Risk Aversion In Credit Markets Spikes Amid Coronavirus Fears

Risk aversion has spiked across local credit markets amid the rapid spread of the coronavirus globally and the increased detection of cases within India as well.

Unless the spread is contained, growth in the Indian economy could slow materially in the first quarter of 2020-21, economists fear. Concerns over weaker growth, along with sharp volatility in equity and currency markets, has rattled the credit markets as well.

After a brief reprieve, credit spreads, or the additional interest demanded by investors over government bond yields, have started to widen again.

Credit spreads for AAA-rated corporate bonds of a three-year tenure have widened from around 85 basis points at the start of March to 107 basis points as on March 17, according to the Bloomberg-FIMMDA Index. Credit spreads on AA-rated corporate bonds for three years rose from 156 basis points at the start of the month to over 172 basis points now.

Corporate bond markets are seeing the fallout of the nervousness in other asset markets, said Lakshmi Iyer, chief investment officer (debt) at Kotak Mahindra Asset Management Company. Even blue-chip corporates have not been spared, she said.

The movement in global markets has pushed paranoia back into the minds of investors, Iyer said. “Bond markets are now clearly reversing from the gains achieved slowly and steadily after the fallout from the Infrastructure Leasing and Financial Services Group and other corporate defaults,” Iyer added.

Credit spreads are bound to widen in a scenario where foreign investors are exiting and economic realities are looking difficult, said Arvind Chari, head, fixed income and alternatives, Quantum Advisors Pvt Ltd.

“We have seen a wave of selling in both the corporate bond segment as well as in the quasi-sovereign bonds segment as liquidity dries out in a negative environment like this. If the coronavirus continues for a few months demand will be permanently disrupted and there could be a severe material impact on economic activity,” he said.

Lower-Rated Issuers To Face The Brunt

While credit spreads have widened, easy liquidity conditions may mean that higher-rated corporates could still get funds, albeit at a higher rate.

Issuers rated BBB and below, however, may see the double whammy of lower availability and higher rates.

Macquarie Capital Securities, in a March 12 report, said credit spreads were widening for lower-rated corporates as money was chasing better-rated corporates. “While credit spreads for AAA-rated corporates have come down a bit, credit spreads for BBB-rated corporates have widened further implying most banks are reluctant to lend to lower rated corporates,” the report said.

Since then, the widening of credit spreads has continued.

Credit spreads for BBB-rated corporates in the three-year bucket have risen to 436 basis points now from 420 basis points at the start of the month.

Ajay Manglunia, managing director and head of institutional fixed income, JM Financial, said until the fears around the coronavirus ease, liquidity in the credit markets would be constrained. Market appetite even for AA-rated debt papers is low and there are few takers for BBB and below-rated issuers.

“Everyone wants to sit on cash not knowing when and where the next opportunity or redemption pressure will come from. At the same time, foreign investors are selling, creating liquidity issues and distortions to yields,” he said.

In particular, non-bank lenders may start to face pressure again, cautioned Fitch Ratings in a note on March 11.

An extended credit squeeze will likely exacerbate asset quality risks for the financial sector, which is already facing pressure from a general economic and property-sector slowdown, and an evolving Covid-19 situation, the rating agency said.

“These events add to the challenging operating environment for Indian NBFCs, with rising uncertainty over funding conditions in the near term,” it said.

Crisil Ratings said credit profiles of firms in sectors such as automotive components, renewables (solar), airlines, hotels, malls, multiplexes, restaurants and information technology could get impacted if supply disruptions continue beyond March.

“Clampdowns are increasing both within and outside India, which would curtail consumer mobility and lead to deferral of spending,” the rating agency said in a recent report. “Near-term liquidity is critical to ensuring confidence in timely debt servicing as businesses adjust to the fast-changing operating environment.”

The rating agency is monitoring 875 companies linked to these sectors and their ability to sustain operations and ensure timely servicing of debt obligations, it said.