India’s budding private debt market is growing in double digits and attracting the attention of high net worth individuals (HNWIs), in large part courtesy of bad debt reforms the country began implementing a year ago, say market experts.

But the country's relatively high taxation levels are hindering even more interest and faster market expansion.

Private debt is an emerging asset class in India, with assets under management estimated at $3.3 billion at the end of December 2016, according to a November 2017 report by Preqin. The distressed part of the market has been growing with particular lustre ever since New Delhi introduced the Insolvency and Bankruptcy Code (IBC) in December 2016. This reform aims to tackle India's non-performing loans (NPLs) problem by fast-tracking the bad-loan resolution process.

Most investors into private debt in India are institutions such as banks, insurance companies and family offices, but sophisticated investors from outside the country are also showing increasing interest, said Nitin Jain, president and chief executive officer of global asset and wealth management at Mumbai-headquartered Edelweiss group.

“We are seeing interest [in Indian private debt] from foreign investors such as sovereign wealth funds and pension funds, mainly from the US and Middle East, as well as asset managers in the Indian private debt market,“ Jain told AsianInvestor.

Edelweiss has an nterest in this market growing: It runs an investment management arm that invests in private debt – Edelweiss Alternative Asset Advisors. But Jain said the growth potential is substantial. He expects India's private debt industry to grow by 25% every year by assets under management (AUM).

This is a rapid rate of growth, but Jain believes India's high individual income tax rate is preventing even greater interest from HNWIs. He said that private debt funds can generate returns between 14% and 20% before tax, but the Securities and Exchange Board of India considers such returns to be interest income and slaps any profits from them with a 30% individual income tax. 

That means after tax, returns could drop to between 10% and 13%, which is hindering even faster growth. “It’s one reason why private debt has not taken off in the country in a much bigger way,” added Jain.

Preqin estimates India’s private debt industry to represent 13% of the entire market in Asia Pacific, and its growth can be attributed to the overall slowdown in the country’s economic growth, which has led to a fall in interest rates, and as a result, banks’ reluctance to lend capital, the report noted.

Even globally, ultra-low interest rates in most of the developed world has led to a swell in demand for private debt, which is expected to last another decade, an AsianInvestor report said recently,.

Distressed and special situations

Until the end of 2016, the most opportunities within private debt was in special situation strategies, according to investment managers. This area had $1.4 billion under assets under management (AUM) in India, according to Preqin. INDIA

Special situations strategies attempt to profit from a change in debt valuations as a result of a special situation such as mergers and acquisitions, spin-offs and share buybacks. These are typically not long-term investments.

Distressed debt and direct lending vehicles represent the second and third-largest segments of the market, with $811 million and $712 million in AUM, the Preqin report noted.

Distressed debt's appeal lies in heavy discounts to valuation, typically because the issuer is facing major financial problems or has defaulted on payments of either the debt's interest or principal. Stressed assets in India, which include non performing loans (NPLs) and restructured loans, are estimated at nearly Rs11.5 trillion ($181 billion). That accounts for about 14% of the total outstanding loans by the banking sector, according to local media reports

Direct lending is conducted by financial firms such as insurance firms or hedge funds, which raise funds from investors to support acquisitions or start-up funding.

Investors have been particularly attracted to distressed debt investing. Their interest increased following the 2016 Insolvency and Bankruptcy Code, and then on October 24 2017 the Indian government approved a plan to inject Rs2.1 trillion into state-run banks over two years. While up to 64% (Rs1.35 trillion) will come from the sale of “recapitalisation” bonds, the rest will come from government budget allocations and market fund-raising.

The combination has led to increased opportunities in Indian distressed debt, said Ilfryn Carstairs, partner and co-chief investment officer at Värde Partners, an alternative investment firm.

“The size of the opportunity—and problem—is significant and on the scale of other markets such as Spain and Italy,”  told AsianInvestor. 

“The trigger for us is not how much NPL stock there is, but whether there is a catalyst for the clean-up. And the new bankruptcy code provides just that,” Carstairs added. He said the government and regulators deserve praise for their proactive steps in cleaning up the banking system.

“This is an important first step – we’ve found that bank recapitalisation is a key ingredient in dealing with NPL problems in banking systems around the world,” added Carstairs.

You need a proactive regulator focused on identifying the problem and forcing banks to take provisions, but you also need enough equity in those banks to enable them to take losses on the NPLs and sell or clean them up.”

Carstairs, declined to comment on what returns could be made from India by investing in distressed funds. But he said more steps need to be taken to better handle NPLs. The IBC still needs to be tested on large and long-running cases and investors will have to be prepared for slow progress, with occasional setbacks likely.