Week Ending 04th May, 2024

# Markets

Profit booking on Friday triggered by market chatter on changes to capital gains taxes on equities—piling on to prevailing election jitters—dragged India’s benchmark equity indices to their lowest in three weeks, before Hon’ble FM Nirmala Sitharaman dismissed what she called “pure speculation”. Section of the market also attributed to investors cutting bets ahead of a crucial US job report later in the day. Foreign portfolio investors, net sold shares worth a provisional ₹2,391.98 crore on Friday, while domestic institutional investors, or DIIs, net purchased ₹690.52 crore, helping the market recover to an extent.

The US Fed signalled fresh concerns about inflation as it reaffirmed it needs more evidence that price gains are cooling before cutting interest rates from a two-decade high. Leaves rates unchanged as expected but hinted higher for longer. The Fed maintained language in its policy statement Wednesday that suggested an interest-rate cut was still more likely than an increase—a so-called easing bias. All the three broad indices in US ended 1% higher.

US Bonds which continued to harden early week, softened taking cue and on  weekend publication of statistics –Nonfarm pay rolls advanced 175K (higher than consensus) Unemployment rate (higher at 3.9%), average hourly earnings (lower at 0.2%), private non-farm pay rolls (lower at 167K) etc., Gsecs in India which continued to harden, softened on Friday on announcement by RBI on Centre’s buy back of Rs 40000 Cr. of G Secs, first such repurchase since 2018.

# 2 RBI

2.1 RBI on Friday has proposed new guidelines to revamp project lending rules, aiming to facilitate funding for infrastructure while managing risk.

• The new norms require categorisation of projects as per their phase and lenders to set aside 5% of the money as general provisions for all existing and new loans. Currently, banks have to provide only 0.4% of the loan amount for exposures that are not in default.
• Once a project starts operating, lenders can reduce the provisioning to 2.5% of the money lent.
• If the project is performing well and has sufficient cash flow to repay loans, the provisions can be further reduced to 1% of the money lent. Performing well would mean that the total long-term debt of the project with the lenders has declined by at least 20% from the outstanding at the time of achieving Date of Commencement of Commercial Operations
• The new norms require 1% provision even after project completion, which is more than double the existing provision.
• Rules for consortium lending, minimum exposure requirements, and credit event norms have been prescribed.
• The RBI discourages moratoriums on repayments post project commencement and limits repayment tenors.
• The guidelines also address PPP model considerations, equity infusion monitoring, and require projects to demonstrate positive net present value for lender financing.

This move could impact profits of banks with significant exposure to such projects.

The cost of project financing will increase due to higher interest rates. The provisions will also reduce banks’ profits as they have to be carved out of their earnings. The new norms have also reduced the flexibility available for lenders, as they have hard coded what needs to be done under different scenarios such as project delays.

The new norms come at a time when asset quality has improved in project lending partly because most project funding is where Govt is counterparty.

2.2 RBI last week has reportedly cautioned banks on gold loan disbursement concerns through fintech’s. The central bank has flagged “concerns with the evaluation process” by these banks and fintech’s, especially in cases where the gold is sourced through field agents of companies, Rupeek, India Gold and Oro Money are a few of the major players that source gold loans for banks. Gold prices have risen by over 20% in the last year.

Concerns:

• Gold loan disbursals are capped at 75% of the value of the asset and the Loan to Value [LTV] cannot exceed 75%, throughout the tenure of the loans. RBI is concerned that this is not complied due to:

– Heavy involvement of field staff and possible overvaluation of gold

– Offer of personal loans on top of the gold loan to meet the customer’s credit demands, which would bring down LTV in case value of gold falls.

– Interest can be charged every month, and the length of the loan cannot exceed 12 months where RBI is concerned that this is permanently rolled over.

– commercial banks’ exposure to gold loans rose to INR1.02 lakh crore as of March 2024, 15% higher than the previous year.

• Following closely on the heels of penal action on IIFL, RBI is taking pro active steps to prevent recurrence of such events.

2.3 RBI on Monday proposed a revised regulatory framework (Draft Master Direction – Reserve Bank of India (Electronic Trading Platforms) Directions 2024) for electronic trading platforms [ETPs] in the wake of increased integration of the onshore forex market with offshore markets. ETP refers to any electronic system, other than a recognised stock exchange, on which transactions in eligible instruments are contracted. Eligible instruments mean securities, money market instruments, foreign exchange instruments, derivatives.

• an entity seeking authorisation as an ETP operator should maintain a minimum net worth of Rs 5 crore, maintained at all times.
• ETP operator should conform to all applicable laws and regulations, including the FEMA 1999.

The new framework is aimed to ensure fair access through transparent, safe and efficient trading processes, robust trading infrastructures and prevent market abuse.

2.4 RBI directed on Monday regulated entities [REs – banks and NBFCs] to review their lending practices in line with the Fair Practices Code 2003 after it found that some lenders were resorting to certain unfair practices in charging interest rates. It also directed REs to disburse loans through online account transfers instead of issuing cheques.

Concerns:

• some lenders charged interest on loans from the date of sanction or execution of the loan agreement rather than from the date of disbursement.
• loans were disbursed by cheque, and lenders charged interest from the cheque date, whereas the cheque was handed over to the customer several days later.
• disbursement or repayment of loans happened during the month, yet some regulated entities charged interest rates for the entire month, rather than charging interest only for the period the loan was outstanding.
• REs collected one or more instalments in advance but reckoned the full loan amount for charging interest, the regulator observed.

# 3 SEBI

3.1 As covered in previous week’s blog, pursuant to notification, SEBI issued detailed circulars covering liquidation scheme and encumbrance on securities of portfolio company.

1. Guidelines on liquidation scheme:

• Additional period for liquidating investments at the end of Fund life provided – period to be decided by the consent of investors subject to maximum of original to fund life subject to AIF securing consent from 75% of investors by value. Failing which, in specie distribution to be done.
• In case the Manager is unable to obtain bid for a minimum of 25% of the value of unliquidated investments of the Scheme, AIF can still opt for dissolution period with consent from 75% of investors by value. The value would be then deemed as Re 1/- for the purpose of reporting performance reporting.
• No Management Fee to be charged.

For VCFs registered under old repealed VCF Regulations, SEBI is still evaluating a framework. In fact, the solution was required mainly for VCFs as AIF guidelines came into force from 2012 only. The dissolution period framework for now is only notified for AIFs.

1. Guidelines on encumbrance:

• Category I and Category II AIFs are permitted to create encumbrance on their equity holdings in investee companies for the purpose of borrowing by the investee company, specifically in infrastructure-related projects.
• Existing schemes of Category I or Category II AIFs without investors prior to April 25, 2024, can also create such encumbrance subject to disclosure of associated risks in their documents.
• Encumbrances created before April 25, 2024, can continue with explicit disclosure and investor consent obtained by October 24, 2024, otherwise, they must be removed by January 24, 2025. However, encumbrances created on securities other than specified infrastructural projects must be removed by October 24, 2024.
• The duration of such encumbrances should not exceed the remaining tenure of the AIF scheme.

SEBI seems to have prescribed a grandfathering mechanism for encumbrances created earlier by AIFs in investee companies other than in infra. This is of course subject to meeting conditions as laid down under clauses 3.1 and 3.2 of this circular – the business of development, operation, or management of companies. But at least it seems SEBI will not take any action for past encumbrances created on non-infra portfolio entity shares subject to compliance with above clauses.

3.2 SEBI In a consultation paper last week, floated the idea of permitting issuers to launch NCDs or NCRPS in private placements, with the face value of Rs 10,000. It may be recalled that in October 2022, SEBI reduced face value of bonds to Rs 1 lakh from Rs 10 lakh.

• The move is aimed at enhancing the participation of non-institutional investors in the corporate bond market.
• Issuer should appoint a merchant banker who would carry out due diligence for issuance of such privately placed NCDs and NCRPS and disclosure requirements in the private placement memorandum.
• Record date has also been standardised to 15 days prior to any interest payment or redemption date. Previously the date for determining for eligibility for interest or redemption was left to issuers.

Impact:

• As more than 90 per cent of the issued corporate debt is privately placed, reduction in face value of such debt will accelerate the retailisation of the corporate bond markets.
• Currently, there exists a cumbersome process for identifying and communicating record dates to investors as there is a large variance in practices. Standardising this period streamlines the industry, provides clarity to investors and makes the bond markets more efficient.
• Preferable to impose reasonable restrictions on the criteria such as outstanding amount and issuer ratings, aiming to mitigate the risk of mis-selling.
• Funds raised through debt private placements in FY24 amounted to Rs 9.41 trillion, up from Rs. 4.74 trillion in FY15 mostly from institutions.

Retailisation is thus a great move to deepen bond market.

3.3 SEBI on Tuesday approved a proposal to increase participation from non-resident Indians (NRIs) and Overseas Citizens of India (OCIs) through the foreign portfolio investor (FPI) route in local markets.

• FPIs with NRIs and OCIs as clients should be based out of International Financial Services Centres (IFSCs) in India and regulated by the International Financial Services Centres Authority (IFSCA).
• 100% participation from NRI and OCIs permitted, provided FPIs submit copies of PAN Cards of all their NRI and OCI investors, along with their economic interest in the FPI to the custodians.
• If an investor doesn’t have a PAN, the FPI should give a suitable declaration along with other prescribed identity documents.

Sebi’s decision to permit up to 100% NRI and OCI participation, from the current less than 50% permissibility exclusively for IFSCA regulated FPIs, will augur well for onshoring of India-focused offshore public market funds in IFSCs.

This opens doors for NRIs to invest a larger portion of their money in Indian stocks through global funds.  This move could attract more investment from the Indian diaspora into the Indian stock market.

3.4 SEBI on Tuesday approved a proposal to streamline and simplify norms for passive schemes of domestic MFs.

• equity passive schemes to take exposure up to the weightage of the constituents in the underlying index. This exposure would be subject to an overall cap of 35% investment in the group companies of the sponsor.

At present, mutual fund schemes are not allowed to invest more than 25% of their net asset value in group companies of the sponsor. This restricts the passive funds from effectively replicate the underlying index, in cases where group companies of sponsor comprise of more than 25% in the index. This also puts such fund houses to a relative disadvantage as compared to other asset management companies who may not have a sponsor group company comprising more than 25% in the underlying index.

This move will therefore help to create a level playing field for all asset management companies.

3.5 SEBI on Friday relaxed the digital onboarding process for clients of portfolio managers. While onboarding clients, portfolio managers will have to ensure that new clients use a typed or electronically written note saying that they have understood the fee structure rather than the current practice that focuses on clients giving the same in their own handwriting.

SEBI on Thursday decided to promote collective oversight of PMS distributors by making registration with the Association of Portfolio Managers in India (APMI) mandatory for them. The new directive would come into effect from 1 January 2025, and APMI would issue the criteria for registration of distributors by 1 July this year, Sebi said in a circular.

The move is aimed at promoting ease of doing business initiatives for portfolio managers.

3.4 SEBI on May 2, 2024, released a framework for the supervision of Research analysts (RAs) and Investment Advisers (IAs) by stock exchanges. Sebi outlined the criteria for a stock exchange to obtain recognition as a Research Analyst Administration and Supervisory Body (RAASB) or Investment Adviser Administration and Supervisory Body (IAASB). The new provisions will be effective from July 25, 2024

• To be eligible for recognition as RAASB or IAASB, a stock exchange must have been operational for at least 15 years and possess a net worth of at least Rs 200 crore.
• They should maintain terminals all over India and investor service centres in 20 cities.
• They should maintain necessary infrastructure like adequate office space, equipment and manpower and should have a robust grievance redressal mechanism, including online dispute resolution.
• An applicant seeking registration as RA and IA is required to be enlisted with stock exchanges RAASB or IAASB.

Under the new framework, RAASB and IAASB are tasked with monitoring the financial and regulatory compliance side of RAs and IAs.

# 5 Economy

5. 1 India’s manufacturing sector experienced rapid expansion in April, reaching its fastest pace in three-and-a-half years according to the HSBC India Manufacturing Purchasing Managers’ Index (PMI). Although slightly lower than the previous month’s 16-year high, the April PMI of 58.8 comfortably exceeded the long-run average of 53.9.

• Robust demand, both domestically and internationally, drove this growth, with total new orders rising sharply.
• Consequently, employment in the sector improved, with moderate job creation observed, the quickest since September 2023.
• Raw material stocks increased, supported by timely deliveries from suppliers whose performance improved for the second consecutive month.

5.2 OECD, last Thursday, revised India’s FY25 growth forecast upward to 6.6% from 6.2% projected earlier. It attributed this to strong investment and improving business confidence in India despite relatively sluggish private consumption growth.

Domestic demand will be driven by gross capital formation, particularly in the public sector, with private consumption growth remaining sluggish. OECD also projects the Indian economy to register 7.8% growth in FY24, higher than the 7.6% estimated by the government. The revision from OECD follows similar upward revisions by other international agencies on the back of strong domestic fundamentals of the Indian economy.

5.3 Goldman Sachs in its report released last week has predicted that,

• India’s services exports will rise to $800 billion by 2030, (12.4% of GDP) up from $340 billion in 2023.
• This growth is expected to make India’s external sector more resilient to supply-side shocks and reduce rupee volatility.
• India’s high-value services will drive top-end discretionary consumption and demand in commercial and residential real estate.
• Current account deficit of 1.1% of GDP is projected assuming no significant moves in commodity prices and goods trade balance beyond 2024.
• there is also scope for India to increase its share in the insurance, financial, transport and travel sectors.

India has been gaining share in professional consulting globally, which is relatively less concentrated than other sectors, and India has scope of gaining further share with the rise of Global Capability Centres (GCCs), as demonstrated by the number of GCCs which has more than doubled to 1,580 in FY23 from 700 in FY15, with revenue increasing nearly fourfold to $46 billion.