India has long been considered a country of enormous opportunity, but in recent years numerous factors have prevented it achieving its full potential. Change, however, is in the air and India may soon be ready to take its seat at the economic top table. What does this all mean for the business and treasury landscape in the country? Treasury Today Asia investigates.
In 2016, the IMF predict that India will grow faster than any other major emerging economy at 7.5%, eclipsing the 6.3% predicted of China in the same year. If correct, this will prove a big boost to the Modi government which entered office with a promise to transform and grow India’s then troubled economy.
In his first 12 months in charge Modi took a number of small, but significant steps in the right direction, to modernise, liberalise and open up the economy to more foreign direct investment (FDI) and make India a more business friendly location. For instance: the red tape has been loosened and many permits required to do business can now be obtained online, there has been increased spending on India’s infrastructure, corporate tax is due to be cut an unprecedented 25% over the next four years and investment limits on sectors including insurance and defence have been lifted.
Overall, it seems that this strategy is working. India is not just growing at a great pace, it is also proving to be the world’s most popular investment location. According to a Financial Times study between January and June 2015, the country garnered $31bn of FDI, surpassing China ($28bn) and the US ($27bn).
And India, it seems, is set to continue in this positive direction, despite the strong economic headwinds being felt across emerging markets. The reason for this, according to Indian Finance Minster Arun Jaitley, is because the country is a net importer of commodities, unlike many other emerging economies that are net exporters. As a result India, in recent years, has saved $44bn from the drop in oil prices. This dynamic has also enabled India to build its foreign exchange reserves to an all-time monthly average high of $328bn. India’s strong fiscal position was echoed by ratings agency Moody’s that said: “India is less exposed to global risks because of its more resilient economic growth and the impact of positive policy reforms momentum.”
Despite this, it hasn’t all been positive news for Modi. A number of the government’s larger economic initiatives – such as amending the land acquisition act, standardising tax and revising the labour laws – have hit roadblocks and will require more support before they are passed through parliament. Therefore, according to numerous commentators, India still has some way to go before it can reach its full potential.
The financial sector
A key component in India’s journey will be the financial sector which is widely regarded as being fairly well developed and is dominated by local state owned lenders such as the State Bank of India, ICICI Bank and Bank of Baroda. Just under 40 foreign banks are present in the market, these however have a limited share of the total banking assets (around 5%). The rest of the sector comprises privately owned banks and rural or regional lenders.
There is an over reliance on the banking system for addressing the funding needs of corporates which then puts pressure on banks in times of distress. Alternative financing mechanisms are still evolving.
Harish Barai, Senior Deputy Manager, Corporate Finance – Treasury, Larsen & Toubro
Given the dominance of the state owned banks, the government looms large over the financial industry. Yet the Reserve Bank of India (RBI), which regulates the sector, has become increasingly independent in recent years and no longer sets the rate of interest banks charge. It does, however, play a role in dictating where the banks cash must flow – notably into priority sectors such as agriculture and infrastructure projects. As a result, the state owned banks have invested heavily in many unprofitable projects, and as the Financial Times recently reported, have been left in aggregate with an alarming level of bad or doubtful loans which may perhaps limit their willingness to lend moving forward.
Limited financing options
Corporate treasurers in India are certainly keeping a close eye on what is happening in the sector, and for good reason. As Harish Barai, Senior Deputy Manager, Corporate Finance – Treasury at Larsen & Toubro explains: “There is an over reliance on the banking system for addressing the funding needs of corporates which then puts pressure on banks in times of distress. Alternative financing mechanisms are still evolving.”
One of the alternative mechanisms still evolving is the capital markets which are considered undeveloped. This has been cited by numerous bodies as a serious impediment to companies who require access to low-cost finance.
The reasons for the slow growth of the capital markets in India is multi faceted. Firstly, the government is a large issuer in the country and can often crowd out the private sector, particularly as banks are required to hold a large portion of government paper. Also, in recent years, a large number of Indian corporates have entered into unprofitable public/private partnerships and taken on a lot of debt. As a result, a number of these companies have been downgraded by the ratings agencies, again limiting their ability to tap the domestic capital markets – particularly as the shallow investor base is unwilling to take on such risk. “Discussions around development of a proper bond market has been around for quite sometime and regulators are trying hard to push through, but the turn of economic cycle and loss of confidence is complicating matters further and shying investors away,” adds Barai.
In an attempt to diversify their funding needs some Indian corporates, in particular the highly rated names, have looked overseas to raise funds. “The desire by Indian corporates to use international capital markets has been because dollar funding has been cheap,” says Muzammil Patel, Partner at Deloitte India. “Even when corporates considered the fully hedged landed cost of issuing abroad, it has tended to be cheaper than the rupee cost of credit. And although the arbitrage is reducing, it still exists.”
Corporate treasurers will however be encouraged to hear that companies can now raise funds overseas using the rupee. The so called Masala Bonds look set to help internationalise the rupee and also deepen the financial system. The current RBI’s norms allow an Indian entity to raise a maximum of $750m per year through Masala bonds with a minimum maturity of five years. For corporates, the ability to issue such a bond will not only shield the Indian entity against the risk of currency fluctuation, but also allow for a more diversified range of funding sources and perhaps even lower costs moving forward.
An increasingly sophisticated environment
Whilst there may be questions around the health of certain aspects of the financial sector and limited funding options available, there is better news on the cash management front as corporates operating in the country have access to many of the products they would expect to receive in more developed markets. As Dhiraj Bajaj, Head of India Corporate Sales, Bank of America Merrill Lynch explains: “The financial sector in India is in a constant state of evolution, led not only by the RBI, but also by the government, participating banks and the large local and multinational corporations. This evolution has resulted in improvements in the payments infrastructure and broadened the range of innovative working capital funding options.”
The developments in the payments infrastructure now mean that corporates have multiple choices in executing local currency domestic payments with same day value. This is largely on account of the multiple payment platforms supporting low value and high value payments within the country. “Encouragingly, local banks have rapidly adopted core banking infrastructure ensuring that the end consumer can participate in all forms of wire transfers, minimising the usage of cheques in the country,” adds Bajaj.
These movements have enabled corporates to develop centralised models facilitated by the use of sweeping and pooling arrangements. Larsen & Toubro for instance have adopted this model. “Our cash flows back to the head office banks and we utilise technology to ensure that we have high visibility in order to avoid running idle balances,” says Barai.
To date, however, corporates have been unable to extend their centralised operations further and implement more advanced concepts such as multi-entity pooling or a full in-house bank structure. “The former has been difficult to implement because of the Companies Act and Income Tax Act which create arms-length, accounting and taxation related issues around these structures,” adds Deloitte’s Patel.
Whilst advanced solutions are becoming more common in the India market, Deloitte’s Patel highlights one area where banks need to improve. “Whilst there are many sophisticated products and services available in the market, many banks fall short when it comes to helping corporates find a solution and implement these.” Patel believes that this is because until recent years, discussions had largely been focused on credit; extra services were then bundled in for free with this. “The desire from corporates to pay for that next level of service has therefore perhaps been lacking and the banks haven’t yet seen a need to invest in this. Given that today many corporates are highly leveraged and have less appetite for credit, I expect to see this service element increase exponentially from banks.”
The evolving role of treasury
It will come as no surprise to hear that the growing sophistication of products being offered to corporates in India runs parallel to the developing role of the corporate treasurer. As a recent study by Deloitte titled ‘2015 India Corporate Treasury Excellence’ highlights, the top three priorities for corporate treasurers in India today are:
- Controlling working capital.
- Managing financial risk.
- Providing and managing liquidity.
Whilst the study highlights that these core treasury competencies will remain vital in India moving forward, it also draws out the fact that the role of treasury is becoming increasingly strategic, particularly around the areas of managing risk, funding long-term growth and acting as a financial advisor to the business.
The role has certainly evolved lots since it began its journey in the 1990s. “Corporate treasury became a big focus for corporates in the late 1990s and early 2000s because the FX rules in India were relaxed,” says Patel. The RBI also became more pragmatic and pushed through a host of reforms that also make it easier to take hedging positions. “As a result of this there was considerable innovation from the banks and corporate treasury became a core corporate discipline in the mid-2000s.”
At this time the role was very markets focused and it was therefore largely populated by ex-bankers with an external facing skillset. “As the profession has evolved it has become far more inward looking and treasurers in recent years have paid particular attention to understanding their liquidity flows, exposures, how their activity reflects on the P&L and a whole host of other internal pieces,” says Patel. “The market element still exists but this inward facing analysis is something that drives the profession forward.”
Challenges for corporates
Despite the positive steps that have been taken by the regulators, the financial sector and by corporate treasurers themselves, there remains some key challenges that are having to be dealt with. According to the Deloitte survey, Indian corporates are wrestling with the economic headwinds being felt by companies around the world. The understanding and navigation of changes in global regulation is another shared challenge with the wider corporate community.
The survey also highlights some challenges that remain more prevalent in India than perhaps in other more developed markets. One for instance, is gaining a clear view on their exposures. A key reason cited for this was the lack of adequate information from business units. Of course, many corporates around the world have utilised technology to provide this visibility, but this doesn’t seem to be the case in India. “Treasury technology is not as developed in India as it should be,” says Patel. “Treasurers have therefore been unable to use their company ERP to begin undertaking some of the treasury processing. A lot of data that is required for treasurers sits in this system and I know that many would like to use this as their treasury management system, but this has not yet happened.”
Fraud and managing fraud risk is another challenge that while not unique to India is certainly amplified in the country. In fact, a study conducted in late 2014 by global accounting firm Grant Thornton highlighted that instances of fraud in corporate India had increased in the past two years, with over 75% of those surveyed believing that cases of fraud had either increased somewhat or significantly. The move away from paper based transactions as mentioned earlier by BAML’s Bajaj is certainly helping in this regard. Despite this a staggering 71% of the Grant Thornton survey respondents believe that incidents of fraud would continue to rise over the next five years.
Evolving regulation
Many of these challenges which corporates face in India are largely a result of the country’s stringent regulatory environment and the well-publicised red tape. Overall, the Deloitte study highlights that corporates appear content with the level of regulation but the laws impacting cash pooling and inter-company funding remain a key challenges. As BAML’s Bajaj explains: “Repatriation of trapped cash in light of the dividend tax implications and repatriation of profits by a multinational company is an issue for many corporations. Equally, restrictions around notional pooling limit the ability for interest optimisation for local currency balances held in the country.”
More broadly than these treasury specific restrictions, the red tape in India has meant the country has often been regarded as an extremely difficult and unfriendly place to do business. In many instances it still is, as highlighted by the fact that India was ranked 130th out of 189 economies in the World Bank’s Ease of Doing Business survey in 2015.
But, as previously mentioned, change is occurring. The Modi government are taking significant steps to encourage greater investment in India and turn the country into the world’s next key manufacturing hub through the Make in India initiative – a national programme that is designed to facilitate investment, foster innovation, enhance the skills of the workforce and ultimately build a best-in-class manufacturing infrastructure.
This is already having a positive impact as Larsen & Toubro’s Barai explains: “One year from now it will be very easy to do business in India – the regulators are removing lots of the restrictions for both foreign and domestic companies. Before the Modi government came in, forms were being submitted to government agencies and they just sat there not being processed. Now we see these move through at much greater speed and it is my belief that in the next year or so India will substantially move up the ease of doing business rankings.”
