India Ratings and Research (Ind-Ra) expects interest rates to stabilise at the current level and the Indian currency to undergo structural changes. The agency believes culmination of the rising growth-inflation dichotomy and a sustained improvement in the balance of payment account will become crucial determinants for ensuring ultra-loose monetary policy conditions by the Reserve Bank of India. Ind-Ra opines the near-term conditions in the credit market would be cautiously optimistic.
During the COVID-19 outbreak, abundant liquidity in debt capital markets has played a major role in alleviating excessive risk version sentiments and common funding challenges prominent during a the crisis time. The Reserve Bank of India (RBI) has taken various steps to encourage banks to lend to entities in need and mitigate the impact of cash losses during the lockdown. This was further aided by the regulatory forbearances and targeted fiscal support. All these have ensured capital flows to a large section of borrowers and lenders at a cheaper cost. Though the access to capital and bank credit was largely concentrated among few top-rated borrowers during the initial months, the access to capital for lower rated borrowers has improved recently.
The agency believes that debt capital markets will remain conducive for AAA and AA category borrowers. However, the damages in the economy due to the pandemic is not something to go away anytime soon; therefore, it needs to be monitored and examined. A fragile and two-track recovery both at the macro and micro levels would keep the financial condition unstable. In this regard, the agency believes that benign monetary policy conditions could only act as an enabling factor, and for broad-based recovery on a sustained basis, a combination of massive private and complementary public spending is necessary.
Rating Actions during COVID-19 Outbreaks: Ind-Ra expects the pressure on corporate credit profile has not abated, though regulatory forbearance and restricted business activities have provided an initial breathing space. Ind-Ra in its Mid-Year Mid-Corporate Outlook opines the eligible issuers impacted by COVID-19 and primarily rated in the investment grade (BBB and below) category could benefit from the RBI’s debt restructuring scheme over FY22 and FY23; however, issuers rated in the speculative grade (BB and below) category who are ineligible for the restructuring scheme could see negative rating actions. Ind-Ra opines that the intensity of rating downgrades, including defaults, particularly for leveraged entities and entities lower on the rating scale, will depend on the effective transmission of the recently announced economic stimulus package and banks providing timely and adequate funding support. For the financial sector, while most of the entities rated by Ind-Ra have adequate short-term liquidity and capital buffers, the sustainability of overall recovery, conducive credit flows and collection efficiency over the next couple of quarters will be a key monitorable.
Currency to Undergo Structural Change: Ind-Ra believes the that the dynamics of global trade conditions will remain fluid, and the COVID-19 outbreak has intensified such tension. Key factors such as the rejigging Chinese economy in terms of domestic growth and easing capital account restrictions would have a significant impact on the emerging currencies. Moreover, the US economy is undergoing changes. Additionally, the policy makers in the South East Asian countries are actively engaging in attracting a portion of manufacturing base to the respective countries. On the other hand, monetary policy conditions have also undergone massive changes by adopting massive quantitative easing through various means. In the backdrop of these structural changes in the trade, capital and contour of monetary policy, Ind-Ra believes the underlying currency would find new normal in the medium term, followed by a bout of volatility in the short term.
Rate Transmission and Shift to Capital market: Ind-Ra believes rate transmission, incrementally in both capital market and banking system, will be sluggish. This is largely to do with the fading-out expectation regarding a further monetary easing and resurgence of growth-inflation dynamics. Moreover, the massive surplus liquidity and buoyant balance of payment account would add liquidity in the system, therefore limiting scope for open market operations by the RBI.
The agency, believes, that the buoyant capital market and attractive rates will continue to garner borrowers’ interest to shift away from the conventional banking system to capital markets, especially for the short-term funding requirement. Whereas in one- to three-year buckets, borrowers would benefit owing to intense competition between banks and capital markets.
Lenders are Better Capitalised: In the wake of COVID-19 led full-blown crisis, both large banks and large non-banking finance companies have raised capital. On the other hand, system liquidity has been increased to abundant (around 5% of net demand and time liabilities) from adequate (1%). Therefore, the liability side of financial institutions, especially for large entities, has been reinvigorated. Ind-Ra believes this will be conducive for a recovery, subject to stability at both the external and domestic credit spaces.
Key Risks: Ind-Ra believes the buoyancy in capital markets has largely been driven by the abundant flow of funds at a cheaper rate. Most of the global central banks have resorted to quantitative easing during the crisis period in a meaningful way, which was unconventional till sometime back. A combination of pumping money in both targeted and non-targeted ways and strong assurances by the respective central banks has made the sentiment in the capital market agile.
In the Indian context, the prospect of further leveraging households’ balance sheets appears limited, given the skewed distribution of income. Therefore, the aggregate demand in the economy would have to be largely dependent on push factors such as spending by government, private sector or exogenous factors e.g. a meaningful improvement in exports. In absence of that, the underline risk to recovery would largely remain elevated and the agency believes that a fragile recovery could pose challenges to the capital market sentiment. In this regard, the agency believes coming 12 months would be extremely crucial, given early recovery condition, and have to be well guarded through the policy intervention or redistribution of income.