India at Deutsche. “However, if a bank has made the call that it’s important to do a particular trade, you’re not going to put less effort on it because it pays no fees.”

India is one of those rare world economies with a problem most others would like to have. Growth is good, but is it too good? The biggest challenge facing Indian policymakers today is not spurring the economy but stopping it from driving inflation out of control.

In July the International Monetary Fund (IMF) raised its 2010 growth forecast to 9.4% from 8.8%. “We are fairly bullish on the short term prospects for India, and mainly that comes from two things,” says Kalpana Kochhar at the IMF in Washington DC. “One, there is very strong domestic demand, consumption and investment, driven by a big push in the infrastructure field. And two, India’s exports have been much more resilient to the global crisis than one would have imagined. Between those two things we don’t see, as we do for a lot of other countries, major headwinds.”

India today looks as if the financial crisis never happened – and on the ground, one can argue it didn’t. “In the past six to 12 months it has become very clear to us that the growth dynamics in India didn’t slow down a lot,” says Rahul Bajoria, an economist covering India for Barclays Capital. He is expecting at least 8% growth this year. “I think most drivers like domestic demand and private consumption are likely to remain on a pretty strong footing.”

The problem is that domestic demand is so strong, and so much more boisterous than the supply side, that inflation has become a pressing issue. India’s wholesale price index rose 10% year on year in July, for example, and the consumer price index has flirted with double digit growth through the year. “Generally we are very optimistic about the outlook for India, but the prime challenge we see is inflation,” says Frederic Neumann at HSBC. “The risk is that if the RBI [Reserve Bank of India] doesn’t manage to stabilise inflation in the near term that could do more lasting damage.”

Neumann says it’s “not time to sound the alarm bell yet,” but there was a time when the RBI was widely considered to be too reticent. Many felt it should have raised rates in the first quarter, although it has made up for it with sharp rises since, most recently with a 25 and 50bp hike in the repo and reverse repo rates in July. “There was an impression in the first half of this year that the central bank was a little bit behind the curve,” he says. “But they have had unscheduled rate rises and more hawkish rhetoric saying inflation is a bigger concern than growth, so the central bank appears to be catching up.”

Managing these issues is enormously challenging. “It’s a tightrope walk,” says Neumann. “You have to raise interest rates to temper inflationary pressures, but the dilemma policy-makers face is that one reason inflation is rising in India is because the industrial sector cannot keep up with soaring demand. You need to raise investment to keep up with that demand growth, but if you raise interest rates too rapidly you risk stifling that investment.” Managing this requires close cooperation between fiscal and monetary policy, Neumann says, noting that historically they are “not necessarily pulling on the same string.” He would like to see a more dramatic cut back in fiscal expenditure, which would temporarily curtail demand without having to raise rates so aggressively, which in turn would keep the atmosphere conducive to investment.

Getting it right also has important social implications. “When you have rapid growth you take a lot of people with you but you leave some behind,” says Kochhar. “And if that grows rapidly in India, with so many poor people, there’s always the potential for a problem.” Bajoria adds: “A large portion of the population is on subsistence income, which makes it particularly important to control inflation.”

Another challenge is that the issues creating inflation in India are quite unique to that country. It’s chiefly about food inflation, with the added problem that it spills over into non-food sectors, but the behaviour of food and agriculture in India has unique characteristics apart from the historically low agricultural productivity. One is the government policy for inclusive growth, including its national rural employment guarantee scheme, enacted in 2005 and now in widespread operation. Under this scheme, any rural household is entitled to have 100 days of employment, on demand, at the wage of 100 rupees per day. “This has boosted rural demand,” says Kochhar. “Given that supply even beforehand was not able to keep pace, it is being strained even more, and this is pushing up food prices.”

Infrastructure development will be a crucial method of improving supply and thus balancing out inflation. The government has made it a mainstay of its policy to boost infrastructure spending and development. Nobody would argue with that. But numerous successive administrations have seen the same requirement and sought to address it, rarely with great success. There are landmarks to point to in airports, highways and ports – New Delhi’s new airport terminal was entirely financed by the private sector – but in the vital area of electricity generation, for example, there are familiar problems with land acquisition and tension between state and federal government bodies in this most vibrant of democracies. “Unless there is some clear measure to incentivise the private sector and at the same time hold it accountable, progress on infrastructure improvement is going to be painstakingly slow,” says Venkatraman Anantha-Nageswaran at Julius Baer. “There’s the legal challenges, the financing, the rules of the game changing in midstream, and the corruption. It all adds to the cost of executing infrastructure projects for the private sector.” Neumann echoes these sentiments and argues availability of capital is not the real problem. “It is often said that the availability of finance is the main problem curtailing infrastructure, but I think that’s only partially true,” he says. “A bigger hindrance is the somewhat arcane legal and regulatory environment in India, which makes it exceedingly difficult to build highways, ports and airports where they are needed. It’s a by-product of the very commendable democracy in India, but it’s also something that needs to be addressed.”

Kochhar acknowledges that “they have been talking about it for several years and consistently under achieving by large margins”, but she is more optimistic for two reasons in particular. One is greater movement on a corporate bond market, discussed in detail below; the other is that there has been no sign of a clampdown on foreign financing following the financial crisis – instead a gradual tilt towards modest liberalization. For a next step, “We have been advising India to have a one-stop shop, a person or committee who is in charge of implementation,” she says. “If I was a private investor I could go to this one place and have confidence all my problems could be handled.”

Infrastructure development affects two other crucial areas of Indian finance: the banking sector, and the development of a bond market. Banks generally are doing well in India. “The banking sector is on strong ground in India,” says Bajoria, citing prudent policies at the RBI, generally high credit quality, greater integration among ordinary people with the financial markets, and low NPLs. Neumann adds: “The banking sector on the whole is very geared towards investment in government bonds and lending to government-type entities, so from that angle bank balance sheets look reasonably sound.”

But will they stay sound with major lending to infrastructure projects? “One concern is the big push on infrastructure, given the way the Indian financial system is still very bank-centric,” says Kochhar. She explains: “One thing we have been warning about for three years is that financing long-gestation infrastructure projects through a banking system that has, on average, short liabilities is not a good idea.” Doing so clearly introduces asset-liability mismatches, which is a particularly unpleasant prospect when there is still a danger of non-performing loans increasing in the wash of the financial crisis.

This is one reason the IMF and others want to see further development of a corporate bond market. “That’s much better equipped to deal with the provisions of long-term financing and insulating the banking system from anything that goes wrong with the projects,” says Kochhar. “When you are making a big push [as on infrastructure] you are bound to make some mistakes, but the trouble is if the banking sector is involved and the big mistake becomes propagated through the whole economy.” (Not everyone agrees with the impact of a buoyant bond market on infrastructure; Anantha-Nageswaran feels “It will make a difference at the margin. But there are countries that have grown without a bond market.”)

India actually already has a vigorous capital market, but it lacks two things: an entrenched establishment of institutional investors such as pension funds with long-term liabilities that would match long-term bonds; and foreign participation. “The big reform India might contemplate is to broaden access of foreign investors into the fixed income markets,” says Neumann. “It would help to bypass some of the big financing bottlenecks for infrastructure. We believe foreign investors would be very happy to finance public infrastructure development in India, or purchase government bonds,” which would indirectly have the same effect. Nobody is expecting or calling for instant deregulation, even the IMF: “The IMF has never recommended for a country like India to have unfettered capital inflows and outflows,” says Kochhar. “We’ve been quite happy with the pace of liberalization.”

Which is just as well, as India has never moved at anything other than its own rate. “I think as with everything in India it’s moving in the right direction, but at a glacial pace,” says Neumann of capital markets development. “We just have to wait and see if that pace is sufficiently fast.”

“Basmati,” says Rajat Beg, “is the champagne of rice.”

As an executive of India’s REI Agro, one of the world’s major basmati producers, you might say he’s biased. But he has a point. Basmati – the word means “the fragrant one” in Sanskrit – isn’t just a source of sustenance: its rarity, and the sheer difficulty of producing it, has made it a status symbol in its own right. In class-conscious India and elsewhere, if you serve basmati rice, you’re making a statement.

Basmati’s prestige stems from the painstaking process involved in growing it. Everything from the temperature to the soil, the humidity, the timing and the storage of the rice is vital. It grows in only two countries in the world, Pakistan and India; and within India, which accounts for three quarters of the global harvest, it only grows in four provinces and constitutes barely 2% of the Indian national rice crop.

So what do you need to grow basmati? It’s a highly specific checklist. Basmati needs the rich alluvial soil that comes down in the snow-melt from the Himalayas, which is why it only grows in the foothill states of Punjab, Haryana, Uttranchal and a chunk of Uttar Pradesh. Those snow-fed waters are important too, and there needs to be a median temperature of 28 to 33 degrees Celsius and a minimum humidity of 60%. Even the hours of daylight and the gentle winds there are crucial. It’s a very picky breed of rice.

On top of that, the timing of sowing is important. Top growers sow in the nursery in the first week of June, then grow in the kharif season – through July and August, during India and Pakistan’s south-west monsoon season – and harvest from September to December. Everything about this timing matters: it smells better when it ripens in cool weather.

Next, basmati must be matured for 18 to 24 months before it is sold. It is dried, processed and carefully stored. If you buy a packet of top-grade basmati from a store today, it was probably harvested at the end of 2007 at the latest. “Basmati is like wine,” Beg says. “The fragrance and cooking qualities are enhanced with ageing.” Understanding why gets you into some complex science: as moisture reduces in the rice during storage, a cocktail of about 100 chemical compounds is formed, and that’s what makes the rice sweet with a unique nutty aroma.

This convoluted process makes it much more expensive. Whereas mainstream rice goes for around 20 rupees per kilo in India, premium basmati can be five times more than that. So why buy it? Partly, it tastes good: it’s aromatic, it doesn’t stick, and since it loses moisture when stored, it cooks better than normal rice. But it’s more than that. The rarity creates exclusivity, and with it, prestige. “Any family function or get-together in India is incomplete without the basmati recipe,” Beg says. As one producer slogan in India goes: “Basmati is no product. It is a status symbol. It doesn’t just feed; it elevates.”

And, while this social side certainly matters in India, it is still more potent elsewhere. About 60% of the Indian basmati crop – representing almost half the global total – is exported, and of that, almost half goes to Saudi Arabia, and plenty more to the other big Gulf states: United Arab Emirates, Kuwait and Yemen. This is where the prestige of basmati is most powerful: the sense that what you eat, and what you serve, says something about you and your wealth.

It’s a prestige Indians have been prepared to go to court for: when a Texan company won a US patent on basmati rice lines and grains in 1997, the furore went all the way to the top and caused a diplomatic standoff between the Indian and US governments. India didn’t follow through on a threat to take it to the World Trade Organization – the US company withdrew most of its patent claims instead – but to this day the WTO only allows certain varieties of rice grown in India and Pakistan to be labelled as basmati.

Indian scientists have developed molecular market systems – rice detectives, you might say – in order to authenticate traditional or evolved basmati from other forms of rice, so important is it to be sure that only the best crop is sold under the name. Exporters get a “purity certificate”. It’s quite something when your rice has to be fingerprinted: welcome to the exclusivity of basmati.

It seems a long time ago that the markets were swamped with Indian convertible bonds: zero coupons, tightly priced with the fees squeezed til they hurt. That glut of convertibles came to an end in 2008 and there’s been little sign of it since – until a little-known Indian education company called Core Projects & Technologies reopened the market in April.

Core Projects is not an obvious name to revitalise the Indian CB market: it is a mid-cap with a market capitalization of about US$500 million, and is pretty much unknown to international investors. But in April it raised US$60 million in a five-year offshore convertible, sole lead managed by Standard Chartered.

Explaining how it came together, Standard Chartered’s global head of equity-linked solutions, Nathan McMurtray, starts by differentiating it from the 2007 explosion of convertibles. Those deals were driven by hedge funds and in particular those focusing on convertible arbitrage strategies, he says. “They were becoming increasingly dominant in convertible bond product,” he says. “They tend to be the least price sensitive and the most willing to give a company favourable terms, which is what calls the shots at the later stages of a bull market. They largely pushed strategic equity and debt investors to the sidelines.”

This worked for Indian deals so long as there was a strong equity story, with a lot of potential upside, but as the financial crisis kicked in this group of buyers – who had been heavy on leverage – were squeezed even more than other investors as banks and prime brokers withdrew funding. Regulators in India were making it progressively more difficult to sell stocks to hedge exposure, and on top of that volatility and credit spreads started to soar. “Suddenly you had a lot of pressure on a strategy that was successful to that point but optimised to a market that no longer existed,” McMurtray says.

And so the market shut down for two years. What’s brought it back is the resurgence in Indian equity markets and a levelling of credit spreads. “That started to create conditions where you could take a straight equity or credit view. When you factor in the return of equity and credit investors who had largely been sidelined, the result was people who could put a value on that equity and credit came back into the market and have begun to dominate it.” Many big straight debt and equity deals have come out of India this year, but in Core Projects Stanchart saw something different: “an opportunity for a solid business in a really good sector, but which doesn’t have an analyst following, to come to the attention of investors.” A non-deal roadshow was organised, and then the deal was attempted.

It wasn’t particularly cheap funding: the deal priced with a 7% coupon, the generous end of marketing, and a 10% conversion premium. They were sold at 900 basis points over Libor. It was a long way from the zero-coupon deals with huge conversion premiums from 2007, but then again the world looks very different today.

In any event, the terms were hardly the point so much as the fact that an Indian convertible had once again found investors. For a small deal, it went to a lot of accounts: more than 20, in Asia and Europe, including pure equity players and hedge funds. “We had to cut people back: nobody got their full order,” McMurtray says.

Will there be more? “I think there will be increasing amounts of issuance out of India, from this size to much larger ones,” he says. “During the crisis in Europe India has come through with much less effect generally on the credit and equity markets than other places in the region.” Some of that may be high yield, but regulatory restrictions which set a maximum yield that can be charged on a debt instrument make that tricky to do. “I think it will be predominantly convertible bonds.”

Others are less certain. “You need to have a view that the equity is undervalued and be able to sell that to the market to get convertibles away,” says one senior banker. “The market values are even more in India now than they were when you saw the rush of issuance. But there is an argument you could see CBs pick up first because they have a lower headline yield, and that gets you through some of the regulatory hurdles that hit a standard bond deal.”

Bankers hoping to entice Indian companies into offshore bonds face a number of challenges. Regulation creates a few hurdles, but that’s not the real impediment: instead, the biggest problem is that conditions are so good for borrowers in the domestic markets there’s scarcely any point going overseas.

“Indian issuers have relied a lot on the domestic markets in the last year or two, and those markets have lived up to it: in pricing, amount and tenor, it has been pretty comfortable,” says Maneesh Malhotra, director and head of debt finance, India, at HSBC. “Even now the cross-border markets have opened up, the domestic market has remained vibrant.”According to Dealogic, 117 issues had raised the equivalent of U$12.31 billion in the domestic market in the 12 months to April 14, compared to US$2.04 billion from six deals in the offshore markets.

There’s a lot to be said for it: liquidity, tenor, pricing. “Liquidity is probably $500 million to $1 billion for most of the top rated credits, those rated domestically triple A through double A,” says Ashwini Kapila, managing director at Barclays Capital. “There’s more flexibility in terms of being able to use the funds when you issue locally. There is a credit market available for those below AA, and there is tenor available for higher rated bonds up to 15 to 20 years, particularly for public sector issuers.”

This point on tenor is widely noted: in a region where few local currency markets bar Malaysia offer the opportunity for truly long-term financing, India’s rupee debt market stands apart. “We’ve seen 20-year issuance in the past, and there are a few public sector companies which do 15-year money two or three times a year,” says Malhotra. “Ten to 12 years is easily available. And you can raise up to US$400 million equivalent in these tenors.”

It’s also likely to grow from here. Fergus Edwards at UBS draws a comparison with China and ponders what it tells us about the direction India’s market will take. “If you look at the domestic market for RMB bonds and Indian rupee bonds, you can draw one of two conclusions: either there’s massive scope for absolute growth in the domestic Indian bond market, or the funding is currently being provided to Indian companies through other routes, such as domestic loans,” he says. “Either way there’s got to be massive capacity for growth.”

All of this presents a challenge for international investors who want to get exposure through offshore deals. “If you are an international investor, you want to buy the biggest names and the sector leaders to build up benchmarks,” says Edwards. “But if that’s who you are as a borrower, then you have the best access domestically. The international market just hasn’t seen a real benchmark borrower coming from India with frequency.”

There have been offshore deals, but they have tended to follow a pattern. Apart from Indian Oil Corp, most offshore borrowings have been for banks who have specific reasons for needing offshore capital. “All these borrowings have essentially been for offshore branches: using the funds for on-lending overseas,” says Malhotra. “The funds are not coming back into India but supporting clients of these banks such as large or medium Indian companies with operations overseas who require foreign currency funding.”

So why isn’t there more? Apart from the relative appeal of local currency markets, there are also clear regulatory restrictions that are off-putting when an Indian issuer looks to overseas bonds.

“Investors naturally would like to get more exposure to the best corporate names in India, but there are a number of structural issues in the market that have so far pushed Indian corporate to look at other forms of finance, chiefly domestic bonds or loans,” says Alexi Chan, managing director of debt capital markets in Singapore for HSBC. “In order to unlock that pipeline one of two things needs to happen: the structural issues need to change so there is more of a level playing field for a borrower considering which instruments to use; or conditions in the international credit markets, with a significant tightening of credit spreads to make offshore bond markets more compelling.” The demand is there, Chan says. “The overwhelming reception we got for Indian Oil demonstrates that pent-up demand is there.”

The structural issues Chan refers to are things like the RBI’s guidelines on overseas borrowing. This sets things like a minimum tenor, maximum pricing, and also conditions on end use. “They’ve worked well,” acknowledges Malhotra. “I don’t think there has been a stifling at any point of time.” But they do complicate the picture for issuers. Another issue is withholding tax, which depends on tax treaties India holds with each corresponding countries. This can be as high as 20% if you don’t know the domicile of each investor, something that doesn’t apply with syndicated loans, where the domicile of the participant banks is very clear. “That is an issue in terms of why Indian corporates do not borrow so much in the Indian bond markets,” Malhotra says.

The maximum pricing is 7.5%; any higher and the RBI won’t approve it. And it’s not likely to change much in the near future. “Don’t expect too much liberalization in the next one or two years,” says Rakesh Garg, Director, Barclays Capital.

Still, as one banker points out, “in a low rate environment it does become easier to hit pricing thresholds which minimise withholding tax. That’s an improvement, but it’s because of the market, not regulation.”

Although the domestic market clearly offers better all-in pricing, that doesn’t deter all issuers, even those who don’t need the funds offshore. “Although most Indian issuers use their offshore funds for overseas operations, issuers such as Indian Oil have used the cross-border market and brought the funds back into India,” Rakesh says. “Their objective was to diversify and enlarge their investor base, even if the cost may have been relatively higher.”

One oddity of India’s capital markets is what isn’t there. “What we don’t have is a sovereign benchmark internationally for India,” says Chan. And there isn’t likely to be one anytime soon. Ashwini says: “There’s no stated policy that India will ever issue or not issue a sovereign, but we all know on the ground there is big resistance from decision-makers in the government.”

In its absence, investors have instead hunted for a suitable alternative. “The State Bank of India is seen as a proxy to raise money for the government,” Ashwini says. “Effectively investors have taken it as given that there will not be a sovereign bond and see State Bank of India as the closest equivalent.”

The market was most grateful for SBI when it launched a vital issue in October 2009, a $750 million deal that was the first Indian offshore issuance for the better part of two years, and yet which priced agreeably at mid-swaps plus 190 basis points. “It reopened the market for Indian borrowers,” Edwards says. “You hadn’t seen anything remotely like it for 18 months, so it helped make clear the degree to which India’s pricing had changed over that period. That was very material. The size of the trade also demonstrated the volume of cash available for Indian borrowers.”

UBS was a bookrunner on that deal, as were HSBC, Barclays, JP Morgan and Citi. All consider it a landmark: Chan at HSBC calls it “A very helpful deal for establishing a benchmark for the country post-crisis,” and Ashwini adds: “Given that there had been no primary issuance by an Indian financial institution in nearly two years, the SBI bond issue reopened the international markets for Indian borrowers by creating a new benchmark.”

Subsequently, several Indian issuers – particularly banks – met with investors and priced at the first opportunity after the SBI deal. But banks like Axis and Bank of Baroda ended up postponing their deals in light of uncertainty around Dubai World and heightened sovereign risk, before coming back for a second attempt in a flurry of issuance in March. In the space of a week, Bank of India raised US$500 million, Axis Bank $350 million and Bank of Baroda $350 million; Deutsche, HSBC, Barclays and Citi appeared on all three deals. “In the end, all issuers successfully priced their transactions, and met with strong investor demand,” says Ashwini. “All the bond issues were well oversubscribed.” The Bank of India book, for example, was said to be close to $4.5 billion.

When deals like this do come they have tended to be Regulation S rather than targeted at the US, and are often underpinned by Asian demand. “It’s been a very good mix but you always notice Asia is a bit of an anchor,” says Malhotra. “It has closer physical proximity; Asian investors understand Indian names far better than someone sitting in Europe.” That said, Europe has shown strong demand too, while a recent 144A deal from ICICI shows the interest of funds in the US. By type, Malhotra reports a good mix of investors with private banks particularly strong over the last year alongside the fund managers.

They have good macro reasons to want to take part. “There is a general interest from emerging market investors to get more exposure to India,” says Chan. “There’s a general feeling that the Indian sovereign credit environment should be improving, India will undoubtedly continue to develop as one of the world’s largest emerging markets, and as this happens the number of companies that would wish to tap international markets would naturally increase.”

And it’s likely that if Indian borrowers ever ventured to the US, they would find just the same enthusiasm there. But by and large they haven’t been tempted to try. “The market is disappointed that more Indian borrowers haven’t gone down the 144A route, because US accounts are keen to increase Indian exposure,” says Edwards. “But that doesn’t make the 144a pricing necessarily cost competitive against a local loan market that is flush with cash.”

There is an exception, though: ICICI, which raised $750 million in November. “ICICI was quite different to the rest of the Indian bank borrowers because it has for some years done its international bonds issues in the 144A format, whereas most Indian borrowers have launched Reg S Eurobonds predominantly targeted at investors outside the US,” says Chan. ICICI has focused on 144A bonds sold to qualified institutional buyers (QIBs) in the US. “We saw tremendous demand from the US for Indian paper but there is very limited supply to the US from India. That’s another theme that will develop as Indian borrowers want to raise a larger quantum of funding: they will look at the 144A QIB market and tap into that investor base.”

If US-targeted bonds do prove to be a new theme, what else should we expect? “The next question is when do those borrowers that have come in a senior format start to consider sub debt,” says Edwards. “At that point, you start to see interesting transactions with longer term strategic benefits,” Edwards says.

18 months ago, India was considered a hotbed of convertible bond issuance. Could we see that come back? “You need to have a view that there is material upside in the share price,” says Edwards. “So as Indian equity market valuations have increased, so you would expect to see fewer CBs.” That suggests no room for a revival in issuance, but the regulatory challenges to straight dollar bonds may yet cause some issuers to consider it. “The international CB may still have attraction compared to regular bonds if keeping the headline cash yield low to pass some of the regulatory and tax hurdles to issuance matters.”

Domestically there is room for development in structure too. While onshore deals have mainly been somewhat plain vanilla, there are examples of more complicated structures. One was ETHL, an issue of zero coupon non-convertible debentures in January pledged against Essar’s 10.97% stake in Vodafone Essar with a put option on the shares. This deal, which effectively pierced the sovereign risk ceiling since Vodafone is rated three notches higher than the Indian sovereign, raised Rp42.3 billion – almost US$1 billion equivalent – from the domestic market.

Deals like this show that apart from being full of cash, investors in India are prepared to consider more complex stories. “It showed the market is willing to look at clearly structured deals,” says Ashwini. “The investor base is maturing.”

Asia’s bond markets enter 2009 at a crossroads. Last year many of them demonstrated that they were credible alternatives to credit-clogged G3-currency markets, at least for local borrowers. But  what happens next? The coming 12 months will demonstrate whether Asian markets have shown sufficient depth and maturity to hold their ground as a key funding source or will once again be only an afterthought to the major global currencies.

“Local currency markets are a lot more important than people give them credit for,” says Sean Henderson, head of debt syndicate for Asia Pacific at HSBC. Dealogic, the data provider, says bonds in the 10 main Asia ex-Japan currencies combined amounted to the equivalent of US$231.8 billion in 2008, compared to US$28.3 billion for Asian issuers in dollars, yen and euros combined. “Both in terms of scale and the trajectory of the markets, local currency became a lot more important in 2008,” Henderson says. In particular, Asia proved itself a rare location in which borrowers could raise bank capital: Maybank, UOB, DBS and OCBC all raised tier one capital locally in 2008, and several Philippine lenders raised tier two funding.

Different markets responded to the opportunity – if one can call a global credit crunch an opportunity – in different ways. The standout, by a considerable distance, was China. The 10 largest local-currency bonds out of Asia last year were all in Chinese renminbi, and the smallest of those 10 was worth Y19.5 billion (US$2.85 billion). Consider China Ministry of Railways: in September, as Lehman Brothers plunged towards bankruptcy, it raised Y20 billion; a month later, as world stock markets hit some of the worst volatility for nearly a century, it raised another Y20 billion; and in November, amidst all that global uncertainty, it trumped them both by raising another Y30 billion in the largest bond of the year. China National Petroleum Corp, China Merchants Bank, China Development Bank and the sovereign itself have all raised billions of dollars worth of local money in 2008.

“China’s bond markets are starting to play a more meaningful role in the overall economy and we expect to see this welcome development continue,” says Mark Leahy, head of global risk syndicate for Asia at Deutsche Bank. “The regulatory framework around the bond market, and in particular the corporate bond market, continues to be strengthened and will allow more participants to play a more active role. This is the area we believe will have the most rapid growth in the coming years.”

But China is something of a special case. “It is the most cloistered of the domestic bond markets,” says Fergus Edwards at UBS in Hong Kong. “Local investors have a relatively limited number of markets to consider, and at present those with cash are less likely to invest in equities or in property than they were a year ago. That makes the bond market a very attractive third option.” Also, Edwards says, the Chinese are a relatively protected investor base, unaffected by declines in global markets, forex wobbles or the oil price. “Chinese companies continue to grow strongly, driven by continued, if weaker, domestic demand. The renminbi market allows them to domestically fund the investment that generates this growth.” Edwards, who was on the October Ministry of Railways deal, says the ructions in world markets at the time were “not a problem. Chinese accounts focused on the strength of their home market rather than the weakness of others.”

Elsewhere in Asia, though, few places were quite that resilient. Most markets showed healthy issuance until the October crash, and then locked up just like everywhere else. Malaysia, for example, hosted deals in ringgit worth $500 million or more from Cekap Mentari, Syarikat Prasrana, Cagamas (twice) and Khazanah, but there’s been nothing of any size since September. Barring an encouraging $554million-equivalent deal for Woori Finance in December, the same is broadly true of the Korean won. Philippine pesos and Indonesian rupiah have been active in low quantities (though Indonesia effectively shut down in August), but traditional stalwarts, especially the Hong Kong dollar, have been all but dormant: there hasn’t been a deal worth US$100 million in Hong Kong dollars for almost a year now.