Wednesday, 17 October 2018
Monday, 15 October 2018
Saturday, 13 October 2018
Monday, 8 October 2018
When DSP Mutual Fund received a redemption request from its corporate investors on the debt fund, the real reason was that the client was a tad worried. The fund has a large exposure to the bonds issued by IL&FS, both in the long duration and the short duration. A sharp fall in the NAVs due to a rating downgrade meant that the short term funds started showing losses. That immediately triggered sell orders from treasuries. With a huge redemption request, DSP needed to generate the requisite cash. It could either sell the G-Secs in its portfolio, but that would mean booking losses in a rising yields scenario.
The better option was to book the loss in private debt where there was anyways an element of risk. That is exactly what DSP did when it sold bonds of Dewan Housing at a huge discount. As against the market yield of around 8%, DSP sold the bonds at a yield of 11%. That means, an Rs.100 bond was sold at Rs.82, incurring a large loss in the process. That triggered worries in the equity market that there were similar problems in DHFL too and that is what led to the sharp crash of 60% in DHFL in a single day. Other HFCs like Indiabulls were also not spared as they too relied on the short and medium term bond markets to raise funds on a continuous basis.
How the rating downgrade triggered the panic
The whole problem started when rating agencies downgraded IL&FS drastically the moment the default broke out. The downgrades were swift and very drastic. The long-term ratings of the parent entity IL&FS were downgraded multiple notches from AA+ to BB on September 8 and then to D on September 17. The short-term rating was downgraded from A1+ to A4 on September 8 and then to D on September 17. Similar rating actions were witnessed across debentures and CP on several other group entities – IL&FS Financial Services, IL&FS Tamil Nadu Power Company Limited, IL&FS Energy Development Company Limited, IL&FS Transportation Networks Ltd and IL&FS Education & Technology Services Ltd. The main reason stated was the sharp deterioration in the risk profile of IL&FS. That was the starting of the trickle-down effect. But the big question is whether this story can become much larger than just one DSP MF selling bonds? Or could it become something much larger where there is panic selling in bonds and also equities wherever companies are found to lack in transparency or whether there is a risk of maturity mismatch.
Will it really impact the mutual funds?
It would be naïve to believe that mutual funds in any way could be immune from this series of downgrades that IL&FS has faced. Mutual funds have a major exposure to the bonds issued by IL&FS, which were generally preferred by mutual funds for the higher yields that they offered. And the total exposure that Indian mutual funds have to the IL&FS is nearly Rs.2200 crores, which is not small by any standards. More so because most of these are short term instruments where there are corporate investors with their own internal risk management constraints. Secondly, there are nearly 10 FMPs that are exposed to these IL&FS bond in a big way. A default will mean that the very concept of a Fixed Maturity Plan (FMP) will be diluted as they will not be able to provide quasi assured returns any longer.
The problem may become a lot graver in the coming months for obvious reasons. Some of these exposures were due to mature in September, which were returned due to insufficient funds. Several funds held aggregate exposure in excess of 5% to IL&FS and group companies in their portfolios. Given the Mark to Market (MTM) impact on these bond prices, these funds witnessed a sharp drop in NAV. While upgrades and downgrades are expected to happen, what really hit the mutual funds, as in the case of Amtek Auto earlier, was the swiftness of the downgrade. This resulted in a significant MTM impact on bond prices. In some cases the MTM impact of the first round of downgrades on bond prices was as significant as 25%. That means; a 5% position for the bond in the fund would result in a -1.25% MTM impact, which is huge considering the low returns that these short term funds provide. For the first time, Indian mutual fund investors may see the risks of debt funds in real time. For the real impact, watch out of funds like DSP MF and Aditya Birla; where the exposure to the IL&FS group is in excess of Rs.600 crore each. But DSP and Aditya Birla are much larger in terms of AUM. The real problem could arise for AMCs like BOI AXA, LIC MF, Principal and Tata MF, where the exposure although smaller is a significant proportion of their overall debt exposure.
Friday, 5 October 2018
If you open the bond markets page or the economy reports, the one concept you will often get to hear is that of Open Market Operations or OMOs in short. The government through the RBI intervenes in the money markets and bond markets in many ways. The main purpose is to maintain balance and stability in the bond markets. Bond markets can become unstable if the yields become too volatile or when the liquidity in the market becomes too volatile. There are 3 broad ways in which the RBI intervenes and regulates the rates and liquidity in the debt markets:
- Use of repo rate trajectory. We see this being done by the Monetary Policy Committee (MPC) once every two months. The repo rates are the benchmark for lending and borrowing in the market and the RBI can raise or cut these rates to send signals. In the last 2 policies in June and August, the RBI had hiked rates by 25 basis points or 0.25%.
- The RBI also regulates the bond and money markets through reserve requirements. Banks are required to maintain CRR and SLR with the RBI in the form of liquid deposits and in the form of SLR securities. These requirements can also be shifted to regulate the liquidity and rates in the market.
- The third method is called open market operations (OMOs), where the RBI will buy or sell government securities and the same will be used to infuse and absorb liquidity in the markets. When liquidity is too high, OMOs will imply selling bonds to absorb the liquidity. When the liquidity is too tight, the RBI will buy bonds in the market to infuse liquidity. Recently, the RBI had announced an OMO of Rs.10,000 crore to improve the liquidity in the bond markets.
What exactly are open market operations (OMO)?
Open market operations are conducted by the RBI by way of sale or purchase of Government securities (G-Secs) to adjust money supply conditions. Why does the RBI do that? The RBI sells G-Secs to suck out liquidity from the system and buys back G-Secs to infuse liquidity into the system. These OMOs are often conducted on a day-to-day basis with a view to balance inflation while helping banks continue to lend. The daily OMO figures of the RBI are disclosed on the RBI website. The RBI uses OMO along with other monetary policy tools such as repo rate, cash reserve ratio and statutory liquidity ratio to adjust the quantum and price of money in the system. We have already seen the three principal tools above.
What is the relevance of OMOs under different conditions?
In India, liquidity conditions tighten in the second half of the financial year (mid-October onwards) due to a slowdown in government spending and at the same time the onset of the festival season leads to a seasonal spike in currency demand. Moreover, activities of foreign institutional investors, advance tax payments, etc. also cause an ebb on flow of liquidity.
That is where the RBI intervenes because if liquidity gets too tight then call rates may shoot up sharply and skew the entire money market equations. The RBI manages the availability of money through the year to make sure that liquidity conditions don’t impact the level of interest rates that the RBI has targeted to maintain the delicate balance between inflation and GDP growth in the economy. Liquidity also has another very important implication. Liquidity management is essential so that banks and their borrowers don’t face a cash crunch. The RBI will buy G-Secs if it thinks systemic liquidity needs a boost and offloads such bonds if it wants to mop up excess money.
What do OMOs mean for investors?
The RBI’s roadmap on OMO is an important forward-looking statement of intent. Liquidity has a bearing on both interest rates and inflation rates and that is why OMOs are so critical. The fact that the RBI wants to maintain ample liquidity in the system, hints that it is now less worried about inflation and is keen that banks should transmit lower rates to borrowers. In fact, the OMO outlook also tells you about the RBI’s outlook for interest rates and inflation.
There is one more thing to watch out here. Large open market purchases by the RBI can give the government a helping hand in its borrowing programme and investors normally frown upon such measures. This is nothing but the virtual monetisation of government debt by the Reserve Bank and could have larger inflationary implications. However, when the government is reconciled to a higher fiscal deficit then the RBI has normally been accommodating towards larger government debt by way of OMO.
Sufficient liquidity via OMOs is always welcome. What the RBI needs to ensure is that such an endeavour is in sync with the largest objectives of the monetary policy.
Thursday, 4 October 2018
Markets has fallen so drastically and with very high amount of intensity. You won’t know understand the overall scenario by just looking at the Nifty, but the midcaps have fallen around 20% this year, and the small caps, are down nearly around 30 percent!