GLASNOST IN THE INDIAN ECONOMY

The past decade or so has seen unprecented growth in the Indian economy. Liberalisation, particularly since the late 1980s has been the major contributing actor towards this growth. India has inally trans ormed itsel rom a control!bound, inward loo"ing economy, to a mar"et oriented, outward loo"ing one. This mo#e towards the ree mar"et has been re lected in the inancial sector as well. $on#entional sources o inancing %essentially loans rom ban"s and inancial institutions& are no longer attracti#e to the corporate sector. 'isintermediation is now the "ey phrase in inancial circles. (ew and inno#ati#e instruments or raising unds directly rom the mar"et ha#e been introduced. Three such instruments ha#e been studied in this report. They are ) $ommercial paper, *sset!bac"ed +ecurities, and ,uro!con#ertiable bonds and e-uity. The report traces the origin o these instruments, discusses their

applicability in the Indian en#ironment, and e.amines the issues that need to be resol#ed be ore the instruments can ta"e o in India. The Issue of Paper $ommercial paper pro#ides companies with a cheaper alternati#e to the cash credit system or raising unds to meet their wor"ing capital needs. Till #ery recently, this alternati#e was a#ailable only to large companies with an e.cellent credit standing. The recently announced credit policy o the /0I has rela.ed the stringent eligibility criteris, thereby ma"ing the use o this instrument accessible to many more companies. In the west, commercial paper has o#erta"en all other money mar"et instruments in terms o growth and popularity. That the same will be the case in India, is still a matter o guess. 0ut gi#en time and some encouragement, commercial paper may replace the archaic and much abused cash credit

system or meeting the

short term instruments o companies, thereby

nudging tthe entire process o unds raising towards a more economically e icient, mar"et oriented system. Securitization of Debt +ecuriti1ation is a broad term, describing the acti#ity o 2structuring and selling negotiable in#estments in order to spread o#er a broad group o in#estors, a ris" which would normally be ta"en by a single lender or syndicate.3 In this report, howe#er, securiti1ation has been dealt with in a narrower sense, essentially describing the process whereby which lending institutions can generate more unds by selling old debts %that appear as 4assets in their balance sheets& in the orm o securities with di erent denominations and #arying maturities, to in#estors who buy them according to their ris"!return pre erences. These 4asset!bac"ed securities are a boon to inancial institutions, who, in the ace o the se#ere resource crunch are inding it increasingly di icult to meet the demand o unds rom the these corporate sector. 5nce made to impro#e the mar"etability o

securities, debt securiti1ation may pro#e to be the major source o resources or lending institutions %as well as corporations& in the years to come. G oba isation of In!ian Co"panies The go#ernment announced, last year, its decision to allow Indian companies to raise unds rom international mar"ets through the issues o con#ertiable bonds and e-uity. ,arly this year, our companies were gi#en the inal go!ahead. 6inal o icial appro#al came in the wa"e o the budget this year, which con erred on ,uro!con#ertiables and ,uro!e-uity, a ta. status identical to o !shore unds. 7ithholding ta. on di#idends and capital gains has been slashed to 108 and procedural wrangles ha#e been ironed out by the /0I in line with that remains o the 6,/*. /aising oreign currency unds rom international mar"ets is a new and e.citing concept or Indian companies. 9owe#er, than"s to the hitherto closed nature o the Indian economy, little is "nown o these companies abroad. Initial issues,

there ore, will be placed directly with large pension unds and other mutual unds. (e#ertheless, :erill Lynch, a leading international merchant ban"er, is con ident that the companies will be able to raise ; <00 million rom the ,urop!mar"ets in the irst year itsel . ESSENTIAL #EAT$%ES $ommercial paper is a money commercial paper are ) 0* It is an unsecured promissory note issued or a speci ic amount and maturing on a speci ic date. *ll commercial paper is negotiable. 1* The $= is typically issued on a discount to ace #alue basis, but can also be issued in interest bearing orm. 2* The rate o ered on commercial paper depends on its maturity, on how much the issue wants to borrow, on the general le#el o money mar"et rates, and on the credit rating o the issuer. 3* It essentially o ers to the large irms, a cheaper alternati#e to ban" credit or short term unds. GENESIS The origins o commercial paper traces bac" to the 19th century when irms in the >nited +tates began to use the sale o open mar"et paper as a substitute or ban" loans to meet their wor"ing capital needs. Their need to do so arose due to the unit ban"ing system in the >.+.* that restricted ban"s rom operating on a nation wise basis. There ore irms located in credit scarce and high interest cost areas were compelled to raise resources by selling paper elsewhere, or e.ample (ew ?or" and other capital rich cities. 6or the irst hundred years or so, $ps were issued by non! inancial mar"et instrument, issued by irms or

raising short term unds directly rom the mar"ets. The essential eatures o

business irms. Later consumer inance companies also stated selling their paper. 0y early 19<0s there was a large mar"et or $=s in the >.+.*.

Today, acti#e $= mar"ets thri#e not only in the >.+.*., but also in the >.@., Aapan, +ingapore, 9ong"ong, :e.ico, $anada and *ustralia. * limited mar"et e.ists in 0ehrain as well. THE COMME%CIAL PAPE% COMES TO INDIA The $= was introduced in India on the recommendation o the wor"ing Broup on the :oney :ar"ets %i.e., the Caghul $ommittee&. 0ased on its recommendations, the /0I announced, in 1989, its decision to introduce a scheme o $ommercial paper and set up guidelines or the issue o $=. The highlights o this new instrument were ) 4* It would be a new source o short term unds or the corporate sector. 5* It would be transe erable. 6* The arate o interest would be mar"et determined. 7* This process o disintermediation would reduce the cost o unds or the commercial borrowings. G$IDELINES #O% THE ISS$ES The guidelines with regard to commercial paper are gi#en in the (on 0an"ing companies %*cceptance o 'eposits through $ommercial =aper& 'irections, 1989. These guidelines, ramed by the /0I, came into e ect rom Aanuary 1, 1990. They ha#e been rela.ed and modi ied rom time to time. The salient eatures o the directions are ) %1& * company can issue $= only i it has ) 8* * target (et 7orth o not less than /s. < crores as per the latest audited 0alance sheet. 9* * wor"ing capital % und based& limit o not less than /s. 10 crores. 10* * minimum credit rating o =!1 rom $/I+IL which should not be more than D months old at the time o issue. 11* 9ealth code status (o.1 assigned by the ban" to the borrowal account o the company.

12*

* minimum current ration o not less than 1.EE)1 as per the latest audited balance sheet.

13*

Its shares should be listed on one or more stoc" e.changes.

%D& The paper will ha#e a minimum li e span o 90 days and ma.imum o 180 days rom the date o issue. %E& The minimum denomination o the $= %i.e., ace #alue o each $=& will be /s. < lacs and the minimum in#estment re-uired by a single primary in#estor is /s. D< lacs. %F& The issue o $= shall be a part o the und based wor"ing capital limit enjoyed by the company and can orm upto a ma.imum o E08 o that limit. The drawing power o the company will bereduced by the amount o $= issue or the tenure o the $=. %<& The paper, being a usance promissory note, will be negotiable by endorsement and deli#ery. The rate o discount will be determined by the company issuing the $=. The paper will be subject to stamp duty. %G& In#estment in the paper can be made any person or corporate bodies registered or incorporated in India %including ban"s&, as well as unincorporated bodies. (on resident Indians can also in#est in the paper on non!repartiable basis. %H& The paper cannot be underwritten or co!accepted in any manner. $ommercial ban"s can, howe#er, pro#ide standby acility or redemption o the paper on the maurity date. NE& G$IDLINES The /0I announced, on *pril D1 199D, its new credit policy, in which it has rela.ed some o the stringent guidelines or issue o commercial paper. The Chan'e are ( 14* The stipulation o a minimum und wor"ing capital limit o /s. 10 crores has been rela.ed to /s. < crores.

15* 1. 16*

The minimum credit rating re-uired will be = ! D instead o = !

The ceiling on the aggregate amount to be raised by $ps has been hi"ed rom E08 to H<8 o the companys wor"ing capital.

17*

$losely held companies will be allowed to raise $ps.

)ENE#ITS O# COMME%CIAL PAPE% Cheaper Source of #un!s for the Issuer *n issue o commercial paper wor"s out to be cheaper than resort to either credit or bill inancing, especially when money mar"ed situations are easy. Thus, a blue chip company can utili1e is good credit standing to raise short term unds at a lower cost. Enhance! Li*ui!it+ for the In,estor The commercial paper is trans erable and carries li-uidity. 7hile the

secondary mar"ed or $ps is yet to de#elop in India, the '69I pro#ides li-uidity to the $= by o ering continuous two way -uotations. Disinter"e!iation of the #inancia Mar-ets 'isintermediation re ers to the process o progressi#ely decreasing reliance on institutional inance and relati#ely increasing reliance o the users o unds on the sa#ers directly. $ommercial paper, by allowing direct inter ace between the company needing unds and those with surplus unds, a ects disintermediation in the money mar"ets, ma"ing them more economically e icient. DISAD.ANTAGES O# COMME%CIAL PAPE% Proce!ura #or"a ities for the Issuer The issue o commercial paper may be a time consuming and cumbersome process or the issuer. ,laborate arrangements ha#e to be made with the dealer, the issuing and the paying agent. Time is also in#ol#ed in obtaining a $/I+IL rating. The additional costs incurred include the stamp duty,

which orms a major portion o the issue e.penses. * committment charge is also le#ied by ban"s or pro#iding stand by acilities. The reduction in drawing power is also a major handicap or the company. A!,erse I"pact on the Profitabi it+ of Co""ercia )an-s $ps ha#e ad#ersely a ected commercial ban"s by hitting them on both sides o their balance sheets ) The loss o their healthiest loans %+tatus 9ealth $ode