Podcast 24th April 2015
High global liquidity at almost zero cost is chasing any kind of yields available in the markets. The liquidity has brought down yields on PIGS (Portugal, Italy, Greece and Spain) countries bonds (except Greece) to record lows despite no improvement in debt profiles of the these countries. Junk bond spreads have fallen to record lows in the US and Eurozone. Credit spreads of emerging issuers are down sharply over the last three years.
India has seen record inflows of USD 27 billion into the bond markets in fiscal 2014-15 taking up FII debt limit utilization to 86% of total limits of USD 81 billion. Policy makers are debating on increasing the FII limits to spur more flows into its markets. Given demand for loans and bonds of Indian companies, policy markers are also looking to free ECB (External Commercial Borrowings) norms. If freed there could be a surge of ECB’s leading to rising external debt and leaving the country vulnerable to both domestic slowdown issues and withdrawal of global central bank liquidity.
India should learn from the recent debt default by Chinese Developer, Kaisa Group Holdings, which defaulted on its obligations on USD denominated debt that it issued to foreign investors. Kaisa had raised large amounts of money from foreign investors to buy land and develop properties when the country was going through a property boom in the 2007 to 2013 period. The bonds issued by Kaisa carried twice the interest rate that was offered by similar rated bonds of issuers in the US.
Kaisa borrowed money from foreign investors to buy land and develop properties as Chinese authorities banned developers from using funds borrowed from Chinese banks to buy land, as they wanted to curb excessive property speculation. Many other developers like Kaisa too borrowed from foreign investors and are also struggling to service their debt.
The result of default on debt by Kaisa can be widespread. Foreign investors will tend to push up credit spreads of even good issuers leading to higher borrowing costs. Foreign investors could sell bonds denominated in local currency on risk aversion leading to domestic borrowing costs going up and impacting currency value. China fortunately has enough reserves and liquidity to withstand any impact of debt default by developers but it will see fall in property prices hurting domestic investors and lenders who have lent against the property.
India should be wary of allowing issuers unrestricted access to global markets for funds. Sectors that are susceptible to high speculative activity should only be only allowed limited access to global markets. Global liquidity is fickle, it can embrace the weakest when sentiments are high and shun the strongest when sentiments are down. The credit bubble burst in 2008 is still fresh in the minds of many strong borrowers who saw spreads on their bonds rising to unsustainable levels threatening the very existence of their business.
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