RBI’s liquidity lifeline won’t solve debt MFs’ structural problems

The Reserve Bank of India’s (RBI) special liquidity facility for mutual funds, intended as a rescue package to help debt funds tackle redemptions pressures after the Franklin Templeton fiasco, has seen tepid response so far. The facility is said to have received bids for just ₹2,000 crore out of the ₹50,000 crore offered on the first day. There appear to be multiple reasons for the poor offtake. One, the RBI has chosen to extend this facility via banks, and it is well-known that Indian banks are currently in an extremely risk-averse mood, preferring to park much of their available liquidity either with the RBI itself or in SLR (Statutory Liquidity Ratio) securities, while eschewing lending. Though this special facility allowed banks an opportunity to earn lucrative spreads by borrowing at the repo rate and buying investment-grade corporate bonds off MF books, they seem to be choosing to stay off. Bankers appear to be taking the call that, at times like this, deploying money at low or even negative spreads is preferable to making credit decisions that can be questioned later. This is also the reason why the RBI’s special facility for NBFCs has come a cropper. Two, it is also quite possible that credit risk funds, which face the maximum heat from illiquidity of lower-rated paper, don’t have a large enough stockpile of investment-grade bonds to trade in for this bailout. Three, given that any mutual fund availing of this facility will be seen as facing redemptions, AMCs are probably wary of sending out distress signals by tapping it. One needs to see if sustained redemptions prompt MFs to rethink their position in the days ahead (the facility is open until May 11).

But lifelines such as this offer only a stop-gap solution to what is a structural issue dogging MFs and their corporate bond exposures. Even in the best of times, Indian debt markets offer only patchy liquidity on corporate bonds for all but AAA issuers. When crisis hits, this tends to completely dry up, as had happened even after IL&FS and Dewan Housing episodes. With MFs having amassed large assets in open-end debt schemes with the core promise of any-time liquidity, both SEBI and MFs need to thrash out a durable solution to the mismatch in corporate bond funds that doesn’t involve borrowing. An interval structure, a market-making mechanism or allowing temporary gating of redemptions can be considered.

While developing a deeper corporate bond market has been on the RBI’s to-do list for over a decade now, with multiple committees offering fixes, it has been strangely reluctant to implement some of the prescriptions such as merging depositories for bonds and equities, dis-intermediating the market and allowing direct retail access. Debt mutual funds have evolved as an important conduit to channel retail and wholesale savings into financial assets, emerging as a key funding source for India Inc. One episode must not be allowed to ruin this.

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