We can be blind to the obvious, and we are also blind to our blindness. This profound observation is explained by Daniel Kahneman with the acronym WYSIATI—‘what you see is all there is’. Belief in WYSIATI yields no allowance to factor in gaps in the knowns and the unknown and leads to construction of a narrative to fit the conclusion.
For the past few weeks, in episodic bursts of panic, India’s stock indices have plummeted from historic highs and wiped out the gains of the calendar year. The benchmark Nifty50 has slid from 11,760 to 10,303 points and the Sensex from 38,859 to 34,315 points. Indeed, in just four weeks, the Nifty50 has given up 8.26 per cent of gains and the Sensex 7.56 per cent—year-to-date returns on Nifty 50 are at minus 2.16 per cent and on S&P Sensex at 0.76 per cent.
For sure sentiments are impacted by a triangulation of rise in interest rates in the US, the spiralling of crude oil prices and the dwindling value of the rupee. It is equally true that the US Federal Reserve has hiked rates six times since March 2017, crude prices have risen to USD 80 from USD 52 per barrel of Brent in April 2017, and the rupee has slid from Rs 64 per dollar to Rs 74 per dollar. This did not stall the rise of the stock indices to historic highs in August. Since September, the fall in the stock markets has eroded an estimated Rs 20 lakh crore of public savings and investments.
The question that needs to be addressed is do markets know what the regulators, RBI and SEBI do not. Are the markets spelling out fears which the regulators are shying from calling out? Alan Greenspan, the colossus who coined the phrase irrational exuberance and is routinely panned for his let-the-bubble-burst-before-you act thesis, has been witness to both euphoria and despair in the markets. Greenspan warns, “Contagion is the critical phenomenon which causes the thing to fall apart.”
Contagions are caused by and are a consequence of action and inaction. The saga of IL&FS, India’s shadow infrastructure banker and investor, represents the state of sloth in the system. It is true that the management of IL&FS stinks of scandal. It is equally true that unpaid dues have aggravated the crisis. The good news is that the government has put in place a new board to review the state of affairs and recommend repair. But what about past defaults and the demands for redemption that will follow? IL&FS owes over Rs 34,400 crore to banks, of which Rs 23, 900 crore is to public sector banks. What is stopping the government from creating a senor paper to cover the obligations of IL&FS? Contagions are not deterred by pious promises but by action.
There is a need to look beyond the IL&FS saga at the structural factors to comprehend the fear of contagion. The rise of indices and market capitalisation was fuelled by much-discussed domestic inflows. In August 2018, the value of assets under management in mutual funds was around Rs 25 lakh crore. Just over half of the funds, that is 53 per cent or roughly Rs 13 lakh crore, came from retail investors, and the rest from institutional investors, including enterprises which must invest in treasury operations pending deployment of funds. Arguably, nearly half the assets with mutual funds, particularly debt funds, could be vulnerable to institutional indebtedness, illiquidity and redemptions forced by defaults by issuers and borrowers.
Now juxtapose this with the rise in role of NBFCs in credit delivery. The share of credit disbursal by NBFCs, including housing finance companies, has risen sharply to 16 per cent even as the share of public sector banks dropped to 51 per cent—just under retail credit NBFCs have a loan book estimated to be around Rs 7 lakh crore. As banks could not lend further they passed on the borrowers to NBFCs. Add credit to enterprises in the construction and infrastructure sectors.
So how did NBFCs fund their growth, where did they raise the money from? And how does this work in terms of tenure of borrowing and lending? The money is raised in CPs and CDs for periods ranging from seven days to one year. Typically, the standard operating formula of NBFCs is to borrow in the short term and lend in the long term, be it for housing or roads. The mismatch of borrowing and lending tenures is no secret and is known to RBI. Indeed, lending by banks and housing finance companies too is backed by short-term monies and is deployed long term. Ergo, the recent RBI sermon to the financial sector is kind of rich!
Who are buyers of the issued paper? It is estimated that as of August 2018, mutual funds have over Rs 2.48 lakh crore of paper issued by NBFCs. To appreciate the risks of contagion, factor the known unknowns: a borrower goes bust aka IL&FS, a mutual fund struggles to fund redemptions aka the DHFL episode, a borrower is downgraded aka the Supertech scare. Now add the unknown: enterprises who borrow for operating expenses and invest in debt or equity and are stranded—the debt market is illiquid and returns on equity are negative.
The spectre of the Trump trade war with China, the November 4 deadline for sanctions on Iran, the recent dismemberment of a Washington Post columnist in the consulate of Saudi Arabia, the threats and counter-threats do have implications for the market that are yet to play out. Just in 50 days since September, foreign portfolio investors have pulled out over Rs 55,000 crore—and the fear of contagion is spooking both foreign and domestic investors.“Fear and euphoria,” Greenspan explains “are dominant forces, and fear is many multiples the size of euphoria.” The observation made following the 2008 crisis is worth remembering.
shankkar.aiyar@gmail.com