It can be well-argued that the current liquidity crisis fears soaking the Indian markets are linked to IL&FS’ multiple defaults. There is fear and concern that there are more skeletons in the cupboard. Nobody knows that for sure, but the chaps at rating agencies were supposed to know their job. With the defaults and reactive downgrades, there is a question mark over the role of these credit rating agencies. At the same time, the Indian government has found itself firefighting continuously.
Side by side, the Indian rupee is plumbing new depths against the greenback. As if to add salt to injury, retail fuel prices are now pinching the middle-class. It’s not a mumble anymore, it is a grumble. Inflation has automatically made the central bank cautious and using its most commonly used tool – interest rate hike – can threaten the Indian growth story being sold to global investors. Still, the government of the day has shown maturity and good sense to come out with measures to steady the ship. RupeeIQ takes a look at the five things being done by the government to control the situation. We also add two more steps that you could see in the future.
1) Govt to borrow less
The government’s borrowing for 2HFY19 has been pegged at Rs 2,47,000 crore, down from Rs 2,88,000 crore in 1HFY19. This is a reduction. Gross market borrowing has been cut from Rs 6,05,500 crore to Rs 5,35,000 crore.
The Rs 70,000 crore cut in gross borrowing will be met through higher inflow into small savings given the recent increase in small savings rate, and partially through a reduction in buybacks, says Teresa John, Economist – Institutional Equities, Nirmal Bang.
The government remains committed to its 3.3% fiscal deficit target, and will try and meet it even if it warrants a cutback in capital expenditure or other measures. The government’s lower borrowing programme did enthuse investors, at least initially. The 10-year generic government bond yield, which last closed on 8.02%, opened at 7.9% on Monday and finally closed at 7.98%.
2) Govt’s IL&FS takeover
IL&FS and its mountain of Rs 91,000 crore debt have been worrying. Capital markets have been nervous about a Lehman like blow-up even though IL&FS did not leverage. On Monday, the government stepped in. The Narendra Modi government moved to take immediate control of Infrastructure Leasing and Financial Services (IL&FS). The National Company Law Tribunal has granted approval to a petition made by the central government.
This is like a redux of the Satyam episode when an accounting scandal threatened the confidence of the IT sector. The government has the NCLT nod to replace all IL&FS board members.
The new board shall hold a meeting and report the roadmap for IL&FS before October 8. The new six-person IL&FS board will have a mix of bankers and ex-bureaucrats – Uday Kotak, G.C Chaturvedi, Vineet Nayyar, Malini Shankar, Nand Kishore and GN Bajpai.
While a new board is a great move to assuage ruffled feathers in the capital markets, it will have to seriously look at the bad assets at IL&FS and come up with solutions. Of course, the government’s intervention could now mean that the IL&FS’ restructuring plan that secured shareholder support is in a state of flux.
3) Import duty hike
On the import side, the government has decided to raise import duty on 19 items. We don’t know whether this is a case of good optics or not. But, the intention behind the move is to lower overall imports.
The import duty hike on the 19 items can potentially affect the total value of imports estimated at over Rs 85,000 crore. That is 3% of merchandise imports. The higher tariffs could help the domestic industry survive and compete.
India is a net importer country. So, reducing even a small bit of import should theoretically help. But if you assume that the 19 item import duty hike will solve all problems, that’s a wrong approach. The items on which import duties have been raised include ACs, washing machines below 10 kg, refrigerators, compressors, speakers, footwear, non-industrial diamonds etc.
4) Oil relaxation
Higher crude prices, or rather boiling oil, has been a persistent headache for the Indian government. So, a step in that direction was always on the table. According to a Reuters report, the government has for the first time allowed state refiners to buy 35 percent of oil imports in tankers arranged by the seller. This is supposed to enable them to swiftly tap cheaper cargoes.
The Indian government has to prepare for November 4. It is on that date when US President Donald Trump prepares to halt Iranian oil sales through a new set of sanctions that take effect from this day .
A surging oil import bill in the face of rising oil prices and a weaker Indian rupee is a deadly cocktail that India can’t afford to gulp down.
6) A likely 25bps rate hike on Oct 4
There is a strong expectation of a 25 basis points rate hike at the Monetary Policy Committee (MPC) meeting on 4 October, 2018. This is very much on the table given the sharp depreciation of the Indian rupee over the past two months. The RBI may also try to hike it by 50 basis points in one shot, to give shock treatment to debt markets.
The Indian financial world is waiting for the RBI to take a call on policy rates. If rates are increased, this would neutralise the increase in US Fed rates. The Fed rate activity is being blamed for the movement of the US dollar away from emerging markets. A higher interest rate in India can also help arrest further weakening of the rupee.
7) FOMO to OMO
RBI’s Open Market Operations or OMO purchases in an environment of tightening liquidity are something we could see next.
The Indian equity markets even a few days ago were ruled by FOMO – Fear of Missing Out. Throw in a default, a weak rupee and possibility of a liquidity crisis in a seasonally tight September month…and voila! You may get OMO.
At least that’s what top economists expect RBI to do next. “We highlight that time is running out for RBI to step up OMO as we enter the October-March ‘busy’ industrial season. After plugging in Friday’s borrowing calendar, our liquidity model suggests that the money market deficit will average Rs 50,000 crore in the December quarter even after Rs 90,000 crore of RBI OMO,” says Indranil Sen Gupta of BofA Merrill Lynch Global Research.
Bets are now on the RBI to do OMO of $40 billion plus by March if FPI flows end FY19 flat. So, far FPI outflows are in the $10 billion range. Many expect the RBI to issue an OMO calendar that will assure durable liquidity, contain rising yields, reverse FPI outflows and stabilize the rupee. Will it? Your guess is as good as ours.