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Debt market crisis leads to contagion effect on equity markets

After the defaults by IL&FS in the past month, liquidity crisis fears are gripping the debt market

September 23, 2018 / 10:51 AM IST
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At a time when the debt market is still reeling from the defaults made by the Infrastructure Leasing and Financial Services (IL&FS), the equity markets paid the price on September 21.

After the defaults by IL&FS in the past month, liquidity crisis fears are gripping the debt market.

According to sources, there are concerns being raised of a contagion impact of further defaults in case of more cash worries in the market, especially when the yields on bonds are rising (bond prices are lower when yields rise). However, there is no certainty of the same.

Market participants also suggested that some investors are exiting mutual funds and hence the fund houses are trying to build liquidity by reducing their exposures in their bond holdings.

On September 21, the BSE-benchmark Sensex and Nifty had a roller-coaster ride starting with Yes Bank, which fell to as low as 34 percent and moving on to mortgage lenders — Dewan Housing Finance Ltd (DHFL, fell 60 percent) and Indiabulls Housing Finance (35 percent).


Also Read: Cash crunch fears, risky exposures to debt market hurt financial stocks

A DBS note explained that when a bond buyer comes to the market, banks seldom take them up and warehouse them. Instead, they strive to pass on the risk to another buyer, availability and appetite of whom can be highly variable.

Yes Bank ended 29 percent lower on the back of its CEO and MD Rana Kapoor's tenure being cut short to four months. The board is set to meet on September 25 to decide on the action plan ahead.

The Yes Bank crash was followed by a significant fall in other stocks as well. At day's end, shares of DHFL and Indiabulls recovered to close at 42 percent and 8 percent lower.

Both DHFL and Indiabulls Housing Finance blamed rumours of distress selling of DHFL bonds, which were held by DSP Mutual Fund. The selling led to panic among investors, sparking concerns of liquidity crisis over likely further defaults in the bond market, especially after IL&FS had been unable to make repayments on two of its bond maturities.

Even though the equity benchmark Sensex opened on  a strong footing, after around 1 pm, it plunged to sharpest levels by 1,500 points (3 percent from the day’s high), its biggest swing in four years.

Sector-wise, the realty sector declined by 3.5 percent, banking 3.1 percent and finance 2.5 percent while the healthcare, power, auto and IT sector were weaker by over a percent.

"A further rise in volatility is likely given the macro outlook, but would likely be exaggerated by the market structure... Non-banking financial sector has taken on some chunks of risk-taking activities from banks," said Taimur Baig, chief economist, and Radhika Rao, economist, DBS Bank, in the note.

The DBS note also warned that post-crisis regulatory environment may have made banks safer, but not the entire financial system.

The Reserve Bank of India (RBI) has asked banks, especially smaller ones under prompt corrective action (PCA) framework, to limit and diversify their loan exposures to risky portfolios such as large infrastructure, construction, power and similar stressed sectors given the rise of bad loans.

However, worries about exposures of mutual funds, pension funds and insurance firms among other financial services are yet to be ascertained and may need to be watched.
Beena Parmar
first published: Sep 22, 2018 08:08 pm
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