Modi gives lift-off to Indian capital markets

The Modi government has cut withholding taxes on offshore bonds and raised limits on foreign investment in insurance companies.
Narendra Modi
Narendra Modi

The new Narendra Modi-led government last week introduced a slew of proposals aimed at boosting capital markets activity and attracting foreign investment.

To create a more investor friendly environment, the government has curbed the use of retrospective taxation, a move aimed at allaying concerns among investors raised by Vodafone's long-standing tax dispute with the government.

Mobile operator Vodafone's wrangling with the government started when it acquired Hutchison Telecom's stake in Hutchison Essar in 2007. An Indian court ruled in early 2012 that the deal was not taxable by the Indian government as it was transacted by companies incorporated outside of India.

However, later in 2012, the Indian government changed its Income Tax Act retrospectively to make sure that companies operating out of tax havens were still subject to the taxation. This scared off investors from buying assets in India. The Indian tax authority demanded that Vodafone pay about $2.5 billion in capital gains tax. Vodafone has not yet resolved the tax dispute with the Indian government.

With the changes, analysts said confidence could improve. “Investors were afraid because of what happened in 2012, when the government created tax liabilities retrospectively,” Vikas Halan, a senior credit officer at Moody’s told FinanceAsia in a phone interview. “Foreign investors will find it less intimidating to enter India and we could see more acquisitions and asset sales as some companies that were afraid of retroactive tax liabilities could start evaluating proposals,” he added.

In addition, the Indian government has raised the foreign direct investment limit on insurance and defence companies from 26% to 49% – which opens the door for foreign companies to raise their stakes.

However, according to one Hong Kong-based M&A banker, his clients are in watch and wait mode and, while equity markets have run up, long-term investors remain more cautious. “The government keeps changing the laws and that has been the main source of frustration, so I'm not sure if there will be a huge amount of inbound acquisitions,” he said. He added that Indian companies are also heavily leveraged and unlikely to make big ticket acquisitions overseas. 

Bond withholding taxes cut

On the bonds side, the Indian government has proposed lowering the withholding tax on foreign currency bond issuance from 20% to 5%. In the past, only infrastructure companies were allowed to tap the bond market at a tax rate of 5% but that has now been extended to all borrowers. Companies can tap the markets at a 5% tax rate up till July 1 2017 and the lowered tax rate will take effect from October 1 this year.

While debt bankers are optimistic that this will result in more companies tapping the offshore bond market, analysts say there are other factors at play. “Whether this is going to have an impact on the amount of issuance remains to be seen,” said Halan.  “The incremental amount of offshore bond issuance will depend on the hedging cost and the differential that exists in local and foreign currency,” said Halan.

Companies with refinancing needs, such as Tata Steel, are expected to benefit from this change. The steel maker is eyeing the US dollar bond market as part of a giant refinancing package and deciding between the Reg S and Reg S 144a market, according to one source familiar with the matter.

Lending to the beleaguered infrastructure sector also got a leg up as the government has allowed banks to raise long-term debt that is exempt from statutory liquidity requirements and cash reserve requirements -- which typically ties up about a quarter of the funding raised.

“In the past, Indian banks didn’t issue domestic senior long-term bonds. There was no restriction but it was a grey area, so banks typically ran maturity mismatches when they extended long-term loans. The government has allowed banks to raise long-term bonds, which will help to remove the mismatch,” said Srikanth Vadlamani, senior analyst at Moody’s.

The government has also proposed tax incentives for real estate investment trusts (Reit), though the actual details will have to be hammered out before India can see its first Reit listing. Indian regulator Sebi had released draft guidelines for Reits last year but the government's proposal is another step towards opening up the market to Indian real estate and infrastructure companies that now typically head to Singapore, which has an established Reit market, to list.

“They have provided tax incentives to allow Reit-type structures for commercial property and infrastructure projects and although we are waiting for the fine print, it should be positive for the banks as many of them have a lot exposure to the infrastructure sector,” said Vadlamani.


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