India Private Credit – Looking Back, Predicting Ahead
A PERFECT STORM WITH A SPOTLESS RAINBOW?
India’s macro position was already stretched when the COVID-19 pandemic struck in March 2020. The funding environment was constrained following a series of problems in the banking sector in 2018-19, the INR was held back by persistent current account deficits, with government spending power limited by persistent fiscal deficits. The pandemic has crystallised, accelerated, or exacerbated pre-existing trends in the economy including the role of technology, government, globalisation, and environmental/social factors.
The response of the Indian government has necessarily been muted, reflected largely via easing monetary policies and ongoing regulatory reform, albeit cautious ones. While government yields have fallen, the strained funding conditions have amplified credit spreads; allowing for risk-adjusted returns more commensurate with the rest of the region, and therefore attractive investment opportunities. Furthermore, in recent months, India has benefited from large foreign direct investments given high levels of global liquidity and the genuine opportunity that exists in-country across various sectors. ADM Capital believes there is still a funding gap for mid-sized corporates and remains positive about the market opportunity that India represents, while being selective in considering specific sectors, sponsors, and end use of funds.
Although India continues to report some of the largest new daily Covid-19 cases in Asia, death rates have been moderate and are lower than global averages, and case volume is reduced from September 2020 highs. Meanwhile, the easing of lockdowns and restarting of the economy has reduced GDP declines. While fiscal year 2021 is expected to close at an overall GDP contraction of -9.5%, real GDP growth for fiscal 2022 is projected to sharply outperform, in excess of 10%, led by growing industrial sector output on account of thriving consumer demand. Initial signs of inflation are somewhat concerning but a mild outlook for oil prices will likely keep the current account deficit in check.
Simultaneously, agriculture sector and labour law reform and a privatisation push has provided a fillip to foreign interest in India, with Foreign Direct Investment (FDI) tallying ~USD30bn for the period April to September 2020, a 15% increase year-on-year and a peak in recent times. FDI has largely been in digital, asset management, and infrastructure sectors.
In the current environment, demand for funding is largely among mid-sized companies seeking growth financing. ADM Capital has taken advantage of several opportunities that facilitate the refinance of existing lenders who are unable to renew or expand their loans, to fund the business growth of their investee companies. In recent months, a number of CAPEX and acquisition opportunities have emerged in our pipeline as performing and low leveraged corporates seek to use their balance sheet to fund attractively priced investment opportunities.
ADM CAPITAL’S APPROACH
In the last 12 months, ADM Capital has been actively reviewing and disbursing loans to India’s new economy sectors, i.e. digitally disruptive businesses with experienced, professional management teams and institutional private equity sponsors. Cash flow predictability in our India loan portfolio is a key priority, and as such we prioritise opportunities in sectors with stable demand and lend to companies with annuity streams of cash flows. Furthermore, we are addressing currency risks by considering businesses with a natural USD/INR hedge via exports, cross border business, or access to international financing. Invariably, distressed assets and non-performing loans are a part of the opportunity set; ADM Capital will pursue this space selectively and with considerations to the sector, the commercial prospects and the promoters.
ADM Capital has successfully integrated Environmental, Social and Governance (“ESG”) considerations within its investment process. With this in mind, we have specifically focused on lending opportunities in our pipeline that have a low carbon risk, and increasingly in sectors that are aligned to various United Nations Sustainable Development Goals, including financial inclusion, health care, sustainable transport, and renewable energy among others. ADM Capital’s process has evolved from ESG risk mitigation to value-creation, and we have begun recording the positive impacts enabled by our capital, documenting and measuring key performance indicators to reflect ESG compliance and performance.
Furthermore, ADM Capital encourages its borrowers to establish ambitious ESG targets. For instance, an Indian fintech borrower has developed attractive financing solutions for female borrowers to improve the gender balance in its customer base. At ADM Capital’s behest, another borrower has designed a carbon emission calculator to quantify the carbon footprint arising from shipments that they logistically support. Yet another has established an approach to measure the energy they help save in implementing energy efficient projects for their customers.
The potential for ESG additive strategies in India is significant, not only due to the sheer domestic investment potential but also due to demographic and cultural changes, and an increasing realisation among borrowers of how sustainability efforts can support their bottom-lines and long-term growth.