The Reserve Bank of India (RBI) has finally stepped in with Rs 50,000 crore credit line for the mutual fund industry. The liquidity infusion via banks is more than double the combined last two liquidity infusions in 2008 and 2013.
The higher credit line from the central bank shows the extent of the problem in the debt investments of mutual fund industry. The MF industry subscribes to debt instruments like commercial paper and bonds of corporate as well as NBFCs.
Unlike 2008 and 2013, the Covid-19 is not a financial crisis yet, but it could become one if there is a chain reaction of defaults in the corporate sector.
The investors, especially institutional investors, are turning risk averse, and not rolling over their investments and insisting on repayments. Similarly, corporate sector with investment in debt schemes is also withdrawing to create a war chest for meeting their own liquidity needs.
The MFs with illiquid debt and not enough emergency cash are the ones finding the going difficult. The first one to crack was Franklin Templeton, which announced closure of its half a dozen debt schemes.
The government and the RBI feared a chain reaction where even the good MFs could have come under redemption pressure. This quick thinking from RBI will certainly put a halt on redemption pressure in MFs debt schemes.
In any crisis, the market witnesses panic withdrawal from investors, which gets compounded to create a bigger problem of liquidity for the industry.
In 2013, the RBI had to pump in Rs 25,000 crore for the MFs, while the 2008 package included Rs 20,000 crore. While the global financial crisis jolted the global markets, the 2013 crisis was restricted to emerging markets like India when the global central bankers of US and Europe halted the quantitative easing (pumping in money) and decided to absorb the excess liquidity in a gradual manner.
In a post-Covid situation, the global central banks have come forward to create liquidity for businesses and MFs. The US Fed has offered loan of up to one year to banks to buy assets from money market funds, which are facing liquidity issues like what we are seeing in India.
While the MF industry will get much needed funds, there are also lessons for fund houses not to chase higher returns by risking investors' money in illiquid assets.
Many suggest the crisis is self-created as MF industry often takes bets in below investment rated bonds of corporate sector to lure investors. In the last 4-5 years, the corporate sector has been facing a rough weather because of over leveraging, low demand and the general slowdown in the economy. The IL&FS debacle was also a reminder that the MFs should also analyse companies and sector more carefully than just go by the credit ratings.
But it seems some MFs didn't heed this advice as they thought the markets were stabilising. Firms were also showing encouraging signs like higher capacity utilisation and pick up in demand. They actually factored in an interest rate risk, but they never thought the credit risk would come to haunt them.