Dollar Shortages To Debt Fund Strains, Red Flags  Neelkanth Mishra Is Watching
A danger sign hangs across a walk way in the crusher room in the underground mine. (Photographer: Carla Gottgens/Bloomberg)

Dollar Shortages To Debt Fund Strains, Red Flags Neelkanth Mishra Is Watching

The possibility of dollar shortages, rising corporate bond yields and availability of credit are some of the strains showing up across Indian financial markets, which authorities must try and quell as India deals with the fast-evolving impact of Covid-19. That’s according to Neelkanth Mishra, India strategist at Credit Suisse.

While regulators will need to take steps to ensure the smooth functioning of the markets, growth will need large fiscal support, said Mishra, who spoke to BloombergQuint in an interview on Friday.

Dollar Shortage & Liquidity Strains

Among the first issues to crop up is the reduced availability of dollars. Mishra explains that when global trade and supply chains stall, the velocity at which dollars are circulating in the global financial system drops. Parallel to that, risk aversion drives outflows from emerging markets raising the demand for dollars. This creates an imbalance.

“Some of the responses from the U.S. Federal Reserve, such as the forex swap lines being offered, were in response to the dollar funding problem,” said Mishra, adding that money has flown out of emerging markets at a pace faster than the global financial crisis.

The shortage of dollar and dollar funding, in turn, creates a credit problem.

As of the latest data available, India had $107 billion in short term external commercial credit. Of this, $103 billion was in the form of trade credit.

With no dollars available, these firms will have to tap into the domestic financial system. But apart from the already existing strains in the Indian financial sector, the smaller private banks have also turned cautious after the Yes Bank moratorium. This is worrying,
Neelkanth Mishra, India Strategist, Credit Suisse

To be sure, the Reserve Bank of India has offered $4 billion in long-term forex swaps and has also been seen selling dollars in the spot market to keep markets liquid. Central banks will have to adopt a “trial and error” approach because there is no clear rule book to deal with this, Mishra said.

Equally, liquidity strains are emerging across mutual funds, where secondary market trades have pushed up bond yields. Over the past week, even blue-chip non bank lenders have seen their commercial paper trades at yields of close to 8 percent.

Watch the full interview below:

Assessing The Business And Stock Market Impact

Assessing the precise economic impact, particularly of the recently announced lock-downs across a number of states, is difficult. Equally difficult is judging the stock market impact, Mishra said.

The first wave of selling, coming mostly from foreign investors, has been indiscriminate. “It’s clear that people are selling what they can and not what they should.” While Mishra hopes that first phase is over, he cautions that it is difficult to be sure at this stage.

Once the first wave of selling abates, investors will first need to assess the size of economic damage. “We have to see what steps are going to be necessary to control the spread of the virus or to make it manageable...Does that mean a three-month or six-month clampdown? Will we see a second wave (of infections)? All those uncertainties will need to be resolved,” Mishra said.

Right now there is an uncertainty discount in the market and only once that uncertainty ends does the market bounce, he added.

Once the liquidity issues are tackled and there is clarity on the level of economic sacrifice needed to contain health risks, investors will need to judge who takes the losses.

For instance, at present, there is a concern that retail loan defaults may spike due to loss of income. “Should the banks bear that? Should over-leveraged borrowers take responsibility? Or is it better to have regulatory forbearance? Those decisions will help us allocate the costs,” Mishra said.

And finally, an assessment will need to be made on how soon economies and businesses can expect to go back to where they were in January, before the Coronavirus spread worsened.

All of these things need to happen for the market to get back to normal. And I would say that is still some time away.
Neelkanth Mishra, India Strategist, Credit Suisse

The Policy Response

For now, policymakers have a number of immediate issues to tackle.

Managing lockdowns, such as those announced across a number of states, will mean ensuring that daily wage workers don’t need to step out to make ends meet. “I see no other way than to ensure that their lifestyle is maintained,” said Mishra, referring to the need for some form of cash transfers.

Jan Dhan accounts can be mined to determine a set of people who need most immediately by looking at average balances and transaction history. While there will be leakages, we may have to live with it in the interest of providing timely relief, Mishra said. “You have to act within days and not months later.”

In rural areas, Mishra suggested, that the demand-led rural employment guarantee scheme be used to ensure incomes to workers who may have migrated back from cities.

Within the financial markets, refinancing lines to mutual funds may be needed and steps may need to be taken to keep corporate bond yields in check. Some form of credit guarantee can also be used to ensure lending doesn’t freeze, Mishra said.

The government could consider back-stopping some of the potential losses on loans, for instance to small businesses, to ensure that banks keep lending, Mishra said.

At a macro-economic level, a further fall in nominal growth, which seems inevitable, will mean that policy interest rates will need to be bought down. That may be mostly signalling, Mishra said.

The central bank will also need to step up purchase government bonds so yields don’t rise. “It is clear that there needs to be a fiscal stimulus, you don’t want bond market worrying about who will buy those bonds,” he added.

According to Mishra, all of these steps can help in orderly functioning of the markets. In order to support and revive growth, the government will need to step in.

I think the monetary and financial system can be just made to function better but the revival in growth may need very strong fiscal measures.
Neelkanth Mishra, India Strategist, Credit Suisse

Also read: It’s Time To Start Putting Cash To Work, Says Morgan Stanley’s Ridham Desai

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