IN THIS EDITION

 
     
 

 

 
     
 

 

 
     
 

 
 

The June 2018 Monetary Policy review surprised some of the market participants with a 25-basis point (bps) repo rate hike. Factors that influenced this decision were a rise in the headline and core CPI inflation in April 2018, the hardening of inflationary expectations in May 2018, and the risks emanating from higher crude oil prices, in addition to a weaker rupee. Nevertheless, the retention of the neutral stance instead of a shift to withdrawal of accommodation, suggests that future rate hikes would be data dependant. Going forward, the MPC has maintained its GDP growth forecast at 7.4% for the current year and expects a sustained revival in economic activity for FY2019. ICRA, however, continues to expect the GDP growth to record a shallow recovery to 7.1% in FY2019 from 6.7% in FY2018. ICRA’s baseline projection foresees the average CPI inflation to rebound by 100 bps to 4.6% in FY2019.

While rising bond yields have resulted in a slowdown in domestic bond issuances, we, nevertheless expect non-banking finance companies (NBFCs) to dominate the domestic retail bond issuances in the current financial year, FY2019 and are likely to surpass their previous high in terms of amounts mobilised. This will be partly driven by the increasing challenges in terms of borrowing from the public sector banks (PSBs) as well as the rising global interest rates, which make overseas borrowing unattractive. Historically, the NBFCs have offered 25-75 bps higher interest rates for retail category investors, and the same could happen again, thereby leading to better investor appetite.

We also look at the recent Cabinet decision to bring home-buyers at par with the financial creditors during the insolvency proceedings of bankrupt real estate developers. This is as per the recent amendments to the Insolvency and Bankruptcy Code (IBC). This move is likely to help home-buyers recover their hitherto uncertain investments from insolvent developers.

Finally, Insight examines the trends in domestic gas prices, which, after a consistent fall, have subsequently recovered some lost ground. Also, the total natural gas supply potential is expected to increase significantly over the next five to six years with higher domestic gas production and commissioning of firm re-gasification capacities during FY2018-22. ICRA, however, feels that the upcoming LNG capacities may operate at relatively lower utilisation and the new entrants would face significant pressure on volumes and margins as they will have to compete with the existing terminals and brownfield expansion, which are more cost efficient because of lower capital intensity.

The issue concludes with the regular features: monthly rating updates, upcoming ICRA events, and news features related to the company.

I hope you will find this newsletter useful and informative.

Best Regards

Anjan Ghosh
Chief Rating Officer, ICRA Ltd

 
 
 
 
     
  MPC surprises market with unanimous repo rate hike  
 

The June 2018 Policy review was widely awaited, with the likely three outcomes of a pause, a change in the stance to withdrawal of accommodation, and a pre-emptive rate hike, generating much interest into the likely voting patterns of the individual Monetary Policy Committee (MPC) members. Out of these three options, a 25 basis points (bps) rate hike emerged as the unanimous outcome, surprising the markets and resulting in a modest uptick in bond yields.

The repo rate hike was prompted by the rise in the headline and core CPI inflation in April 2018, the hardening of inflationary expectations in May 2018, and the risks emanating from higher crude oil prices in addition to a weaker rupee. Based on these factors, the MPC sharply raised its projection of the CPI inflation in H2 FY2019 to 4.7% from 4.4%. Nevertheless, the retention of the neutral stance instead of a shift to withdrawal of accommodation, suggests that future rate hikes would be data dependant.

The MPC maintained its GDP growth forecast unchanged at 7.4% for FY2019, a considerable rebound from the 6.7% recorded in FY2018. The Committee highlighted that domestic economic activity has displayed a sustained revival in recent quarters and noted that the output gap has nearly closed.

However, the Committee projected a mild dip in the GDP growth from 7.5-7.6% in H1 FY2019 to 7.3-7.4% in H2 FY2019, with risks evenly balanced. In our view, a waning of the favourable base effect related to demonetisation and the transition to the GST is likely to weigh upon economic growth in H2 FY2019, notwithstanding the expected back-ended broad-basing of the investment recovery. We continue to expect the GDP growth to record a shallow recovery to 7.1% in FY2019 from 6.7% in FY2018.

ICRA’s baseline projection foresees average CPI inflation to rebound by 100 bps to 4.6% in FY2019. If the average price of the Indian crude oil basket climbs to US$80 per barrel in FY2019, and higher prices are completely passed through to the domestic fuel prices, ICRA expects the CPI inflation to increase to around 4.9% in FY2019, unless Central and state taxes are reduced. If this scenario materialises, and is accompanied by a firming up of risks related to food prices and fiscal outcomes, it could prompt a back-ended rate hike by the MPC in H2 FY2019.

 
     
  Record public issuances of bonds likely in FY2019; NBFCs set to dominate  
 

Domestic non-banking finance companies (NBFC)s are likely to dominate public issuances of bonds in the current financial year, FY2019. The public issuances are likely to surpass a previous high of Rs 42,383 crore witnessed in FY2014. Typically, NBFCs have accounted for ~40% of the public issuances of bond during the FY2011-18 period; the balance being accounted for by tax-free bonds. This trend is also visible in FY2019 as public issuances of bond from NBFCs during Q1 FY2019 itself are likely to surpass ~Rs 20,000 crore, much higher than ~Rs 4700 crore during FY2018.

The NBFCs have often relied on diverse funding sources like banks, commercial papers, public and private placements (NCDs), overseas issuances and retail fixed deposits for their funding requirements. However, tighter liquidity conditions, rising bond yields and weak capital position of public sector banks (PSBs) which enjoy a dominant 70% share of bank credit is likely to increase public issues of bond by NBFCs during FY2019.

Regarding alternative funding means, overseas funding is not the best option due to hardening global yields and the depreciating Indian rupee (INR), leading to higher hedging premiums. In case of rupee-denominated overseas borrowings, investors expect higher returns to offset the currency risks.

Hardening bond yields from Q3 FY2018 made NBFCs shift to the banking channels for their credit needs. This is reflected in the growth of bank credit outstanding towards NBFCs to Rs 4.96 lakh crore as on March 30, 2018 as against Rs 3.68 lakh crore as on December 22, 2017. However, given the numerous challenges faced by PSBs, especially on the capital position, this trend is unlikely to sustain.

It is likely that NBFCs may tap retail investors through higher fixed deposit rates as well as the public issue of NCDs, as mutual funds, one of the key investor segments, could witness a moderation in flows in a rising interest-rate regime.

To sum up, reducing liquidity surpluses and rising bond yields may require NBFCs to tap public bond issuances during FY2019 to meet their funding requirements, given the challenges of the banking sector and overseas borrowings. Historically NBFCs have comparatively offered 25-75 bps higher interest rates for retail category investors, and the same could happen again, thereby leading to better investor appetite amid the limited increase in rates for bank deposits and volatile returns in debt and equity markets.

 
     
  Recent amendments in norms to consider home buyers at par with financial creditors, a positive for real estate sector  
 

As per the recent amendments to the Insolvency and Bankruptcy Code (IBC) by the Cabinet on May 23, 2018 and by the President of India on June 06, 2018, home-buyers are likely to be treated at par with the financial creditors during the insolvency proceedings of bankrupt real estate developers.

This move is likely be a cause for cheer for home-buyers as it would help them recover their investments from insolvent developers, placing them at par with financial creditors. Earlier, homebuyers were merely regarded as consumers while filing their claims against bankrupt developers with no clarity over recovery of their hard-earned money. Typically, for a real estate project, to fund the execution, the customer advances accounted for around 1.5 times the debt availed for the project. Therefore, it was essential to grant the home-buyers a similar status as that of banks and financial creditors, especially when the execution and completion were suspect.

In addition, this elevation of the status of the home-buyer to that of a financial creditor was likely to instil discipline in the developers and make them act more responsibly towards the customers. This shift in stand is likely to prove a confidence booster for the consumer who will begin to feel more protected and will surely underpin the ongoing consolidation in the sector and bring in transparency.

Under the Real Estate Regulatory Authority (RERA) Act, there are restrictions on withdrawal of funds collected from customers by way of having separate accounts for each project which, along with the other added protection for home buyers like penalty on developer/promoter for delay in project etc., act as an enabler for the industry. Further, measures that build upon consumer confidence and promote transparency in the sector will help create a better operating environment for all stakeholders.

Retail home loans accounted for around 67% of the loan book of HFCs while the balance 33% constituted of construction lending, LAP financing etc., as on December 31, 2017. The financial creditor status accorded to the home buyers, therefore, is also a positive for the HFCs, although the benefit is partially offset because of the higher cut the lenders may be required to take on the construction lending book.

Despite issues like home-buyers’ status in relation to a secured financial creditor or unsecured financial creditor and the role of the aggrieved buyers’ cohort in the committee of creditors, remain unresolved, still the recent amendments to the IBC is a big positive for the long-term growth of the real estate sector.

 
     
  Significant rise in LNG re-gasification capacity to spell lower capacity utilisation, muted returns for new players  
 

Domestic gas prices have been on a consistent fall following half-yearly downward revisions between April 2015 and April 2017, resulting in the prices sliding by almost 50%, to US$2.48/mmbtu (GCV basis) in H1 FY2018 from US$5.05/mmbtu during November 2014-March 2015. The prices, however, have increased to US$2.89/mmbtu in H2 FY2018 and US$3.06/mmbtu in H1 FY2019, in line with the rise in global gas benchmarks. Albeit the non-lucrative domestic gas prices, the GoI has provided marketing and pricing freedom (subject to a price ceiling) to players operating in deep water, ultra-deep water and high pressure-high temperature areas. The natural gas price ceiling for such challenging areas is US$6.78/mmbtu as of now, but this may keep varying, in line with the prices of substitute fuel (fuel oil and naphtha prices may increase as crude oil prices rise), as provided in the pricing formula. These could also help improve the viability of gas discoveries in challenging fields and lead to higher domestic gas production over the longer term.

The domestic natural gas production is expected to increase to ~110 MMSCMD by FY2022 and to ~143 MMSCMD by FY2027 from the current level of ~90 MMSCMD. Apart from the marketing and pricing freedom for gas discoveries, there have been several Government initiatives or reforms like the revenue-sharing model, a uniform licence framework and an open acreage policy under the new Hydrocarbon Exploration Licensing Policy (HELP). In addition, there has also been a reduction in royalty rates for the deep water and ultradeep-water areas, which could aid in incremental domestic gas production over the long term. The realisable demand for natural gas is a result of several factors: gas supplies in the market, price competitiveness of gas in comparison to alternative fuel, timely commissioning of the proposed transmission pipeline infrastructure, and regulatory initiatives in the power sector like implementation of the time-of-day tariff. Overall, unconstrained gas demand is expected to rise to ~260 MMSCMD by FY2022 and to ~285 MMSCMD by FY2027 from the current demand potential of ~230 MMSCMD, even though the actual consumption has been much lower, at around 140-145 MMSCMD, over the last four years, most likely due to the steep fall in domestic gas supplies and destruction of demand from some of the price sensitive segments such as power.

As for the total natural gas supply potential, it is expected to increase significantly over the next five to six years with higher domestic gas production and commissioning of firm re-gasification capacities during FY2018-22. The concern is that upcoming LNG capacities may operate at relatively lower utilisation (~50% or even lower) than the current utilisation of re-gasification capacities (above 85-90% on an aggregate basis) in the country. If the re-gasification terminals come on stream over the next four to five years, the new entrants are likely to face significant pressure on volumes and margins as they will have to compete with the existing terminals and brownfield expansion, which are more cost efficient because of lower capital intensity. Sub-optimal capacity utilisation and lower re-gasification margins could also put significant pressure on the returns and credit profiles of new entrants, especially in the initial years of operations. Sponsors with significant captive demand for R-LNG, such as for refineries and CGD ventures, will, however, be able to partly buck the trend. More importantly, expansion of the LNG market to non-traditional applications such as fuel for buses/HCVs, inland waterway vessels and coastal movements will be the keys to alleviate pressure on utilisation.

 
     
 
           
 
   
m Rating Updates for the month of June 2018
   
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June, 2018: Webinar on HFCs: Trends and Outlook
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