In June 2020, India’s sovereign credit rating suffered a double downgrade. First, Moody’s downgraded its rating from Baa2 to Baa3, which came as no surprise as the company had rated the country higher than S&P and Fitch for the past three years. But most importantly, he lowered the evaluation outlook from a steady state to a negative one. Two weeks later, Fitch downgraded its rating outlook to negative (PPP-). These two actions last summer exposed India and its major corporate bond issuers, The country’s sovereign debt is something the country has not experienced since 2007, with the prelude to downgrading it to a “junk bond” category.
As the Govt-19 eruption has been a catalyst for revaluation changes in June, it is understandable that market concerns about the catastrophic development of epidemics have increased in recent weeks, which could now trigger India to downgrade below its critical investment. Quality. Of course, the humanitarian catastrophe that is occurring in the country, which is rapidly increasing in both epidemics and deaths, is putting great pressure on the national public service, while strain will inevitably lead to the adoption of new occupation closures to control the spread of insufficient social distance in the country, as well as the most severe new origin.
In fact, the country is witnessing an unprecedented increase in Govt-19 cases: 2.3 million new cases have been reported in the last 7 days alone. Although the resurgence of the virus in India can be seen across the country, the large political rallies that took place in the elections in five Indian states were certainly a contributing factor. So was the celebration of Kumbh Mela, an important Hindu religious gathering, which is often regarded as one of the largest gatherings of human beings on the planet that occurs once every twelve years.
In this terrifying environment, one can expect Indian markets to fall. However, the market reaction so far has been quite subdued. Since the beginning of March, India’s key Sensex has fallen just 3% and is in positive territory so far this year (until March 27). The Bloomberg Barclays USD Credit India Index is also positive this year, a surprising fact considering the evolution of the US Treasury’s base yield since January. In other words, there are very few signs of tension in the market, let alone panic on both Indian stocks and bonds.
Of course, there are structural explanations for this surprising resistance. For years, India has been a “source of diversification” as foreign investors seeking to expose Asia have been overweight forcing Indian stocks to offset China’s dominance in Pan-Asian markets. The absence of India’s new problems certainly justifies this situation from a bond market perspective. Meanwhile, recent volatility in some segments of the Chinese credit market, including weak bonds from state-owned companies and asset makers, has increased India’s attractiveness as a regional counterweight. However, the key question is whether the market will allow us to look at the growing risks in the Indian economy as there is still a strong demand for Indian bonds.
India has had its share of market fears in the past. In 2018, the surprising bankruptcies of IL&FS Investment and Diwan Housing Finance triggered a decline in the non-bank financial institutions (NPFCs) sector. This is part of the reason why NPFCs should be concerned, as the sector could suffer a major downturn in economic activity as a result of the recent Govt-19 spike. However, we believe the current situation is much different than in 2018.
At the end of 2018, following the bankruptcy of IL&FS, NPFCs had difficulty in obtaining funding due to the prevailing public market sentiment. At the time of the bankruptcy of IL&FS, mutual funds were the main liquidity providers for NPFCs, thus allowing them to repay the loan. However, as large mutual funds have been affected by the bankruptcy of IL&FS, the NPFCs’ financial drought has caused panic among NPFCs, their shareholders and their securities.
Today the situation is very different. Both mutual funds and NBFCs learned from the IL&FS crisis. As mutual funds continue to reduce exposure to the NBFC universe and become more selective with the names of the underlying assets, NBFCs have also diversified their financial resources, usually through ownership of their assets. NBFCs also realized that short-term borrowing was not sustainable due to low interest rates and the use of long-term loans. The share of non-convertible securities and pledges, which accounted for 54% of total NBFC funding in 2018, fell to 34% in 2020. Despite the high cost, the sector has now developed towards a fairly stable business model of adjusting the tenure of assets and liabilities. Growth expectations at IL&FS have also fallen to single digits from the high growth rate of the pre-crisis decade. Investors and banks differentiate between good and bad depending on the quality of the underlying assets, the composition of the loans and the credit rating. From a portfolio perspective, we see strong opposition to exposure to NBFCs in our stock and bond funds.
We do not rule out market risk and hope that both the Indian market, equity and fixed income will be subject to some fluctuations in the short term, at least until the latest Govt-19 spike comes under control. However, in the context of a pan-Asian perspective, we believe that maintaining Asia’s third largest economy for diversification purposes would be even more beneficial, as individual positions are carefully managed and monitored.
Meanwhile, as for the sovereign rating, Fitch confirmed its PPP-investment rating for India this week, following a similar move by Moody’s two weeks ago. While the outlook for both companies is negative, it has eliminated short-term risk. Fitch acknowledges the recent increase in Govt-19 cases, but does not think it will erode the country’s economic recovery. In fact, market ratings are satisfying beyond short-term helmets to focus on medium-term growth. The next few weeks will be crucial in assessing the real economic impact of the human catastrophe that lies ahead of us.
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