Share prices of Indian companies have plunged. The rupee is at historic lows. Profits — barring an exception or two like the State Bank of India — are sharply down. The issuers of Foreign Currency Convertible Bonds (FCCB) are in deep trouble. People are even talking about the possibility of defaults.

The convertible bond has always been a favorite of corporate India. When the Controller of Capital Issues (CCI) decided the premium at which a company could make a follow-on public issue (FPO), the convertible bond was the instrument of choice. You could issue a bond (debt) at, say, US$10 and convert it later into a share of US$1 with a premium of US$9. The share premium account was boosted while the equity capital (which needs to be serviced by way of dividends) stayed low. The CCI would probably have allowed a premium of only US$1 on a share issue of US$1. Everyone was happy as, at the time of conversion, the promoters ensured that the market price was above US$100. Reliance Industries under Dhirubhai Ambani had several series of such debentures.

When the world was experimenting with exotic derivatives in the lead-up to the global financial crisis, Indian companies were taking tentative steps forward with FCCBs. They were very easy to understand. You just borrowed, say, US$100. The rate of interest was much lower than Indian rates. On the pre-decided date of maturity, the lender would be returned US$100 plus the interest. But that was not the principal attraction. Each debenture could be converted into an equity share; the choice lay with the lender. If the share price was higher than the principal plus interest, the lender would gain and opt for the conversion option. When the market was booming, nobody gave thought to a situation in which the FCCBs would be underwater — less than the principal plus interest.

To make a long story short, that is what has happened. Companies had realized this over the past couple of years and they were trying to make arrangements. The conversion option was out, of course; no lender wanted equity. Some companies felt they could generate the repayment funds needed through operations. But high inflation and the decision-making paralysis in Delhi have meant weaker bottomlines. The internal generation is not adequate.

Many companies saw that coming, too. So they borrowed from wherever they could and even sold assets. But the corpus they had collected in rupees is no longer enough. The rupee was 44.36 to the U.S. dollar in early May 2011. At 54.43 on May 19, 2012, the fall is nearly 23%.

“The rupee is the joker in the pack,” Rajesh Subramaniam, CEO of BPO company Firstsource, told CNBC-TV18. Firstsource has to return US$237 million by December 4, 2012. It has made arrangements for US$150 million, but now has to find the rest.

Suzlon Energy is facing a more serious issue; its redemption date is around the corner. Suzlon has to pay back its bondholders around US$360 million by June 17. This includes US$300 million in principal and US$60 million in interest. The company has asked its bondholders for more time; it says it will be able to raise the funds in an extra 45 days. Suzlon had made the FCCB issue in 2008.

Some other companies with FCCBs to pay include Tata Motors, which needs to return US$473 million (by July 12, 2012); Gayatri Projects, US$2.7 billion (August 3); Tata Steel, US$382 million (September 5); and Jaiprakash Associates, US$355 million (September 12). Some of these firms have already made arrangements.

Analysts have likened this to a time-bomb waiting to explode. According to a report by ratings agency Fitch, 20% of these FCCBs are likely to default. According to Fitch, 59 companies have to redeem FCCBs in 2012, involving an amount of US$7 billion.

The saving grace, of course, is that it is not a large figure. The Reserve Bank may allow some relaxation to tide over the crisis. It may allow companies to borrow money at a higher interest rate than earlier to facilitate rollovers.

If there is a default, it will reflect on the country’s image and rating. There were a couple of defaults in the late nineties. But that was a different situation. The wealth tax on shares had gone, courtesy then Finance Minister Manmohan Singh. But structures had yet to be unwound. The foreign borrowings were really a way of shoring up the promoter’s equity, without adding to his tax burden. Today’s lenders are genuine.

If a company has a reasonably healthy balance sheet and a good track record, it will be able to raise the money. If not, watch for fire sales. And, given the state of the rupee, foreign assets may be the first to go.