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Will the IPO crunch hit growth in investment?
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February 27, 2008

Apart from signalling the shape of things to come, the stock markets are seen as an important source of funds for investment - so their health can be critical.

Mahesh Vyas, MD & CEO, Centre for Monitoring Indian Economy Pvt Ltd

'Total resources raised from the primary capital markets accounted for just 8 per cent of total capital formation in 2006-07'

The equity markets crashed 20 per cent in January and the volatility of daily returns has trebled since then. The Reliance [Get Quote] Power IPO closed below its issue price on the listing day. Consequently, at least four companies shelved their plans to raise monies through the IPO route. Many more are believed to have done the same. Nevertheless, the investments boom currently under way would continue unhindered. Here are the reasons why:

The primary capital market does not contribute significantly to investments in India. Total resources raised from the primary capital markets accounted for only 8 per cent of total capital formation in 2006-07. If we exclude the resources raised through private placement of shares and debt raised by banks, this share would fall to less than 4 per cent.

Besides, not all resources raised from the primary capital markets are for investments. The contribution of the primary capital markets is so small in the overall funding of capital formation in the country that it can easily be filled in by alternate sources of funds.

Funds raised through the issuance of shares constitute a small proportion of the total resources raised by companies. Funds raised through the issuance of fresh capital (face value and premium included) accounted for about 14 per cent of the total resources raised by manufacturing companies during the four years ended March 2007.

Retained profits accounted for nearly 28 per cent, twice the resources raised through issuance of fresh capital. So, even for gearing, retained profits play a bigger role to leverage than fresh capital.

Banks are flush with funds and ready to provide credit. Thus, alternate sources of funds are easily available. Between April 2007 and January 2008, commercial banks raised fresh deposits worth Rs 509,582 crore (Rs 5,095.82 billion).

This was nearly twice the amount of new loans given out (Rs 253,398 crore). That leaves them with a significant portion of the over-Rs 200,000 crore surplus that is available for deployment. Banks may not provide risk capital based on fancy valuations for real estate, but they are more likely to provide funds for investments into industrial projects. And, it is the latter that matter.

According to CMIE's CapEx database, about 250 projects account for nearly half the total investments on hand in the country. This includes the large power projects, steel projects, infrastructure projects, refineries and SEZs. Only 14 of these projects have filed for an IPO. The investments envisaged by them account for only 6 per cent of the total investment envisaged by the 250 projects.

Evidently, in all measurable ways, the equity markets - primary and, therefore, secondary - are not important in the current investments boom. The capital markets did play a much bigger role in investments in the mid-1990s. Resources raised from the markets accounted for 18.5 per cent of India's capital formation in 1993-94 and 1994-95. But that boom that went bust pretty soon, while the current one looks a lot more robust.

R Shankar Raman, Executive Vice-President (Finance), L&T Ltd

'Capital will still be available for deserving issuers but with a redefined price tag, which is not a totally unacceptable outcome'

Both the Indian economy and India Inc have been through a dream run during the past few years. Indian corporates laid out their expansion plans to cash in on the favourable market conditions. Healthy balance sheets, strong currency, rich valuations, and performing stock markets combined to favour bold global acquisitions by corporates.

Risk appetite rose in tandem with the growing enthusiasm for emerging market opportunities. The availability of capital at affordable prices ceased to be a constraint for ambitious corporates.

The unfolding of the sub-prime mortgage crisis by mid-2007 signalled a course correction for financial markets. Notwithstanding the stout defence by central banks in general and the Fed in particular, the US economy began its courtship with slowdown.

Like fish to water, uncertainties have returned to the capital markets. Creeping pessimism, dipping valuations, rising credit thresholds and pronounced risk pricing are beginning to rear their ungainly heads. Capital markets have moved into their punishing mode, making investors pay heavily for their endorsement of shaky business plans and suspect fundamentals.

The withdrawal of planned public issues and innovative attempts at repricing issues immediately after allotment are manifestation of the changed market mood.

Where does the new conditions gripping the capital market leave capital seekers and providers? There is no room yet in my opinion to despair. While the spiralling fortunes have lent sobriety to the marketplace, millions of dollars invested in business plans needs to be serviced. The continuing strong performance of Indian corporates provides the much-needed insulation from a drastic change of growth plans.

Opportunities still beckon. Investments to shore up the business competitiveness continue to be compelling and attractive. If anything, the global economic slowdown provides a window for sustained capital flow into our country. Investment in infrastructure and manufacturing technology needs to be expedited. Facilities for the services industry adopting global delivery platforms need to be scaled up.

These would enable capital flow to continue, albeit with far greater selectivity. The issuers of capital will have to revise their benchmarks for valuation. Debt providers will seek a much higher credit risk premium to cover default contingencies. Banks and financial institutions will have to recapitalise their balance sheets coloured in red.

There is value still to be captured. Sustainable plans will endure the changing conditions. History has witnessed such readjustments in the past and could well repeat itself. The current scare in the financial markets provides an opportunity for the players to strengthen their plans and reset the return expectations.

Moderated aggression laced with caution could replace the cheeky nonchalance at the market place. Capital will be available for deserving issuers but with a redefined price tag. Not a totally unacceptable outcome considering much money was being made far too easily.

After all, there is no free lunch.

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