Intelligentguess

Credit rating agency Fitch, today, downgraded bonds issued by ITI Limited, a (sick) Government of India owned telecom equipment manufacturer to default grade “D (Ind) (SO)”.

This, in itself, may not be much newsworthy, except for the fact that these bonds carried the highest possible rating “AAA (Ind) (SO)” prior to this downgrade to default category. The AAA rating had been assigned on the basis of an unconditional irrevocable guarantee given by the Government of India.

It appears that a few investors had opted to exercise their put option. These included a large (politically connected) residuary non banking finance company, a bank and a provident fund. However, there seems to be an inordinate delay in the repayment of principal leading to the downgrade by the rating agency.

This leads us to the question;

• Isn’t an unconditional, irrevocable guarantee as good as an obligation of the Government? Especially, since the defaulting entity is also owned by the government.

To my mind this is as good as a default by the government on debt denominated in (believe it or not) domestic currency. And this is a government which is proudly of its fiscal record.

Frankly, this is not the first time that the government has displayed such disregard for its contractual commitments to investors. We’ve had such instances in the past too.

Which leads me to another closely related issue;

Provident Funds are effectively forced to invest in such bonds, due to the statutory investment pattern. The statutory investment pattern is supposedly devised to eliminate such risks of default. On the contrary, provident funds have piled themselves with such and similar other junk debt. It’s another time bomb waiting to explode.

High time, our communist buddies understand and appreciate market realities and help in bringing about pension reform. Till such time, we are doomed with our retirement funds  invested in such junk investments.

Update (May 25, 10 AM India Time) : The Times of India has some additional details. It appears that Canara Bank, the trustee to the bonds, have not invoked the guarantee. Now, that raises questions on trustee responsibility. Incidentally, Canara Bank is also owned by the Government.

It also appears that the folks at the Times of India read this blog. Notice the similarity in the language.

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The Indian Stock markets traded weak on Wednesday, May 23. The weakness was led by banking sector stocks.

These stocks were weak on rumors floating around in the marketplace that the Reserve Bank of India (RBI) may hike the cash reserve ratio (CRR) – the proportion of deposits that commercial banks have to set aside as a statutory pre-emption. Banks do not earn any interest on these pre-empted funds.

The trigger for the story seems to be the large inflow (in excess of INR 200 bn) expected into the system due to the maturity of a government bond (11.90% - 2007).

Step back to a few weeks ago (I forget the exact date). Bank stocks were on fire (with most of them gaining by as much as 5% on that day). And the story that led to that move was that the RBI was contemplating a cut in the CRR. Ironically, overnight money rates on that day were ridiculously low (less than 0.50% per annum). Precisely the kind of conditions that preclude any cut in the reserve ratio.

However, strange are the ways of the marketplace – the rumor was allowed to perpetuate for the whole day. By the evening, when it was pretty clear that a CRR reduction was never going to be in sight, the story promptly switched to a possible reduction in the statutory liquidity ratio (SLR) – the proportion of deposits that commercial banks have to compulsorily invest in government securities. The SLR story was more credible, I should add.

Coming back to present day moves, what puzzles me is how marketmen react to a piece of information (the upcoming bond redemption) that is known for ages. Weren’t markets supposed to discount all publicly available information (the efficient market hypothesis)? Or is it, that the stock markets are getting around to the RBI Governor Y V Reddy’s penchant for springing surprises.

A CRR cut when overnight money rates were ruling at Japanesque levels – that would have been the coup de grace!

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