Credit markets crisis: What caused it, what is in store and is it over? Find out

The past three months have been quite challenging for the Indian financial markets. Though they have recovered in October, the equity markets witnessed a correction of around 17% from their peaks. The currency has depreciated nearly 15% this year and the yields across the debt markets surged with the 10-year government yield crossing 8%.

Though emerging markets have been under stress in 2018 the last trigger in India was a credit default by IL&FS. It led to a massive sell-off in bonds and CP’s of the NBFC’s having exposures to real estate and housing finance companies fearing cross defaults and led to a mini credit squeeze. There was a massive withdrawal of funds from mutual funds as the scare of further defaults rattled the markets.

What led to this?

The NBFC’s have grown their balance sheets in the past five years by leaps and bounds as they gained market share ceded by PSU banks who have been battling with their NPAs and drag on profitability. The NBFC’s were supported by the post demonetisation liquidity surge which helped them to shore up liabilities as the system was looking to deploy excess liquidity.

The unintended consequence of this was the unsustainable leverage which these entities built-up ranging from 3-20 times of their capital. Leverage is not bad in times of growth but comes to bite when the liquidity tightens and as the global liquidity started to tighten.

The foreign portfolio investors (FPI) withdrew around $12 billion from the Indian equity and debt markets. Another issue is the mismatch of asset liability profiles of the NBFC’s i.e., reliance on the short end of the market and mutual fund’s (MF) one gets prone to uncertain events.

What’s in store?

Off late, the markets have shown signs of stability with all markets have staged recovery i.e., currency, equity and fixed income markets. It’s been a combination of global factors, oil coming down to 70 dollars giving the much-needed respite to the rupee. Also, the Reserve Bank of India (RBI) realising the gravity of the situation has injected Rs 1 lakh crore of liquidity in the system through OMO’s.

The credit markets have thawed a little bit and the NBFC’s have been able to raise /rollovers short-term debts from mutual funds. Banks have also opened their opportunistic tap for NBFCs acquiring assets for their PSL book.

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Is the crisis over?

We may have seen some respite in the credit markets but it’s going to be a long haul before the credit markets come to normalcy. An effective and non-disruptive resolution to the IL&FS case would be the biggest prerequisite.

The wires are interlinked spanning across the financial system. As IL&FS was at a point of time a deemed financial institution the bonds are held by a lot of Provident and pension funds and any default on them would have political and social ramifications.