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Trends in India Corporate

Trends in India Corporate

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Published by: alokshri25 on Dec 20, 2010
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   A  s   i  a   C  u  r  r  e  n   t   I  s  s  u  e  s
Rachna Saxena+44 207 547-6258rachna.saxena@db.com
Maria Laura Lanzeni
Technical Assistant
Bettina GieselDeutsche Bank ResearchFrankfurt am MainGermany
 Fax: +49 69 910-31877Managing Director
Norbert Walter
Corporate investment has been a significant source of economicgrowth over the past several years.
In the past decade, there has beentremendous growth in overall investment levels in India, from less than 25% ofGDP in 2000 to over 35% by 2006. A significant part of this investment drive hascome from the corporate sector. Over the past five years, corporate investment as
a share of India’s GD
P grew by 9 percentage points. Given the links between a
country’s investment levels and its overall economic growt
h, corporate financingand investment are crucial components
of India’s future growth potential. This
paper focuses on the various sources of corporate financing that are used to fundthis corporate investment.
The global financial crisis has hit several sources of corporatefinancing.
Foreign financing of Indian corporations has increased over the pastfive years. This includes external commercial borrowings, foreign directinvestment, credit from foreign banks, and foreign institutional investors that haveparticipated in domestic equity markets. As foreign investors have been hit by thecrisis, they have pulled back from the Indian market and turned risk averse. Whilethe second half of 2009 has seen a rebound in foreign inflows, it still could takeuntil 2010 before capital flows fully recover.
SMEs are most at risk from the financing slowdown.
Given their lack ofsignificant retained earnings and corporate savings, SMEs are generallyconsidered to be most at risk from the financing slowdown. External financing isnot just supplementary capital used to fund growth and expansion plans, butrather essential funds that SMEs use to refinance existing debt and to sustain day-to-day operations.
Equity markets and foreign direct investment could be the mostpromising sources of financing over the next year.
Even if Indian marketscorrect moderately from the currently high levels, we think domestic equity will bean important source of corporate financing over the next 12 months
both throughthe primary and secondary market. In addition, the recovery in global equitymarkets means that GDR and ADR issuance will offer good financing opportunitiesas well. The expected rebound in the Indian economy and gradual implementationof FDI reforms will enable direct investment to grow strongly once again. Finally,there is potential in external commercial borrowings (ECBs) as interest rates godown in credit markets.
However, foreign lenders’ willingness and ability to lend to
smaller companies may be limited.
Note: A shorter version of this article appears in the Indian Journal of Capital Market.
Trends in India's corporatefinancing
October 27, 2009
Trends in India's corporate financingOctober 27, 2009 3
While considerable amounts of firm financing come from internalsources such as retained earnings, sources of external capitalremain highly important. These include bank credit, equity markets,corporate bond markets, external commercial borrowings, foreigndirect investment, and private equity. As the global crisis took holdover the past two years, many of these financing sources dried upand slowed corporate investment and growth. Liquidity conditionsand the stock market have improved since the lows in the secondhalf of 2008 and the early part of this year, but obtaining funds maystill remain challenging for many corporations in India. This articleseeks to provide an overview of the various sources of financing inIndia, looking at the trends for the last several years as well theoutlook over the next year.
Financing from internal sources is important for largefirms
The Reserve Bank of India (RBI) categorises internal sources offunds as paid-up capital, reserves and surplus, and provisions(which includes dividends). Approximately 40% of corporatefinancing for public and private limited companies comes frominternal sources. Charts 1 and 2 highlight the most recent figures.Delving further into the available data, research has found that forlarge firms involved in either the manufacturing or servicesindustries, internal resources account for 67% and 47% of all fundsrespectively. However, the picture changes significantly for smalland medium enterprises. These firms often do not have significantsavings and internal sources average only 10% of total funds.
 Earlier studies covering the period 1994-2003 also found suggestiveevidence that smaller firms face stronger credit constraints vs. theirlarger counterparts.
Thus, small and medium firms can beconsidered among the most vulnerable to the drying up of externalfinancing sources. We examine these sources more closely in thefollowing sections.
anking system remains essential
Bank credit generally forms a part of external funding for manycompanies. In public limited companies, bank borrowings accountedfor 32% of external financing and 20% of total financing according tothe 2007-2008 RBI survey of company financing. In private limitedcompanies, bank borrowings accounted for 28% of externalfinancing and 17% of total company financing in the 2007-2008financial year. Chart 3 on the left shows the sector-wide deploymentof bank credit. Some of the constraints on greater bank lending arethe regulatory hurdles, such as the high statutory liquidityrequirement (which forces banks to keep deposits in governmentsecurities) and the priority sector lending requirement (whichmandates some banks to have almost 40% of their adjusted bankcredit directed to priority sectors).
Thus, many Indian companieshave turned to other sources of external finance. As the Indianeconomy boomed from 2005 through 2007, the growth of domesticbank credit to the commercial sector gradually declined (seechart 4). While several factors account for this trend, it could bepartially attributed to the fact that companies were pursuing other
Allen et al. (2007).
Love (2005).
RBI. Master Circular. Lending to the Priority Sector. July 2009.
Internalsources,36.9%Externalpaid-upcapital,17.1%Borro-wings,28.3%Tradedues &otherliabilities,17.7%
Source: RBI
Financing for public limitedcompanies
Internalsources,40.0%Externalpaid-upcapital,17.1%Borro-wings,19.9%Tradedues &otherliabilities,22.5%Others,0.5%
Financing for private
Source: RBI
limited companies
   2   0   0   4  -   0   5   2   0   0   5  -   0   6   2   0   0   6  -   0   7   2   0   0   7  -   0   8   2   0   0   8  -   0   9
Other sectorsWholesale tradeMedium & Large IndustryPriority sector
Source: RBINote: Non-food credit
% of total credit
Sector-wide gross bankcredit

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