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Posted on 08-Mar-2019 Comments  0

Liquid Funds

SEBI tightens the screws but it was long overdue

The last board meeting of SEBI made two very far reaching changes for liquid funds. For long, liquid funds have been the preferring parking place for corporates to keep money for the short term. Not only were liquid funds secured and tax effective, but the returns were at least 2-3% higher than bank deposits. So, what has changed?

How liquid funds operate?

To a large extent, the liquid funds managed to operate riskless in the market for two reasons. The liquid funds were backed by a portfolio of assets where were very short term assets like call money, CPs, CDs etc. Secondly, the liquid funds did not have to make a provision for MTM losses if the tenure of the bond was less than 60 days. Only for paper above 60 days maturity, the liquid funds were required to provide MTM provisioning. It was here that most liquid funds saw a huge opportunity. Good quality companies were raising funds through the commercial paper (CP) route. That was not the problem. The real problem was that the issuers of CPs were actually deploying these CP funds in long term infrastructure and realty projects. This created a huge risk of mismatch between liabilities and assets. In fact, that is where the entire crisis erupted. Financial companies raised hundreds of crores from liquid funds flush with cash. When they became due, they were just rolled over and it almost looked foolproof.

What has SEBI changed?

The IL&FS fiasco created a mini crisis for liquid funds in particular and NBFCs in general. Money markets became tight as lenders were just not willing to take on the risk at lower yields. SEBI was more interested in protecting investors. SEBI has, therefore, reduced the mandatory MTM provisioning period from 60 days to 30 days. Since MTM is a tough task to follow, most fund managers are now expected to reduce the average maturity of the fund lower and bring it closer to where MTM would not be required. The only challenge is that as you shorten the maturity of your fund holdings, you are forsaking on yield. In fact, conservative estimates are putting the total damage to yield of liquid funds at around 15 bps. That is a big difference for institutional investors. In addition, the gap between the fair value and stated value has also been compressed substantially.

Curious case of subsidy

One of the major objections that SEBI had on the liquid funds issue was that the small investors were subsidizing the large institutional and corporate investors. The 60 day leeway from MTM was actually working against the small investors. SEBI is right in the sense that corporates should know their risks and assume risks accordingly. If the outflows are any barometer, liquid funds may end up becoming leaner and meaner!

FII Buying

The FIIs are back with a vengeance into buying Indian equities

Suddenly the FII buying appears to be back with a vengeance. In fact, since the third week of October, the FIIs have infused close to $3 billion into Indian equities. That is a sharp infusion in a short period of time. What exactly is driving the spurt in FII flows. Let us look at 3 reasons why the FIIs are back!

Politics favoring the NDA

FIIs love stability and had been keen on the current political dispensation continuing at the centre. That looked like a fait accompli till the Congress turned the tables in 3 state elections. However, the narrative has changed substantially in favor of the ruling NDA now. The Pulwama attack managed to unite Indians like never before. But, what really mattered was the follow up action. In less than 2 weeks, the Indian Air Force had struck at the core of the terrorist camps in POK. But the bigger victory that India gained from the episode was diplomatic. Even the traditional allies of Pakistan like the US, China and the Islamic Middle East did not say a word in favor of Pakistan. It was this fear of isolation that forced Pakistan to take the high moral ground and send the captured Indian pilot back. In the entire exercise, Modi scored a moral and, perhaps, political win. The decisiveness was shown, the diplomatic phones were worked and South Asia avoided the prospects of a dangerous war between two nuclear nations. That sagacity should work in favor of NDA.

FIIs like the economics too

If FIIs liked the way Indian politics is shaping, they find reasons to rejoice on the economic front too. Inflation has remained low and the manufacturing sector is seeing a smart revival. The twin challenges of the Indian rupee and oil prices appear to have a semblance of stability now. FIIs are also impressed by the fact that the overall revenue growth of Indian corporates and the pressure in the last quarter was more due to pressure on the bottom line. That is not likely to be the scenario in this year. 

India could also be a TINA story

The TINA factor is all about there being no alternative. That may be a tad presumptuous, but FIIs are beginning to see the logic. Even at annual growth rate of just 7% this year, India remains the only large economy to show double digit nominal growth. Unlike other economies which tend to be cyclical, India is naturally de-risked. India does not have the commodity dependence of Latin America or the China dependence of South East Asian economies. India has the advantage of a huge and growing domestic market, which should be able to absorb most of the global shocks. The TINA factors, perhaps, best explain why FIIs are swarming into India. If favorable politics combines with favorable economics, FIIs may be laughing all the way to their banks. For that we have to wait for elections!

Essar Steel

It is fair and justified that Arcelor Mittal gets Essar Steel

The NCLT Ahmadabad bench has given its verdict on the Essar Steel case and it has gone in favor of Arcelor Mittal. Notwithstanding the fact that the Essar promoters were willing to pay a higher price for Essar Steel, the NCLT bench has decided in favor of Arcelor Mittal. So, Essar Steel will now be part of Arcelor group for a consideration of Rs.42,000 crore. First the background!

How the Essar case unfolded

After the bidding was completed and Arcelor had emerged as the winning bidder, the Essar promoters decided to put in a much higher bid. The Ruias bid was at Rs.54,389 crore against the Arcelor bid at Rs.42,000 crore. In fact, Essar Steel would have been technically able to pay not only the financial creditors without haircuts but also the operational creditors. That was the reason many operational creditors of Essar had openly come out against the Arcelor bid. The final decision is subject to review but it virtually means that the company now gets sold to Arcelor. For Arcelor, it gives access to another 10 million ton steel mill in the fast growing Indian market. After all, the steel industry is expected to see demand tripling by 2030 and that is what most of the NCLT buyers are currently betting on. Also, this will be the biggest single bid under NCLT; larger than the Rs.35,000 crore bid for Bhushan. The decision to prefer Arcelor over the Ruias is not only justified but also tenable.

Arcelor is right; Ruias are wrong

The technical difference between the Ruia bid and the Arcelor bid was that the latter was through the normal NCLT process. One of the core purposes of NCLT was to expedite and so delaying it indefinitely would defeat the purpose. The Essar case had already exceeded the 270 days time limit. Secondly, if the Ruias really wanted to pay off the debts, they could have done it during the settlement period or privately had talks with bankers to resolve the issue. The NCLT bench is right in the sense that once the NCLT choice is opted for, then it must be respected. Also, NCLT cases must not become an opportunity for defaulting promoters to gain entry into their company through the back door at a lower investment. That is not done!

Issues of corporate governance

The NCLT had already received flak in the Binani Cements for having allowed Ultratech to come in later. NCLT deals should strictly prevent any negotiated between promoters and potential buyers. That defeats the purpose of NCLT, which is based on transparency. If parties are allowed to cut deals outside the purview of NCLT, it is likely to largely undermine the entire process. The Ruias deserve to lose control of Essar Steel as they have over the years raised billions of dollars from banks and capital markets and defaulted on them. That surely leaves a lot to be desired!

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