Indian PE Faces Stiff Competition For Asset Allocation

By Tanuj Khosla

  • 24 Mar 2011

There is no dearth of choice for overseas investors.

Private Equity (PE) as an asset class has fared much better than India-focused hedge funds in the last one year. The latter are suffering on both the ends of the investment spectrum raising capital & generating returns. According to VCCEdge, PE firms signed 376 deals and deployed $8.3 billion in India in 2010, up from 331 deals worth $4.7 billion in 2009.

However while PE firms have managed to raise substantial capital in 2010, there is now a realistic possibility of an asset reallocation by global PE investors. This is because India is rapidly falling behind many countries in risk-adjusted returns it offers due to a combination of factors like inflation, high interest rates, political scandals, rising oil prices (India imports 75 per cent of its oil) and a widening current account deficit.


The Sensex has been down by close to 11 per cent since the beginning of this year forcing the PE firms to delay their exits from their portfolio companies. Moreover despite the weak market, the PE valuations of even private companies remain high than their counterparts in other countries. There are two reasons for this:

â too many funds chasing fewer number of companies

â Indian promoters being very bullish about their companies despite the macroeconomic problems plaguing the country and thus demanding higher valuations.


Let us take a look at the concerns of GPs in different sectors of the Indian economy.

Infrastructure: The Planning Commission has forecasted infrastructure spending to go up from US$ 514 billion in the 11th Plan (2007-12) to US$ 1 trillion in the 12th Plan (2012-17). The Government has increased the depth of the corporate bond market by raising the Foreign Institutional Investor (FII) limit in corporate bonds of infrastructure companies to US$ 20 billion from US$ 5 billion in this year's Union budget. However that may not be enough and projects will largely rely on PE funding. The policy makers realize this and have given a series of tax related incentives to infrastructure companies to attract investors. But infrastructure investments require direct contact with government bodies which are badly ridden with bureaucracy and red tape not to mention corruption and giving of contracts to their 'recommended' vendors and suppliers. Consequently the approvals can take a lot of time to come through thereby stretching the investment horizon of the PE investment. GPs have a tough time explaining this to their overseas investors who feel 'It takes forever for things to get done there' for India anyways.

Real Estate: The real estate sector in India has always been known for the lack of clear rules and murky deals. Its reputation has been done no favours by bribes-for-loan scandal that came to light late last year. One of the real estate companies named in the scandal was in midst of raising PE investment at that time. Getting regulatory clearances from the government and acquiring land are constant challenges causing much frustration to the GPs. LPs on their part are unable to fathom the reasons for the same. Even though the potential of the sector is undisputed, one can reasonably expect the due diligence to get more intensive and the deal making to get slower in the months to come up until the government sorts out these issues ranging from corruption, to archaic laws to red tape.


Consumer Discretionary: The private domestic consumption story has been quite sellable to overseas investors in the last two years. Over one billion people and 330 million strong rising urban middle class - these numbers are hard to ignore for anybody. However double digit inflation over the last few months combined with the rising oil prices have forced the aspiring Indians to cut their discretionary spending. This trend is not expected to change in the short to medium term.

How Does The PE Scene Look In Other 'BRIC' Economies ?

Brazil: Brazil is the eighth-largest economy of the world and its stock exchange is the fourth-largest by market value. Overseas investors got badly hurt during the Asian crisis in 1999 when Brazil devalued its currency. It took them over seven years to return, attracted by the economic fundamentals of the country. Brazilian GDP grew by 7.5 per cent last year and by 4.9 per cent in the year before that. As a consequent of the competition between the PE firms, the price for deals has gone up significantly, although companies are still not as expensive as India or China, where there is even more competition.


China: This is the big one. There has been a rapid transformation of the PE market in China, from one that is dominated by foreign PE firms to a market in which domestic renminbi (RMB) denominated funds are being launched thick and fast. The latter have few ownership restrictions, strong government support and less regulatory oversight as China aggressively tries to internationalize the RMB. It is not surprising then that global bigwigs like Carlyle Group, Blackstone and TPG have rushed into joint ventures with Chinese state-owned enterprises and Municipal Governments to launch local currency denominated PE funds. For the global investors of these PE firms it is a double bonanza exposure to the RMB and the explosively growing Chinese economy at the same time. As if marketing these funds wasn't easy enough, government backing to them gives additional comfort to the investors. It is no surprise then that China is beating India hands down when it comes to attracting capital from global LPs.

Russia: The Russian government has been aggressively reaching out to top Wall Street investment banks and PE firms in order to attract foreign capital to local companies. The country is said to be mulling over setting up a fund to co-invest with leading international PE firms. It is believed that Apollo Management, Blackstone & Carlyle companies have already made proposals to join the project.

In addition to the above there are other emerging economies in South-East Asia & Africa that are being closely watched by LPs. Two which particularly stand out are


Indonesia : Consider the following

â Indonesia is expected to grow at 6-7 per cent annually over the next few years.

â The consumer demand has been steadily rising over the last few years.

â Both India & China rely heavily on Indonesia coal.

â Deals worth US$ 15 billion are expected to be signed between India & Indonesia over these few weeks.

â Moody's upgraded the country's sovereign credit rating by one notch to Ba1, just one step away from investment grade.

It is no wonder then that private equity firms are flocking to Indonesia like never before. The Center for Asia Private Equity Research forecast that PE investments could increase fivefold to as much as US$ 3 billion this year, from US$ 570 million in 2009. While US buyout firm TPG Capital has gone in with a local partner, buyout firms including Carlyle Group and the UK's CVC Capital Partners are expected to venture in soon.

However all is not hunky dory. Most Indonesian companies are family owned businesses whose promoters are very reluctant to dilute their equity. They rather take on private debt than go the PE route. Consequently the PE firms in Indonesia have to compete with alternative debt providers.

South Africa: Africa's largest economy has become the favoured destination for investors looking at Africa for either new opportunities or simply diversification. The country hasn't been hit by the inflation seen in other emerging markets such as China and India, but hasn't matched their surging growth either. South Africa's economy is expected to grow 3.5 per cent in 2011, lagging behind sub-Saharan Africa as a whole, which is forecast to expand by 5.5 per cent. Excessive labour regulation and a lack of clear policy on currency (many feel it is too strong) are major impediment in its growth.


At the moment, India offers more potential in PE as compared to Brazil and Russia from middle class population, GDP growth rate, Total Debt/GDP ratio and employment rate points of view. However it faces a real threat from Indonesia and is lagging way behind China. The reason is simple an 8-9% sustained growth rate requires three things which are (a) inflation to be kept under check (b) matching growth in infrastructure (c) sound political and corporate governance. While the RBI is doing a commendable job in trying to keep inflation under check, there is danger of inflation along with collapsing infrastructure derailing (or at least slowing) India's growth. Contrast this with China which is going berserk building high-speed trains, bridges, roads and is called as 'one big construction site' by my Chinese friends. Moreover both Indonesia and China have established special departments that give fast-track approvals to various projects and corporate investments.

In conclusion, the government needs to step in and address the various issues bothering overseas LPs or risk losing PE allocation that is supposed to come India's way in the years to come. That can be very bad news for an economy which requires billions of dollars of investment in infrastructure to sustain its high growth rate and lacks a deep corporate bond market.

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