Liquidity crunch, RBI-govt spat, crude crash and more: Key factors that will drive the market

Stock market, by nature, is volatile. Sometimes the volatility becomes excessive as in recent weeks. When positive and negative forces emerge in quick succession, market oscillates between optimism and pessimism, favouring the bulls and bears in alternate bouts of buying and selling. This kind of oscillation swings the short-term trading strategy from 'buy on dips' to 'sell on rallies' and back again. This can be profitable or painful for traders, depending on the success of their trading strategies. But for investors, this excessive volatility can be a good opportunity. There are some headwinds and tailwinds that have the potential to keep the market choppy in the coming days.  

The liquidity squeeze

A major headwind is the looming liquidity crunch, which has the potential to roil markets. We had a taste of this danger when Infrastructure Leasing & Financial Services defaulted and some debt mutual funds pressed sales in the debt paper of some non-banking financial services (NBFCs) and Housing Finance Companies (HFCs). Redemption or rollover of commercial paper (CPs) and short-term debt, on a massive scale, is coming up this month. Will this pass on smoothly? Or, is there any possibility of a default, which can trigger a contagion of sorts?

Rs 1.52 lakh crore worth of debt papers are coming up for redemption or rollover this month. The market fears that the bunching of redemptions can exert some pressure and aggravate the liquidity squeeze. Between November 9 and November 20, Rs 59,700 crore worth of CPs are coming up for redemption and another Rs 23,376 crore on November 26. This bunching of redemptions might create some pressure, but overall, the transition is likely to be smooth since the stakeholders including the central bank have taken adequate precautions.

Market expects around half of the total redemptions to be rolled over. Rollover involves issuance of fresh papers in the place of old papers that mature. Rs 31,000 crore worth of debt papers have been smoothly redeemed in the first three days of this month. Many NBFCs are raising money through asset sale including good quality loan portfolios and some are raising short-term debt from banks. Also, NBFCs are not growing their books. The cumulative impact of these actions will reduce reliance on CPs and ease the liquidity crunch, thereby removing any probable systemic risk.

RBI-Government differences

Another headwind, which the market fears, is the outcome of the RBI-government differences over issues like Prompt Corrective Action (PCA) and transfer of money from the RBI to the government. The government feels the norms of PCA are too rigorous and need to be made more liberal to boost credit growth in the economy. The issue of transfer of RBI's 'excess capital' to the government is far more controversial.

It was the former Chief Economic Advisor Arvind Subramanian, who first mooted this view in the economic survey 2016-17. There are some experts who believe that if part of the excess capital of the RBI is transferred to the government and used for recapitalisation of the stressed PSU banks, it will go a long way in solving the present PSU banking crisis. But there is no clarity on how this money will be used by the government. Even if it is to be used for recapitalisation of PSU banks, if the RBI doesn't agree, that option cannot be exercised. The RBI feels that the capital and resources of the central bank can be used only for achieving financial stability and for nothing else. Even though the government has initiated the discussion with the RBI on this issue, section 7 has not yet been invoked. If it is invoked and the RBI is directed to transfer the money in public interest, the RBI governor Urjit Patel is likely to resign and the consequences could be bad.

The MSME 59-minute loan initiative

The sharp jump in India's Ease of Doing Business Ranking by 23 points to 77 came as a shot in the arm for the government. To take this global recognition forward and to address the issue of poor credit growth in the economy, the government announced the 59-Minute Loan Approval for the MSME sector. Though this initiative looks attractive in principle, there are concerns as to how this could be implemented without impairing the balance sheets of the already stressed banking system.

Crude crash- a very strong tailwind

Amid these headwinds, there are tailwinds too, enabling the market to move forward. The strongest tailwind is the near 16 per cent crash in the price of crude, which has improved India's macros considerably. If the price of crude sustains at this level, or better still, further moves down, that has the potential to weather the headwinds and make the market resilient. To conclude, alternate bouts of headwinds and tailwinds will keep the markets volatile. Smart investors can use the dips to pick good quality stocks on declines.

(The writer is chief investment strategist at Geojit Financial Services)