India economic update
Milind S. KothariManaging Partner
M & A tracker
Rajesh ThakkarPartner /Transaction Tax
Tax & Regulatory Services
Kiran ChonkarPartner/ Resolution Advisory
Deal Advisory Services
In possibly the most daunting challenge from the time the present Prime Minister, Mr. Narendra Modi took charge of the Indian economy in May 2014, the twin pressure of declining Indian rupee vs US dollar and the relentless march of the Brent crude price now hovering over US $ 85, may end up creating havoc in the Indian economy.
The global headwinds have turned negative for Emerging Market Economies (EME) from the beginning of 2018, attributed to several external factors such as intensification of trade war, particularly between the US & China, accentuated by normalisation of monetary policy led by the US and rise in international crude oil prices following sanctions against oil producing countries, such as Iran.
For the first time, the Indian rupee breached a new low of INR 72.00 to the US dollar in early September 2018, despite macroeconomic fundamentals remaining favourable. The immediate consequence of the rupee depreciation could be that India’s Current Account Deficit (‘CAD’) may widen to an unsustainable level in FY 2019, if the currency slide continues. While, most currencies of EMEs have also been under similar pressure, the 36-currency trade-weighted Real Effective Exchange Rate (‘REER’) a relatively better measurement of competitiveness, remains overvalued by at least 15%. A positive REER would mandate that a panic reaction is not unwarranted. Effectively, the rupee has depreciated 2% in real terms against a basket of 6 currencies since January 2017.
Concern remains on the heavy dependence on imports, oil being the largest, with exports growth remaining sluggish despite favourable currency leverage. The underlying stagnation in net receipts from software and Information Technology Enabled Services (ITES) export is another troublesome trend. India also needs to immediately cut down on unnecessary dependence on imports on the back of embargo on production of metals such as copper and iron ore mining in some parts of India, which is ballooning imports by nearly US $ 20 bn annually.
While both India and China are on the opposite ends of tariffs and market access, both have hit off on talks regarding investment norms in the proposed Regional Comprehensive Economic Partnership (‘RCEP’) pact, along with other nations. In an attempt to fast-track the pact, most participating nations have agreed to ease the Investor-State-Dispute Settlement (ISDS) clauses. This refers to a broad range of legal and policy norms, regulating the process by which an investing private entity from another nation may seek legal recourse in the event of dispute with the state. The RCEP is a proposed pact between 10 ASEAN economies and 6 other nations. Harmonising investors from the Asia Pacific region has always been a target for India in the RCEP talks. For India, RCEP presents a platform to give a boost to its strategic and economic status in the Asia Pacific region.
The juggernaut of stressed assets in India continues to grab headlines for the past 15 months ever since 12 of the largest defaulting companies were referred to the National Company Law Tribunal (‘NCLT’), a judicial authority under the Insolvency & Bankruptcy Code (IBC). Leading global private equity funds and their joint ventures are set to bid for the next round of 28 stressed assets that will be on the block through the IBC process. While, resolutions have been slow to come through due to high-intensity litigation from bidders vying for prized assets, there is a fundamental shift in the minds of promoters who have paid up nearly US $ 15.00 bn in the last one year to the banks on the fear of losing their businesses under this law.
In the race to localise data, much on the lines of similar trends elsewhere in the world, the Government’s draft e-commerce policy is likely to face a major hurdle, with foreign investors set to join hands with domestic retailers and traders, against it. The broad contours of the draft policy discussed with stakeholders have come under criticism for being protectionists and one-sided in favour of big players.
With the economy badly dented by crude prices and currency decline, the present Government needs to come up with smart solutions to keep the electorate on its side in the ensuing general elections which are now around the corner. The chill in the economy has set in even before the winter arrives later this year!
M&A in India
Between July 2018 to September 2018, around 130 M&A deals were announced / completed aggregating to approx. USD 2,966.36 mn; dominated by domestic deals (97) followed by cross border deals (33)
In terms of sectors, Health Care sector saw the maximum deal value with deals worth around USD 1,294.55 mn followed by Materials sector with USD 598.20 mn
(Deals mentioned in the M&A Tracker do not include those with undisclosed deal values as well as those which have been announced but not closed)
Target Company: Thumbworks Technologies Private Limited
Acquiring Company: Capfloat Financial Services Private Limited
Deal Value (in mn USD): 30
- In August 2018, Capfloat Financial Services Private Limited (‘Capfloat’) acquired 100% stake in Thumbworks Technologies Private Limited from Sequoia Capital India IV Limited & SAIF Partners India V Limited for USD 30 mn (INR 2.09 bn) in a cash & stock deal.
- The acquisition would help Capfloat strengthen its new consumer lending business and foray into the Consumer Finance vertical, emphasising a strong strategic focus on leveraging lucrative borrower segment.
- With this acquisition, Capfloat wants to increase its total assets under management to INR 50 billion within a year from INR 13 billion presently and expand its customer base to 500,000 from about 125,000 now, as well as to expand Thumbworks Technologies Private Limited’s coverage significantly from around eight locations currently.
- As a part of the transaction, Walnut’s founders Patanjali Somayaji and Amit Bhor would join the leadership team of Capfloat along with their team of 35 employees, this will bring the total headcount to 650.
- Post the transaction, Thumbworks Technologies Private Limited operates as a subsidiary of Capfloat.
Target Company: TongueStun Food Network Private Limited
Acquiring Company: Zomato Media Private Limited
Deal Value (in mn USD): 18
- In September 2018, Zomato Media Private Limited (‘Zomato’) acquired 100% stake in TongueStun Food Network Private Limited (‘TongueStun’) from Uniqorn Ventures Fund & Haresh Ram Chawla for USD 18 mn (INR 1.27 bn) in a cash & stock deal.
- Zomato plans to incorporate the capabilities of TongueStun app within Zomato app.
- After the acquisition, the TongueStun team would not change and the services would continue in the same shape and form for all business partners.
- Post the transaction, TongueStun would operate as a subsidiary of Zomato.
Target Company: F.R. Pulford and Son Pty. Limited
Acquiring Company: Elgi Equipments Limited
Deal Value (in mn USD): 8.59
- In July 2018, Elgi Equipments Limited (‘Elgi’) through its wholly owned subsidiary viz., Industrial Air Compressors Pty Limited acquired F.R. Pulford and Son Pty. Limited (‘Pulford’) along with Advanced Air Compressors Pty Limited for the total consideration USD 8.59 mn (INR 588.11 mn).
- The acquisition is part of Elgi's strategy to be a key player in the global market. Through Pulford, Elgi gains access to a national pool of customers to grow sales and services in Australia.
- The acquisition would also help Elgi expand its presence in neighbouring geographies.
- Post the transaction, Pulford operates as a wholly owned subsidiary of Air Compressors Pty Limited.
Target Company: NetraDyne Inc.
Acquiring Company: Reliance Industrial Investments and Holdings Limited
Deal Value (in mn USD): 8
- In September 2018, Reliance Industrial Investments and Holdings Limited (‘Reliance’) acquired a minority stake in NetraDyne Inc. (‘NetraDyne’) for a total consideration of USD 8 mn (INR 580.4 mn).
- As part of the transaction, Reliance subscribed to 4,058,647 Compulsorily Convertible Preference Shares of NetraDyne at a price of INR 143 each.
- The investment has potential synergies with the digital services and communication initiatives of Reliance and its subsidiaries.
Mergers & Acquisitions activity in stressed assets space in India
The current times have proven to be very interesting in the Mergers and Acquisitions (M&A) space in India. The advent of the Insolvency and Bankruptcy Code (IBC) has led to the largest shuffle India Inc. has ever witnessed. The Code has been designed to bail out companies facing financial stress on a going concern basis, thereby providing M&A opportunities for funds and financially sound companies in India and overseas. Currently, the government along with regulatory authorities have developed a sharpened focus to resolving the issue of stressed assets plaguing the Indian economy. The market defined price discovery model followed under IBC, facilitates financial creditors to appropriately price their exposures and take haircuts. This coupled with defined timelines & resolution framework, availability of quality assets and growth opportunities, allows acquirers an entry at reasonable valuations.
With India now featuring in the top 100 of World Bank’s Ease of Doing Business rankings and Moody’s upgrading of India’s credit rating, along with various progressive measures, especially in its foreign direct investment policies, India has cemented its position as a preferred investment destination globally. Investors could expect higher returns from emerging markets such as India in comparison to matured economies such as, the U.S. and Europe where low interest rates have pushed down yields. Foreign investors displaying interest, include prominent global players such as Caisse de dépôt et placement du Québec a Canadian pension fund manager, who has made $600 million available to Edelweiss Group for investment in local distressed assets. SSG Capital Management, which oversees more than $4 billion, has deployed a ‘significant amount of capital’ in India. Bain Capital, the world’s leading alternative investment firm with over $95 billion in assets under management, is set to expand its foothold in distressed assets transactions in India.
While demand from investors has been demonstrated across sectors, currently, investment opportunities in infrastructure companies such as steel and cement assets under the hammer, have attracted maximum interest from the bidders. According to various research reports, India is now the second largest producer of crude steel in the world. A noteworthy deal is that of the acquisition of Bhushan Steel Limited by Tata Steel for USD 4.8 billion settlement in lieu of a total financial debt of USD 6.1 billion. The other important deal in process has been the acquisition of Binani Cement - The Aditya Birla Group - led UltraTech Cement and the Dalmia Bharat - led Rajputana Properties have been in the race to gain control of the bankrupt firm, with both parties offering resolution amounts of over USD 1 billion, the entire debt of the Company.
While there are various promising stories of resolution, the road to recovery is not expected to be easy. Investors who are looking to buy distressed assets are advised to ensure that valuations are ring-fenced and no unaccounted liabilities and unpleasant shocks come up post the acquisition of the asset. This risk can be mitigated by engaging resolution advisory experts in the field, who would help ensure end to end closure of the transaction, through their experience in this space. The experts would also assist in appropriate structuring of the transaction, and in negotiations with all stakeholders, which would enable the investors to focus entirely on core business activities while reviving the distressed asset.
India’s trade deficit is one manifestation of its ongoing digital transformation
Within the space of a year, India’s economic environment, largely emanating from foreign conditions has turned volatile. A combination of events and risks - rising oil prices, rising interest rates in the US, the threats & realities of trade wars, response through currency wars via competitive devaluation and an emerging sense of risk; emanating from a massive buildup of private corporate debt fuelled by a global Quantitative Easing infusion of zero interest funds, which might begin to unravel with rising interest rates.
With its strengthening macro indicators buttressed by the deep structural reforms, India had become an attractive destination for global investors over the past few years. By far the most fundamental reform has been the introduction of the Goods and Services Tax (GST), which not only has the potential of curbing tax evasion, but generating enough data to dramatically increase efficiency in targeting government spending. An improvement in transport logistics is already evident. The second major reform has been the Insolvency and Bankruptcy Code, which is seeking to revamp the resolution process - a major plank of attempts to improve India’s Ease of Doing Business. Attempts at improving tax certainty through Advance Pricing Agreements, bilateral agreements with offshore tax jurisdictions, etc., have added to a sense of transparency.
Based on this rising business confidence, Foreign Direct Investment (FDI) flows to India have risen sharply. From an average of USD 30 bn over FY12 to FY14, FDI jumped to USD 35 bn in FY15 and has since averaged over USD 40 bn over FY16 to FY18. Over April – July in the current FY19, FDI inflows have been over USD 16 bn. Over and above the flows into the conventional sectors, one reason for the higher FDI inflows has been India’s rising reputation as a fintech and innovation hub, with global PE and VC funds seeking both the rapidly increasing turnover via e-commerce platforms as well as the expanding reach of electronic marketplaces like Ola, Uber, OYO, and other service aggregators. PE / VC inflows for the period January – July 2018, were over USD 16.9 bn, 45 % higher compared to the same period last year. The annual PE / VC inflows for the year 2017 were USD 26.3 bn.
Ironically, part of the recent increase in India’s (merchandise + services) trade deficit, from a low of USD 45 bn in FY17 to USD 83 bn in FY18 and USD 27 bn in Q1 FY19 – is due to the success of India’s digital transformation. While a large part of the trade gap was due to the rising cost of oil (and coal) imports and to an extent higher imports of gold, a significant part was also due to imports of computing and communications equipment. While the rising imports of smart cellphones is now well known, there is also a significant increase in imports of computing and internet devices, including high end ones like servers, routers, switches, etc. Dissuading imports of even basic mobile phones might not be a good idea, since these are productivity enhancing tools.
Since early 2018, global investors have begun to take notice of vulnerabilities in certain metrics of India’s macro fundamentals, particularly in its external account. The Rupee, which had outperformed almost all Emerging Markets exchange rates post 2014, has, since early 2018, depreciated more than many of our Asian competitors. This has led to policy challenges, including the need to tighten rates and squeeze market liquidity, it has also led to rising cost of funds for borrowers, leading to concerns of stifling a nascent recovery in investment and capex spends. The Government and RBI, working in tandem, have managed to balance the often conflicting policy response to stabilise the economy, and are likely to engineer a soft landing for India amid the troubled global scenario of the coming months.
Views expressed in this article are personal
Saugata Bhattacharya is Senior Vice President and Chief Economist at Axis Bank. He is a member of the CII National Growth and Investment Council and a Special Invitee to the CII Western Region Council. He was a member of the RBI’s Group on of Monetary Policy (2010) and the Finance Ministry Group on Estimating Foreign Savings (2011). He was named a Chevening Fellow of the UK Government in 2017.