Corporate finance during the recession

The financial downturn has shrunk corporate India’s mobilisation of resources in the form of equity and debt. Between 2003-04 and 2007-08, capital issues made by the private corporate sector rose from Rs.37.2 billion to Rs.636.4 billion. But in 2008-09 as foreign institutional investors exited and a crisis engulfed India’s capital markets, the figure fell to Rs. 146.7 billion. According to figures provided in the recently released Annual Report of the Reserve Bank of India (RBI), the number of new issues of equity and debt instruments by both private and public sector firms fell from 119 in 2007-08 to just 45 in 2008-09 and the resources garnered from Rs. 837.1 billion to a low of Rs. 146.7 billion. In terms of rates of growth, capital raised through new issues grew by 158.5 per cent year-on-year in 2007-08, but fell by 82.5 per cent in 2008-09.

The decline was inevitable given the collapse of the stock market in 2008-09 largely as a result of the exit of foreign institutional investors. The Sensex fell by 37.9 per cent during 2008-09 and market capitalisation shrank by 39.9 per cent. This would have had its effect on the primary market as well, with investors showing little interest in new share issues. For a sector dependent on external sources of finance for more than 60 per cent of its funds, this decline in capital access during difficult times must have been debilitating.

Fortunately, the squeeze on funds garnered from other sources was not so severe. Despite the attention it gets, the stock market plays a minor role when it comes to financing corporate investment. The private placement route, involving the negotiated sale of financial instruments by firms not listed in the stock market to financial investors of various kinds such as merchant banks, hedge funds and private equity firms, has been far more important. It is interesting that even during the years of the stock market boom private placement eclipsed public offerings by firms in the stock market, providing the private corporate sector with anywhere between two-thirds and 93 per cent of external resources mobilised from private markets at home. Sums mobilised through private placement rose from Rs. 187.6 billion in 2003-04 to as much as 1296.8 billion in 2007-08. Here too the recession resulted in a decline in resources mobilised in 2008-09 albeit by a much smaller 28 per cent to Rs. 930.4 billion. The smaller decline meant that private placement accounted for 86.4 per cent of the resources mobilised in 2008-09.

The dominance of private placement in resource mobilisation is to be expected since a substantial number of firms in India are still not listed in the stock market. On the other hand, free-floating (as opposed to promoter-held) shares are a small proportion of total shareholding in the case of many listed firms. If therefore there is adequate investor interest, capital would flow out of the organized stock market in search of instruments supplied by unlisted firms.

But, official figures point to an important difference between the new issues and private placement market. In the former, while capital mobilised largely comes from the issue of equity, in the latter it comes almost wholly (more than 99 per cent) from the issue of debt instruments. There could be two reasons for this. First, investors entering the private placement market may only be willing to invest in debt instruments, which offer a defined return and are more secure from their point of view. Second, cash-strapped firms looking for resources to handle the difficult times would be willing to obtain it in the form of debt, even if that involves an interest burden. The shift from equity to debt associated with the growing importance of private placement as opposed to public offerings imply that private placement markets are a mixed blessing for the corporate sector. They offer more capital than the equity market in the course of a recession. But they offer it in a form which makes coping with the recession a little more difficult.

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Printable version | Aug 5, 2020 5:01:44 AM |

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