India: Promoters are borrowing less – is that good?

In India promoters – or controlling shareholders – can borrow money using their stock as collateral. It’s not a new practice – but what is surprising is that the value of these pledged shares as a proportion of market capital fell to its lowest level in over four years in the quarter ended this September.

With corporate debt climbing and putting the spotlight on banks’ nonperforming assets, what’s going on?

promoter pledging india over timeRegulation from the Securities and Exchange Board of India (Sebi) dictates that promoters must declare the shares they have pledged and 761 companies reported on this in the three months to September. Analysts at Morgan Stanley calculated that pledged value compared with companies’ total market capitalisation was down for the first time in three quarters, falling 110 basis points quarter-on-quarter.

This is partly explained by the recent rally in India’s stock market, with benchmark indices hitting record highs in recent weeks. But even when we look at the pledge value of shares alone – in rupee terms and marked to market – the number is down 6 per cent in the quarter to Rs1.39trn ($22.4bn).

Companies where the promoters have pledged a large share of their holding are viewed with caution. Gaurav Mehta, an analyst at Mumbai-based Ambit Capital, explains that if a promoter defaults on this debt the lender transfers the shares into their own hands. When they need funds they dump this stock on the market, leading to sharp movements in the share price. So these new figures are good news from that point of view, and Mehta’s own report on the subject last month was upbeat.

So when promoters borrow against their shares, what are they doing with the funds raised? Are they being used for investment in the company itself or for the promoter and his wider group?

One Mumbai-based analyst commented: “It could be divorced from corporate debt but the debt reduction which is happening could be at the promoter level, honouring their own debt.”

Amit Tandon, managing director of Institutional Investor Advisory Services, says there are two other reasons promoter pledging could be moderating: “Given the slowdown in economic activity there is less of a need for people to go out and borrow,” he said. “Related to this fact, it’s a volatile environment. I would be nervous to lend unless I could be doubly or triply sure of assets on the other side.”

Suddenly, the reasons for reduced promoter pledging are looking less rosy. But as Mehta says of shareholding pledging data: “This doesn’t represent corporate India’s balance sheet health, it more represents the balance sheet health of its promoters.”

Related reading:
An appetite for stronger boards, FT
Guest post: Indian investors waking up to shareholder power, beyondbrics
India: leading the world in insider corporate fraud, beyondbrics