A weak economy and high risk taking, has now accounted for a large infrastructure player, a large housing finance company, a large private bank and a large debt mutual fund among many others. This is a serious crisis. And, we are still grappling with coronavirus and the lockdown, which has entered sixth week. These are unprecedented times for financial investors. In this week’s Finapolis Conversation, Kumar Shankar Roy interviews two fixed income experts: Arvind Chari, head (fixed income & alternatives), Quantum Advisors, and Pankaj Pathak, fund manager (fixed income), Quantum AMC. Known for their no-holds-barred manner of speaking, the Quantum experts come out their prognosis to cure the economic malaise. Read on to know more.
What is your suggestion on how much money will the government put in the hands of the common man to alleviate their income loss and to drive consumption? Given the tight financial situation of the government, how does the government fund such a direct intervention plan?
Arvind Chari: This is a matter of grave concern and unfortunately until now the government and the state government’s response (barring Kerala perhaps), has been extremely disappointing. It’s due to the government actions that people have lost their livelihoods and it is the government’s obligation to make up the income loss at least in part if not in full. It is not a question of driving consumption. For the majority, it will be a question of survival. When faced with something as serious as that, I don’t think money can be a consideration.
Do remember, that unlike the 2008 global financial crisis, where India was relatively unscathed and also India faced that crisis on the back of very strong growth, huge increase in wealth in terms of land and gold prices and high growth in incomes. We have encountered Covid-19, with the slowest growth in recent times, falling land and house prices, very low farm, rural and urban incomes and a very weak financial system. So, I doubt if we have a choice anymore, we have to find the resources.
With the delay in opening up and the delay in providing relief, India’s combined fiscal deficit (centre and states) currently at 6% of GDP would need to be at least doubled to 12 per cent of GDP. This should be prioritized to pre-dominantly counter the impact of loss of income through direct cash transfers for 3-6 months and to an extent offer economic stimulus to the various segments of the industry hit by Covid-19. Wider usage of Jan Dhan Accounts and Aadhar for cash transfer, doubling of NREGA funds to provide for the migrants, who will go back to the villages, large scale liquidation of the food stock with FCI are the easier options to scale.
One of the main arguments against ballooning the fiscal deficit is the chance of a sovereign rating downgrade. Is that a valid fear given that India is not alone in this precarious financial situation? Is a sovereign rating downgrade more precious than the cost of prolonged economic slowdown?
Arvind Chari: As Rakesh Mohan, former deputy governor, RBI, pointed out in a recent interview, that rating agencies should be locked up and ignored. I agree with that assertion. India is a young, highly populous economy with consumption as its main stay. India is a growth economy. Without the growth potential, we would anyways been rated as Junk (below investment grade).
So, If we don’t support growth, the ratings will get downgraded. So, a time bound fiscal expansion to get India back to the six per cent growth level should ideally be taken well by the rating agencies.
Pankaj Pathak: The Bond investors and foreign banks, which provide credit to Indian corporates tend to be the most sensitive to a country’s rating. So, if India is downgraded to below investment grade, we may see some short-term impact on bond flows and on the currency. But, every investor, who invests looks at the overall macro stability of the economy and not only at the ratings level. India’s macro and financial stability depends on its growth potential. I feel investors, especially the foreign equity investors, will be more concerned if due to the lack of a fiscal support, India’s growth potential further deteriorates.
You have earlier said the stressed corporates/ NBFCs haven’t seen benefits of the rate cuts and liquidity infusions by the RBI. The latest steps in your view are also unlikely to resolve the entire issue. Then, in your opinion what would resolve the issue? What should the RBI do more to help stressed NBFCs and corporate?
Arvind Chari: This issue of Risk Aversion has been continuing in the financial economy for many years now. Hit by large NPAs and finally being made to disclose it through the AQR(Asset quality rating), PSU Banks cut down their lending to corporate India in 2015-2016, due to lack of capital but more importantly due to lack of risk appetite. Private Banks, NBFCs, PE/ Real Estate Funds and Debt Funds filled up that gap. It all went well and in fact demonetization helped it fuel faster with the surfeit of liquidity that the banking system. Risk taking went unabated till IL&FS defaulted and sent a shockwave through the entire system.
Now, see what was happening in the background. Demonetisation was a rude shock to the economy and we at Quantum believe that the Indian economy never fully recovered from its shock. A hastily implemented GST further impacted small business. Global Trade war and lack of political focus on the economy has led to a weakening economy. So, a weak economy and high risk taking, has now accounted for a large infrastructure player, a large housing finance company, a large private bank and a large debt mutual fund among many others. This is a serious crisis.
And this is a crisis of confidence. The market is constantly looking out for the next corporate, bank, housing finance company, credit fund entity to default. How can risk taking and lending happen at such times? No amount of RBI liquidity, rate cuts or regulatory forbearance can resolve a crisis of confidence.
Many fund managers including yourself have alluded to the fact that there is not enough risk capital in the Indian system to help stressed companies. In the current context, who will provide the risk capital to SMEs, NBFCs, to help them tide over this period?
Arvind Chari: The answer lies with the government. The government has to take on the risks on its balance sheet and provide the required trust, confidence and guarantee. They can seek help from the RBI and a few other PSUs to do so. But, this crisis of confidence has gone on for a long time and needs to be addressed.
The news about a prominent fund-house shutting down six yield oriented debt funds has shaken the industry. On the equity side, many mutual fund categories have limits for holding stocks in terms of market cap. Do the current regulations have any strict restrictions for debt funds in terms of ratings of investments? Without such limits, wouldn’t these type of events have chances to recur?
Arvind Chari: Quantum’s founder, Ajit Dayal, mentions that Sebi has given us an ‘Asset Management Licence’ not a ‘Asset Gathering Licence’. In the chase for AuM, It is a clear failure of not adhering to the liquidity risks that a fund can take. Was 20,000 crore in 2015 and became close to Rs1 lakh crore in 2018. The secondary market liquidity of the assets held in those funds is not even Rs2,000 cr on a good day. Forget times like these, where the liquidity is zero. Many Small-cap equity funds stopped inflows. We never saw that in credit risk funds. It is important to question and understand, why? Also, did the excess AuM drive the funds to take on higher risks to deploy the money.
Pankaj Pathak: I would also like to point that if you see the Sebi categorization of debt funds, apart from the corporate bond fund category or the credit risk fund category, the amount of credit risks a fund can take is not mentioned. So, a liquid fund or a low duration fund doesn’t too much market risks, but a specific fund can take as much credit risks as it wants. If they have communicated that to the investors, that’s fine, but if not, and as many found out over the last four years, that the investor had no idea that its liquid fund was taking on such risks.
We believe that Sebi should allow for zero credit risks funds in large popular categories like liquid funds, short term debt funds to give the investor the choice of investing without worrying about credit risks. Retail investors really have no way to figure out by looking at the portfolio what is the extent of credit risks.
Have the successive failures of IL&FS, DHFL, etc., and now the Covid-19 induced illiquidity in debt changed the erstwhile definitions of 'risk', 'return' and 'fixed income' in the Indian context?
Pankaj Pathak: Investment management at the core is all about managing the risks. One needs to be clear about the risks being taken to try and earn that return. This is more so in case of investing in fixed income. Why do people invest in debt or fixed income. To try and earn an ‘assured’ income and get the capital back safely. Thus the obvious choice for any investor remains fixed deposits, NSC, PPF,.. all assured.
When they look at debt funds, they are then only looking for an alternative to the savings account, fixed deposit, NSC, PPF, etc. So, the objective remains similar. Debt funds can’t guarantee returns, but a liquid fund can offer an alternative to savings account; a bond fund can replace some of your allocations to fixed deposits. Debt funds also have better liquidity than NSC/PPF. So, it is a great option, but only when managed with a view to keep the risks low and portfolios liquid.
Prior to 2013, the major risks that investors faced from debt funds was interest rate risk. But after 2015, we have seen a very high level of credit risk being taken. This was not only in credit risk funds but across the board and thus we have seen even liquid funds, which is supposed to be the safest category, suffering defaults. The industry is trying to take risks to earn that extra 0.5-1.0% from its investments in a product where the investor’s objective is to keep it safe, liquid and simple.
Even investors turn greedy and they tend to redeem from funds, which do not take risks and thus give lower returns. Firms, which rank and grade funds, we saw had the highest rating for funds which took credit risk. As of course, before the crisis, the credit risk fund where showing a high portfolio yield, but at the first sign of crisis, we have seen what has happened to their returns. Hopefully, everyone learns, and for the majority of the investors, funds, which do not take too much credit risk / interest rate risks and keep the portfolio safe and liquid should be the core allocation.
India has many junk companies and potential soon-to-be junk securities, but why does India have no junk bond market?
Arvind Chari: In India, everything takes time. I’m sure in a few years, learning from this crisis and with better regulation and infrastructure, we will see the development of a junk bond market and also the development of junk bond funds and investors. The introduction of the Insolvency and Bankruptcy Code (IBC) is a great move in developing the required ecosystem for the junk bond market and junk bond funds to exist, survive and thrive.
A developed market like US has a handful of AAA-rated debt issuers. In comparison, why does India have so many AAA rated issuers? We have seen even triple-A rated issuers default....Are our credit rating agencies doing the job as well as they should?
Arvind Chari: I think in a recent seminar, an ex credit rating official, stated that, if India were to apply the global standards of rating in India, then there would be very few AAA companies in India.
Pankaj Pathak: When you manage money, you can’t depend only on an external credit rating agency to do your job. As if the company defaults, you can’t say that the credit rating agency messed up. Ratings are only for validation. We have to do our own proprietary credit research before investing. And I would say that is required even for some ‘AAA’ rated PSU companies. As we saw with banks, many of them were downgraded. So as a fund manager, you can loose money even on downgrade. So, you have to careful, especially in mutual funds, we are managing other people’s money. It is a fiduciary responsibility.