Bond Market Volatility And Impact
In the past few days the IL&FS downgrade has triggered panic in the fixed income market leading to a knee-jerk liquidity freeze. Short-term bond investments are now being called and this has only led to the situation becoming exacerbated. According to fund managers, the pressure is now coming to bear even on equity markets, especially HFC & NBFC stocks. As liquidity has squeezed out of the market, bond yields have moved upwards sharply.
While this is a problem on the surface itself, there are much deeper concerns that are seemingly escaping attention.
To begin, on the surface, there are immediate liquidity concerns that need to be addressed aggressively and immediately. The RBI announcement of its intent to purchase Rs. 36,000 crores of government bonds. With this coming on the back of the government’s reduction in borrowings by Rs. 70,000 crores has had an immediate impact through a drop in bond yields. However, ongoing management and monitoring of liquidity, especially in response to asymmetrical and illogical factors is imperative. Equally important is the need to crack down on the agendas and entities driving such factors.
However, going beyond the surface, the deeper concerns stem from the overall control and management situation of the NBFC sector. The biggest impact of the liquidity freeze would have been seen by HFCs & NBFCs, a number of which are systemically significant. As has been seen in the past few days, this leads to a substantive impact on the equity market in addition to the debt market. Investors, who hitherto may not have laid significant value upon the logical factors mentioned above, would find themselves concerned about these gravely on account of these additional factors unleashed by agenda driven entities.
As NBFC and HFC licenses keep getting issued in large numbers, the market is being flooded with entities which are focused on generating high valuation driven by headline parameters, while putting risk factors on the backburner. A complete lack of understanding of consumer behavior by these new players will only end up with them lending to high-risk borrowers resulting in severely elevated systemic risk. Even as the government takes steps to address it, the overall NPA situation remains one of concern. In such an environment, the economy can ill-afford fresh trouble, especially when the warning signs are all there, and more importantly, the preventive steps are readily available.
RBI has taken a first step towards addressing issues by intervening through bond purchases. The assignment model for banks vis-a-vis HFCs and NBFCs is the ideal next step. Deposit-taking HFCs and NBFCs should have an additional line opened at call with the RBI, with SBI taking the lead. This would stop those entering the industry in search of valuations rather than building customer focus. Preference should be given to retail-focused HFCs such as HDFC, LIC Housing Finance, DHFL and various systemically significant NBFCs that have pedigree and longevity.
It is imperative that the RBI steps into taking appropriate steps to manage liquidity, support systemically significant institutions and prescribe a larger capital base than the current norm. Events that are being triggered by asymmetrical and illogical factors injected into the system by agenda driven entities have to be responded to, investigated and curtailed through proactive action. This is especially true in situations like the current one where macroeconomic factors are already creating the potential for risk.
