Archive for June 6th, 2007

Capital Structure of Indian Companies

June 6, 2007

 This should interest and surprise the visitors on this blog(atleast it surprised me). RBI in its currency and finance report ( I have written about it here as well) has given a pretty interesting picture of how Indian corporates’ sources of capital.

Basically it is a sample of non-government non-financial public limited companies (which means no Banks, no ONGC etc). It tells me that

  • corporates have slowly moved towards internal sources as a preferred mode of capital. It was just about 30% initially of total capital and has doubled to 60% now.
  • Th debt equity ratio has become lower from 88.4 in mid 80’s to to 61.6 now
  • Within external sources, Bank borrowing increased and reliance on equity capital is lower.
  • Debentures which found huge favour earlier in 90s is an absolute no-no.
  • Borrowing from FI (IDBI, IFCI etc) has also come down.
  • Overall summary is that reliance on both bank and bank financing has come down.

Table 7.5: Pattern of Sources of Funds for Indian Corporates (Per cent to total)

1. Internal Sources 31.9 29.9 37.1 60.7
2. External Sources
of which:
68.1 70.1 62.9 39.3
  a) Equity capital 7.2 18.8 13.0 9.9
  b) Borrowings
of which:
37.9 32.7 35.9 11.5
  (i) Debentures 11.0 7.1 5.6 -1.3
  (ii) From Banks 13.6 8.2 12.3 18.4
  (iii) From FIs 8.7 10.3 9.0 -1.8
  c) Trade dues & other current liabilities 22.8 18.4 13.7 17.3
  Total 100.0 100.0 100.0 100.0
(i) Share of Capital Market Related Instruments (Debentures and Equity Capital) 18.2 26.0 18.6 8.6
(ii) Share of Financial Intermediaries (Borrowings from Banks and FIs) 22.2 18.3 21.3 16.6
(iii) Debt-Equity Ratio 88.4 85.5 65.2 61.6
Note : Data pertain to a sample of non-government non-financial public limited companies.
Source : Article on “Finances of Public Limited Companies”, RBI Bulletin (various issues).

Why I was surprised was because I was aware but didn’t expect internal resources to be such a huge figure in the exercise. I also felt that equity capital would have a much larger share. And despite the development in equity markets, the reliance on the same seems to be shrinking.

Going by Pecking order theory:

Companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means “of last resort”. Hence internal funds are used first, and when that is depleted debt is issued, and when it is not sensible to issue any more debt, equity is issued.

So on the look of it it makes sense as we see exactly this. But these are all public listed companies so we would expect that could rely on external capital as well.

Pecking order theory also in a way discusses how the capital structure would change as companies progress. So if we had seen this trend for small companies may be we could have said that we see pecking order theory is taking place in India.

But now, as we see large listed companies following pecking order we can say that profitability has really gone -up and companies are deploying the retained profit route to fund their capital and to expand operations. Also, as earlier the financial system was not developed and we had more or less a closed economy most of the finance came from FI’s and Banks, we are seeing the change in capital structure with developing economy.

It also tells me that capital markets would develop further and we would see more innovation as the % of capital market related instruments in the total capital was about 18% and as of now is just half at 9%. It should go up as more companies expand and build global capacities in order to serve customers worldwide. We are already seeing it as more and more Indian companies are acquiring abroad using innovative capital market related instruments.

Assorted Links

June 6, 2007

1. Menzie Chinn discusses financial openness around the world. He provides a lucid illustration and also provides links to number of research papers on the subject. He basically discusses hiw own forthcoming paper and even provides his database. Excellent stuff.

2. Looks like a damn good book. Talks about Chicago School and goes beyond stalwarts like Friedman, Coase etc. It discusses about all the others who are seldom mentioned but have contributed immensely to development of this hallowed temple of education. Here is a review as well

3. Morgan Stanley plans to sell bonds backed by revenue made from movies.

4. Indian government proposes to sell Rupee denominated bonds to investors abroad.  As India’s sovereign rating has been upgraded to investment grade, the government wishes to raise resources at cheaper rates. How else it would help? Well, as the article points out it would also help corporates who wish to raise resources abroad have some kind of a benchmark rate.

5. This is perhaps the story of the day. Indian coins find usage in Bangladesh for purposes I couldn’t have imagined. They are being melted and used for making blades and cheap artifacts. So much so, RBI had to mint something like 900 million pieces of fesh coins to stabilise the demand-supply mismatch.

6. A trip down the memory lane. Some great ads. Alyque Padamsee also shares his memories. Some good trivia.

Thanks to Marginal Revolution for 2 & 3

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