Home > Finance > Debt funds fiasco: From IL&FS crisis to Templeton fiasco, how & why the debt market crisis unfolded

Debt funds fiasco: From IL&FS crisis to Templeton fiasco, how & why the debt market crisis unfolded

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By Deepthi Mary Mathew


Indian debt market has had a tough ride for a few years now. The slowdown in the domestic economy and the liquidity crisis following the IL&FS fiasco had bruised the debt market sufficiently in the pre-Covid months. And then the lockdown and other restrictions following the outbreak of the pandemic only accentuated the situation.

In

a recent episode, Franklin Templeton Mutual Fund wound up six debt mutual fund schemes. The fund house cited high redemption pressure and lack of liquidity in the bond market as a main reasons for the decision.

Liquidity crunch and risk aversion have been major issues plaguing the financial sector for some time now. In the current scenario, there is a tendency among the investors to dump risky assets and turn to safe havens amid an uncertain economic outlook. This has, in turn, led to increased redemption pressure in the debt market that fuelled the liquidity crunch. While RBI has announced various measures to ensure liquidity in the market, its effectiveness seems to be limited.

RBI announced Special Liquidity Facility worth of Rs 50,000 crore for mutual funds. Similarly, the central bank has also conducted Targeted Long-Term Repo Operation (TLTRO) with a similar objective.

Risk aversion was dominant in the economy, and it got further heightened in the current crisis. For instance, the asset quality review (AQR) initiated by RBI in 2015 made the banks risk averse as they were in a hurry to clean up balance sheets. The IL&FS and DHFL crises that ensued made the situation even worse, as banks became more cautious in lending.

The economic slowdown coupled with risk aversion made it difficult for bond issuers to raise money from the debt market. The NBFC sector was the worst affected, as they mainly rely on issuance of commercial papers to meet credit requirements. However, the IL&FS episode restricted NBFCs borrowing from the debt market, as mutual funds limited their exposure to NBFC securities.

Consequently, several sectors such as real estate faced huge liquidity crunch, as they relied mainly on NBFCs for funds. It needs to be highlighted that the collapse of IL&FS was linked to a structural issue in the economy, as it was the result of a delay in the commencement of various projects due to issues involving land acquisition. And that crisis played a major role in creating the risk- aversion, which resulted in the debt market crisis.

In the current scenario, business activities are being hit badly due to the Covid-19 pandemic. It creates an uncertain situation on whether bond issuers will be able to fulfil their obligations. The measures announced by RBI and the government only helped create buyers for top-rated papers. But there are no takers for the low-rated ones even at higher yields, as the risk appetite of investors weakened.

Debt funds that invested in these low-rated papers are in a difficult spot, as the investors are rushing for redemption. Similarly, the NBFC sector is cash-strapped with limited access to funds unlike banks. Thus, with limited liquidity in the NBFC sector, there are chances that NBFCs would delay or default on payments on securities held by debt mutual funds.

These developments underline the fact that more measures are need to strengthen the corporate bond market in India. Despite various initiatives, the performance of the debt market has not been up to the expected level. Issues such as high cost of borrowing and inadequate liquidity continue to dog this segment. It demands more measures from the regulators as a strong and healthy debt market is essential to meet credit requirements of business and industry in a growing economy.


(Deepthi Mary Mathew is an Economist with Geojit Financial Services. Views are her own)

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