India: Private debt market

Pity the typical Indian business owner. Of the country’s 3,000 listed firms, the largest 10 percent hold 90 percent of listed corporate debt, according to Goldman Sachs, leaving the others to share the rest.

With such low leverage – a result of a banking sector systemically diverted from its core function of providing credit to business – it is not surprising that local and foreign investors are jumping to create a private debt market in India.

KKR is one of those betting big on the debt space and the global investment firm has a second dedicated vehicle in the market. Closer to home, a host of domestic firms have raised capital for debt funds across a range of strategies – including Piramal, Religare, Motilal Oswal and Aion Capital, a joint venture between Apollo Global Management and ICICI Venture.

Pankaj Karna, managing director of Maple Capital Advisors, an investment banking and advisory firm, says businesses are gearing up as they put together capex and growth plans to exploit an economy finally settling down after years of turbulence.

A lot of this activity is in the mid-market, particularly in companies addressing consumer needs, says Karna.

“In that area, corporates are looking to either expand or consolidate their positions and that’s the biggest opportunity. They expect the next two to three years to be good, and they want to be ready to capitalise on it,” he says.

The fact that India has an entrepreneurial community adds to the demand for capital, and private debt is a significant alternative to private equity, says Venkat Ramaswamy, executive director at Edelweiss Financial Services.

Edelweiss’s first private debt fund – a 2009 vintage vehicle – is almost fully harvested and has provided a return of just over 20 percent in gross rupee terms. The firm is currently investing out of Edelweiss Special Opportunities Fund II.

According to Ramaswamy, the biggest advantage of private debt is that the company can postpone dilution and still raise capital needed by the business. “Using this kind of capital in the initial stages as growth capital leads to postponement and, therefore, reduction of dilution – which is one of the primary motives of Indian and Asian entrepreneurs,” he says.

One of the key reasons why investors are backing the growth of private debt is the failure by banks to meet demand for capital.

According to Prashant Purker, managing director and chief executive of ICICI Venture, “the commercial debt market is a bit clogged and growth in credit off-take is lower than desired levels”.

He says that in a few sectors, such as real estate, the corporates require far more than can be supplied by the banks.

Considering the size of the Indian economy, the local credit market is still “very, very small”, adds Saleem Siddiqi, managing partner at London-based MUSST Investments, which plans to launch a credit business this year with backing from a US endowment. MUSST will be working with Karna of Maple Capital and they plan to buy a defunct non-banking financial company (NBFC) this year to give them the necessary licences.

While the biggest 10 percent of Indian companies accounts for most of the corporate debt, a large number are left underserviced by banks that are “either unwilling or unable” to finance them due to their own constraints, says Siddiqi. These banks are also taking longer to finance companies, many of which are unable to meet the eligibility criteria, says Shujaat Khan, managing director at Blue River Capital.

This financing void is being filled by a steady creep in new debt financing structures and Purker expects more firms and investors to launch initiatives in this area. “Post-financial crisis, there was a slowdown in this activity, as a lot of the banks had to tighten what they were doing. So NBFCs and funds are stepping in to fulfil the unmet demand in recent times,” he says.

There is also a supply side factor to why private debt is becoming more prominent. Institutional investors are contemplating private debt strategies on the back of disappointment with the private equity industry. One debt investor says that most private investment funds in the country have been private equity constructions, but over the last 10 years or so “private equity has struggled to deliver real returns and sometimes even the prominent names have struggled to even return capital”.

Where private equity has failed, private debt is moving in. India is expected to be one of the few sources of growth among the emerging markets, and private debt is becoming an effective way for investors to access the strong growth anticipated in the country.


The appetite is there and the corporate demographics certainly match up. Yet, lending in India is not without its challenges. One of the biggest issues is the poor regulatory framework, with little protection for lenders in the event of bankruptcies.

So while there is an open field for lending, alternative players face the same problems that Indian banks have experienced, says Khan: “While the risk profile of businesses is lower [in traditional lending], regulation is still to be had in terms of if the promoter does default and the business does go down. What is your process for getting the money out?”

One of the challenges in India is the mindset of business owners who will agree to almost any terms just to get the capital through the door, adds Khan.

This can be combined with assets that are not as liquid as lenders would like, particularly real estate which is often used as collateral. The result is that if a borrower goes into liquidation the workout can often be complex, making loan and collateral structuring key to success.

However, the common view is that the regulatory framework is improving.
Purker says “people now acknowledge that regulation should be designed such that borrowers have clear disincentives if they do not meet commercial obligations they have wilfully entered into”.

To that end, the latest regulations have “clear guidelines for funds and things like rupee borrowing from foreign sources being allowed”, he adds.

One major legislative change expected to boost alternative lending is the new bankruptcy and insolvency code currently making its way through parliament.

The bill will allow creditors to take control of the assets of bankrupt borrowers, as well as quicken the insolvency and liquidation process. It is the passage of this legislation, which has cross-party support, that prompted Indian businessman Ajay Piramal to announce in January that he would list a 6,000 crore rupee ($885 million; €820 million) fund to invest in distressed loans.

Given the circumstances and the opportunity on offer, Edelweiss’s Ramaswamy expects private debt funds to raise anywhere between $1.5 billion and $2 billion per year for the next three years. To put that in perspective, total corporate debt provided by funds so far stands at around $1.5 billion, he says.

According to Karna, the biggest challenge now is to ensure that the structures mean the borrower has “skin in the game”. The second is to back business owners with the right mindset and a track record of engaging with lenders positively, rather than just swallowing attractive growth figures.

There’s more to it than just capital, he adds. “I’ve seen that 90 percent of the market is lending money and that is where the story ends, but the onus has to be on delivering value and not just money. In short, I would say that managing relationships, mindsets and the right structures are the key.”

So while challenges still abound, private debt is here to stay.

Venture debt is another up and coming market. In the last five to 10 years it has emerged as a significant asset class in India, with more than $5 billion raised by venture capital-backed businesses in 2015.

“The tenures are short for venture debt… it’s a pretty healthy market, and the underlying dynamics are growth-oriented,” says Shujaat Khan of Blue River Capital.

According to Rahul Khanna, managing partner of Trifecta Capital, a venture debt firm that has raised more than 200 crores rupees in commitments from Indian institutional investors as part of a 500 crore rupee fundraise, venture capital-backed businesses also have debt financing needs that are not serviced by traditional financial institutions.

Khanna says that equity financing is typically more expensive than debt: “While venture debt is not a complete substitute for raising equity capital, a healthy mix of equity and debt financing helps reduce the dilution impact on the founder and, more importantly, brings down the blended cost of capital for the business.”

Moreover, as these small businesses scale, their needs include capex or acquisition financing, where debt is preferable but not available from traditional lenders. Lastly, he says, many companies see venture debt as supplementary to an equity capital raise. As it is largely non-dilutive, it extends the runway between two rounds of funding.

The intent from the Reserve Bank of India is very clear – foreign investors are being invited in and domestic alternative lending encouraged. Much of this is because of the struggling local banking sector, which is heavily regulated with large chunks of balance sheets mandated for lending to government and infrastructure projects.

Large slices of public sector bank books were ploughed into infrastructure financing when the times were good. Now lenders find themselves with rapidly increasing non-performing asset ratios, particularly in their power and steel exposures.

Non-performing loans within public sector banks stood at 17 percent as of 30 September, according to the Reserve Bank of India, and research by Credit Suisse suggests that the public lenders have continued to double down on loans to the most stressed sectors.

With their balance sheets dedicated to financing government and infrastructure, banks effectively ignore most of corporate India – particularly the family-owned medium-sized businesses that make up the bulk of the country’s economic activity.

But private credit providers aren’t complaining.