Foreign Currency Convertible Bonds and Indian Rupee

The Impact of INR depreciation on the Foreign Currency Convertible Bonds (FCCBs) issued by Indian Corporates A convertible bond is a type of corporate bond that the holder can convert, within maturity, into a specified number of shares of common stock (conversion ratio) of the issuing company. A foreign currency convertible bond (FCCB) is issued by a company in foreign currency in which the interest and principal payments are made in foreign currency. The FCCBs sit on the liabilities side of balance sheet and are directly proportional to the strength of the foreign currency. If the domestic currency weakens, the issuer has to make extra efforts to meet the interest and principal payment obligations.

FCCBs in India

FCCBs have been extremely popular with Indian Corporate for raising Foreign Funds at competitive rates since the IT boom in 1999 through automatic and approval routes. These are special channels that RBI and Ministry of Finance created to provide incentives to specific sectors like Infrastructure and Power in FCCBs.

Impact of the rupee depreciation on the Companies’ FCCBs

USDINR from Oct 2012 to July 2013. Source Google Finance

Top Ten FCCB Issuers as of May 2013

Total Sum = $2B of which 90% is in USD
Source: http://www.rbi.org.in/scripts/ECBView.aspx
Root Cause of Current Situation

Although India companies have been using FCCBs as a major finance-raising tool for meeting their capex requirement at competitive rates and the Indian regulatory regime has fully supported them in meeting financing needs, certain crucial aspects, in hindsight, seems to have been overlooked. Firstly, companies issuing FCCBs generally hedge their fx-exposure by increasing foreign revenue streams (typically IT companies) or pure currency hedging by market instruments.

However, Indian companies were under the over-expectation that bond holders would convert to equity and consequently have not been successful at insulating themselves from toxic FX exposure. Secondly, a blanket acceptance of constant dollar strength post 2008 crisis by the Indian Companies, while correct till 2011, has costed them dearly. By tapering QE, Fed has taken necessary steps to enhance dollar strength in world markets which also contributed to the rupee depreciation. Hence a combination of external as well as internal factors has contributed to the FCCB crisis.

Impact on Issuer

FCCBs put severe constraints on issuer when it’s share price is declining, as they have to be repaid either by raising debt at higher interest rates or through internal accruals. If the FCCBs do not get converted, it increases the debt equity ratio. If the FCCBs do get converted it leads to equity dilution. Either way, the company’s financials will be deteriorated. In the case of default, FCCB’s being the unsecured debt, doesn’t leave the issuer with much choice.

Although raising domestic debt and injecting equity are possible they are only options in theory as the global crisis has slowed the growth of Indian Companies and made them less able to seek further equity or new debt. Under current conditions, companies can utilize RBI-facilitated advantages like restructuring of FCCBs at a lower conversion ratio or buying back of issues or redeeming the FCCBs by refinancing at higher rates and longer maturities and postpone the principal payment burden. Even if such measures are out of question then the companies has to sell some of their assets and pay back the debts just like Suzlon did in Tamil Nadu in 2012. (Article Word Count = 498)