The CFO's Need:
Diversification Of The Sources Of Working Capital To Reduce Dependence On Bank Credit

The changing nature of bank finance places the burden of treasury management squarely on the corporate. For starters, the once-ubiquitous cash credit facility is fast vanishing. Since interest under the cash credit arrangement was payable only on the amount utilised--and not on the full amount sanctioned--bank credit, essentially, amounted to a floating rate facility, with the interest rate risk being assumed by the bank.

Now, however, for borrowers with working capital limits exceeding Rs 10 crore, bank finance comes in the form of an 80 per cent loan and 20 per cent cash credit. A steadily-rising loan component does not just mean a higher interest bill; combined with the progressive deregulation of interest rates, it also translates into a variable interest rate regime for the CFO. At present, banks charge a fixed Prime Lending Rate (PLR) over the life of the loan. But, in the not-too-distant future, expect a floating PLR that moves in response to the money market conditions.

Already, the M&CP, 97-II, has removed the ceiling on short-term deposit rates, and allowed the banks to offer floating rate deposits. If an increasing proportion of bank liabilities is indexed to a floating rate, it follows that the rates on bank assets, namely loans, will vary too. "To cope with a fluctuating PLR, corporates should run their treasury operations as full-fledged profit-centres," advises Sidharth Kapur, 35, the senior vice-president of Apple Finance.

THE STRUCTURED SOLUTIONS: The development of proactive treasury management strategies has, traditionally, been hindered by a shallow and segmented money market created by an elaborate maze of restrictions that specified participants, rates, and maturities. For instance, the private sector mutual funds were not allowed to participate in the call money market till 1995. But, as liberalisation dismantles such barriers, new money market instruments will evolve, and closed markets will open up.

COMMERCIAL PAPER. In the developed economies, a substantial portion of working capital requirements, especially those that are short-term, is promptly met through the flotation of Commercial Paper (CP). Directly accessing markets by issuing short-term promissory notes, backed by stand-by or underwriting facilities, enables the corporate to leverage its rating to save on interest costs. Typically, the CP is sold at a discount to its face value and is redeemed at face value. Hence, the implicit interest rate is a function of the size of the discount and the period of maturity.

In this country, the CP debuted in 1991, but its linkage to the bank finance limits hobbled its growth. Although these restrictions have limited the investor base, and confined the use of the CP as that of an arbitrage instrument enabling CFOs to exploit the odd interest rate differential, CPs are set to boom as a major short-term funding instrument. Examine the numbers: the first fortnight of May, 1997, saw CP issues shoot up to Rs 404 crore--a 40 per cent jump from the Rs 289 crore issued during the month of April, 1997. By September, 1997, the numbers had climbed to Rs 733 crore.

The immediate impetus to this surge has been the M&CP, 97, which lowered the minimum maturity requirement from three months to one month. Now, CPs can better match the corporate treasurer's maturity preference. Treasurers who require funds only for a month need no longer lock into higher three-month rates. Alternatively, if three-month money is required, and short-term rates are expected to dip further, opt for a strategy that rolls over one-month CPs. This flexibility in CP maturities will provide CFOs with a handy financing strategy: issue CPs for short-term needs, and opt for bank credit for medium-term requirements.

But the real driving force behind the CP boom has been the easing liquidity situation, and the sharp drop in the CP rates from a high of 20.15 per cent in March, 1996, to around 9-12 per cent now. Since the CP is a cheaper alternative to bank credit, where rates start at 12.50-13 per cent, the fact that CP issuance subtracts from the availability of bank finance does not matter much. In fact, the liquidity overhang has allowed the cream of the country's corporate aristocracy to cut their cash costs.

By relying largely on CP issues, AAA-rated corporates like the Rs 9,004-crore Reliance Industries, the Rs 6,600.10-crore Hindustan Lever, the Rs 1,485.60-crore Philips India, the Rs 730.40-crore Gujarat Ambuja, and the Rs 1,026-crore Indian Aluminium have not even drawn on their sanctioned cash credit limits. The linkage to bank credit will matter when the liquidity tap runs dry, as the collapse of the CP market in 1995-96 all too graphically demonstrated. Notes Rakesh Kochhar, 30, chief manager (treasury) of SRF Finance: "If the Reserve Bank of India (RBI) wants to encourage an enduring boom, the issuance of CPs must be decoupled from bank credit limits, as is the case abroad."

FOREIGN CURRENCY BORROWINGS. For treasurers scouting for cheap and flexible alternatives to bank finance, tapping the deep markets abroad is a lucrative option. For an AAA-rated corporate, foreign currency borrowings at the six-month dollar London Inter-Bank Offered Rate (LIBOR) of 5.85 per cent, plus a risk spread of 80-100 basis points, is cheaper than domestic borrowings at a PLR of 13 per cent. This comparison, of course, ignores the foreign exchange risks, but even if one adds on a six-month forward premium of 6 per cent, going abroad is still cheaper.

However, access to these markets is rationed. At present, the External Commercial Borrowing (ECB) guidelines allow corporates to raise upto $3 million for working capital purposes subject, of course, to the ceiling for such borrowings and a minimum maturity specification of three years. Alternatively, banks can provide foreign currency loans against their foreign currency non-resident (FCNR-B) deposits--a useful option for corporates that are not able to go abroad, but are still willing to assume exchange rate risks for lower interest costs. Since the ceiling on deposit rates has been lifted, the rates on FCNR-B deposits will now be LIBOR-linked and, therefore, so will be the rates on the loans extended against these deposits.

Even this limited opening of the foreign exchange window has multiplied the CFO's options. Echoes Rana Kapoor, 40, general manager, ANZ Investment Bank: "Allowing short-term foreign currency loans to meet working capital financing requirements has created the beginning of an on-shore dollar market, which can form a stable source of funding at competitive costs for the CFO." Expect capital account convertibility to prise open that window further. Predicts Paresh Sukhtankar, 35, the head of credit and market risk at the HDFC Bank: "With a fully-convertible rupee, corporates will be able to freely access the international market to raise their working capital requirements."

Once that happens, disintermediation will follow: Corporates will access markets directly by issuing Euro-Commercial Paper. Such paper provides a mechanism for highly-rated borrowers to raise funds overseas even more cheaply in spite of not furnishing the backing of a bank. Once these restrictions are lifted, the choice between domestic and external financing will become purely a function of interest rate differentials and perceptions of exchange rate movements. If domestic interest rates fall and liquidity improves--as is happening now--expect CFOs to toggle back to the domestic markets to raise funds.

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