Lack of liquidity in market fuels weaker borrowers' woes

By Rahul Satija and Divya Patil

A credit crisis facing lower-rated Indian borrowers is deepening and the lack of liquidity in the rupee corporate bond market is making matters worse.

The number of note sales by firms that don’t have an AAA rating has dropped to nearly a decade low this year, as fund managers seek refuge in the highest-quality credits. The extra spread that investors demand to hold short-term AA rated debt over AAA notes has also risen to its highest in about nine years.

The pandemic has made it harder for noteholders to sell lower-rated debt in a pinch. It is also prompting investors to eschew such securities due to concerns that smaller companies will be worst hit by the economic fallout. A funding shortage for smaller businesses -- the bedrock of India’s $2.7 trillion economy -- comes at a time when they need money the most to counter the financial impact of the crisis.

The importance of liquidity was dramatically illustrated to local bond investors in April when Franklin Templeton, a large investor in weaker Indian companies’ debt in recent years, abruptly shut six funds in the biggest-ever such forced closure in the nation.

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“Investors like mutual funds are avoiding investments in non-AAA corporate bonds as there is a fear of illiquidity,” said Murthy Nagarajan, head of fixed-income at Tata Asset Management Ltd. “The other worry is that due to COVID-19, business operations have been hit massively. We still don’t know clearly what and how much exactly is the financial damage.”

The rush to quality is causing a growing divide between AAA and lower-rated issuers, with the highest-quality names selling 3.11 trillion rupees ($41 billion) of notes so far this year. That is nearly four times the total from weaker borrowers in the same period, and compares with 2.8 times in the year-earlier period..

To keep India’s bond market from freezing, the government and central bank have undertaken an array of measures, from guaranteeing some bank loans to businesses to cutting benchmark interest rates to the lowest level since at least 2000. A central bank-initiated moratorium on loan repayments by individuals and businesses that runs to the end of August is, for now, helping alleviate some of the pandemic-related pressures on borrowers. What happens after the debt payment freeze is a big concern, however.

“Most of the banks’ and non-bank financial companies’ loan books are under moratorium, hence how should investors gauge if the companies will service their debt once the leeway ends?” said Tata Asset’s Nagarajan. “The economy needs to improve, companies need to improve balance sheets and cash flows to attract investors back.”