An October 26 letter by the Department of Economic Affairs Secretary lays bare the Finance Ministry's worries.
The Department of Economic Affairs (DEA) fears “significant default” from large non-banking finance companies (NBFCs) and housing finance companies (HFCs) in the next 6 weeks if additional liquidity support is not forthcoming.
In a 26 October letter to the Ministry of Corporate Affairs (MCA) discussing the financial stability impact of the IL&FS default, the DEA described “the financial situation (as) still fragile.”
Moneycontrol has reviewed a copy of this letter.
The letter points out that a prolonged liquidity crunch could hurt fund mobilisation in the debt market, impact productive sectors and affect economic growth at a time when India has emerged as one of the fastest growing major economies in the world.
According to the DEA, about Rs 2 lakh crore of NBFC/HFC debt is due for redemption or rollover by the end of December 2018. The department estimates a funding gap of as much as Rs 1 lakh crore by the end of the year if the pace of fundraising seen in the first half of October (about Rs 20,000 crore or 68 percent lower than the same period in August) is sustained.
A further Rs 2.7 lakh crore of commercial paper and non-convertible debetures will be due for redemption over January -March 2019, the letter said.
“Without additional liquidity support a significant default from among the largest NBFC and HFC could occur within six weeks and the financing cycle of productive sector would be adversely affected,” the letter states.
The DEA's fears underline key issues in the ongoing spat between the Reserve Bank of India and the government. The government wants the central bank to provide liquidity support to NBFCs and HFCs, and relax lending strictures for weak banks. The RBI, on the other hand, believes that the liquidity situation is under control and is loath to relax its rules for weak banks with the NPA problem still on the mend.
NBFCs and HFCs are increasingly significant for credit flow to the economy capturing the space ceded by weak public sector banks. Their business model is largely founded on borrowing from banks and mutual funds to finance their loans. After the IL&FS default which led to the sale of debt and redemption in mutual funds – with outflows of Rs 2.11 lakh crore in September - NBFCs’ source of funding has dried up.
In a Financial Development and Stability Council (FSDC) meeting on 30 October, the government warned the central bank about the NBFC liquidity crisis spilling over to other sectors. The RBI is said to have assured the government that the liquidity situation has not gone out of hand and has continued to provide systemic durable liquidity through open market purchase of government bonds.
The outcome of that meeting appears to have triggered a full-blown confrontation between the Finance Ministry and the Reserve Bank. Media reports were abuzz yesterday that the government had or was considering invoking a rare law (Section 7 of the RBI Act) to make the central bank act on its view, and that RBI Governor had threatened to resign on this subject.
It later took the Finance Ministry to issue a statement, saying the autonomy of the central bank was “essential”.
A prolonged liquidity distress will significantly erode the NBFCs' credit standing, and prove negative for the broader economy as a slowdown in credit growth will dampen overall consumption and economic growth, credit rating firm Moody's Investor Service said in a October 15 note.
However, commentary from the management of a few financial sector firms indicates that liquidity pressures might be waning. HDFC Asset Management Company, for instance, said liquid funds under management grew to Rs 75,000 crore in October compared to an average Rs 40,000 -50,000 crore. In an analyst call, Reliance Nippon Asset Management said inflows into liquid funds in October outpaced the outflows seen in September.
“Given support coming in from banks for a buyout or onward lending, inflow into liquid funds, and RBI’s OMO, we believe it’s safe to assume that the risk-related to maturity of NBFCs/HFCs is likely to wane over the next 20 days,” said Edelweiss Research in a 1 November note.
The DEA letter said that in view of maintaining financial stability, the new board of IL&FS led by veteran banker Uday Kotak should continue as it would restore “confidence and trust of the financial markets.”On 31 October, the new board submitted a broad resolution plan for IL&FS which included capital infusion at the group level, selling subsidiaries and resolution for specific assets.