Companies need money to carry on their business and money generally comes from three sources. The promoters of a company bring in the seed capital. Then they borrow from banks as debt. The third source is to sell equity shares in the capital market so that a large number of investors can participate in the growth and also become the part owner of the  entity.

The Indian economy, after having a boom run for five to six years, is now faced with a slowdown as the country’s GDP growth is likely to drop to 7.5 per cent as against average 8.5 per cent growth in the previous five years. The primary contributor to the deceleration is the sharp pull back in industrial production, which in turn was largely due to the shortage of capital and the rise in the cost of capital.

Strangely, borrowing money has become expensive even though India’s savings rate at 35 per cent is one of the highest in the world. In the last six months or so, the average interest rate for business has jumped up to around 16 per cent from around 13 per cent earlier. As the Reserve Bank of India (RBI), to control inflation, is following a  tight monetary policy, the rate of interest has moved up and money supply has been severely curtailed. A recent study of financial performance of 2500 companies in the April-June 2008 quarter shows that the corporate profits have dropped mainly on account of a 69 per cent increase in interest cost.

A possible alternative to expensive debt is raising money from the  capital market through issue of shares. But here again the corporates are facing a daunting task as the IPOs (Initial Public Offers) and rights issue of shares have almost dried up. The crash in the stock market which saw the Bombay Stock Exchange’s Sensex crumbling 7400 points from around 21,800 in the beginning of 2008 to 14,400 now is the primary reason why new share issue have almost vanished.

Massive crunch

As thousands of investors have bitterly realised that IPOs are no sure shot for making money, losses are more when one invests with borrowed funds, they simply turn around and ran away from IPO market. Prime Database, a company that tracks public share issues, Chairman and Managing Director Prithvi Haldea said,  “History surely repeats itself. Every time the secondary market tanks, the primary market goes into a slumber. Since end-January this year, when the Sensex first tumbled, the IPO market has been badly hit.”

Wheel turned

According to Prime Database, between February and August this year, only 25 IPOs, all small ones, have hit the market, raising a meager Rs 4,345 crore. Last year, these seven months had seen 65 IPOs raising Rs 32,993 crore.

In good times, a company would typically hit the market as soon as it receives the regulator Sebi’s approval. Not any more. In recent months, as many as 22 companies, planning to collectively raise Rs 16,539 crore, have allowed their IPO approvals to lapse. This includes some big names like Jaiprakash Ventures (Rs 4000 crore), Reliance Infratel (Rs 4000 crore), UTI Asset Management (Rs 2000 crore), MCX (Rs 600 crore). There is more bad news. As many as eight companies, collectively planning to raise Rs 4,772 crore have withdrawn their offer documents since January 2008, pointed out Prime.

There are also another 12 companies holding Sebi approval, together aiming to raise Rs 3,643 crore. But given the dull sentiments they may allow their approvals to expire. Mahindra Holiday Resorts (Rs 1000 crore) and DB Corporation (Rs 1000 crore) are two majors IPOs in this segment.

It is also feared that many of the 73 future IPOs who are collectively planning to raise around Rs 43,000 crore may defer their plan because of the bad market and poor valuation. The primary reason behind the downturn in Indian market is the subprime crisis that began about a year ago and has now engulfed the entire financial sector in the USA and partly in Europe.

The subprime crisis is actually the result of a financial engineering where less credit-worthy borrowers were given generous home loans by banks at a rate of interest higher than the prime rates. But the artificial boom created with easy money went bust as borrowers started de-faulting, property prices crashed leading to further defaults. The total loss to the US banking sector due to subprime crisis is expected to touch $1000 billion.

When the world’s largest economy (US) becomes sick, others start sneezing. All emerging countries like Brazil, Mexico, Russia, China are affected by the the US recession and India is no exception. One of the major reasons behind the market crash in India is that the foreign institutional investors (FIIs) are pulling out of the Indian market after losing money in the US subprime debacle. The FIIs, estimated to have sold shares worth Rs 60,000 crore in India since the beginning of 2008.

Disturbing implication

The death of IPO market is certainly an worrying news for the Indian economy. Just how much does the IPOs contribute to Indian companies? In 2007-08 Rs 51,408 crore was raised from IPOs and in the previous year the amount was Rs 25,000 crore.  

Naturally, those who were to use IPO money for new projects, expansion and working capital will either postpone their plans or borrow from banks to fulfill commitments. Since bank loans have become more expensive and come with end-use conditions, project costs will go up.

Many infrastructure projects in the field of power, roads, housing complexes may suffer for the want of money and this in turn may hamper industrial development in general.

Uncertain future

When will the investment climate improve to bring back IPOs in the market? No one knows for sure. The central government has plans to offer 10 per cent of its holding in many government owned companies like BSNL, NHPC etc. The BSNL, for example, may come out with an issue to raise Rs 40,000 crore. Such big ticket IPOs may bring the bang back into the capital market. But there is a great deal of uncertainties on the government’s plan.