Week ending 6th April 2024

# 1. Markets

Markets got clueless last week with Indices remaining sideways and ending flat on Friday as RBI’s policy announcements had no major fireworks. It looks like indices are consolidating after a sharp run up, which is healthy sign. US markets marked worst sessions last week since mid Feb as interest rate uncertainty and geopolitical tensions weighed on sentiment with negative closure for the week, though all the three indices marginally recovered on Friday. This was possibly due to higher numbers reported under non-farm payrolls NFP than what was expected, and unemployment rate published at 3.8% matching expectations.

Net investments by foreign portfolio investors in the debt market surged to $14.58 billion in FY 2024, making it the highest net inflow in the past six years as investors turned bullish following announcements to include government securities in global indices. Over 70% of the inflows have come in the last five months following JP Morgan Chase’s announcement to add Indian government bonds to its Emerging Markets Index. While softening of Indian bonds is therefore certain in medium term, G.Secs hardened last week, following US bond markets.  Government bond yields jumped to a two-month high on Tuesday as unexpectedly firm US economic data dampened hopes of the Federal Reserve reducing interest rates anytime soon, driving up American bond yields and reducing the appeal of Indian fixed-income assets.10Y yields hardened by 15 points and ended the week at 3M high of 4.40% on Friday.

# 2 Banking

2.1 Key points – RBI policy announcement on Friday

• As expected all policy rates unchanged – the Repo rate at 6.5%; Bank rate at 6.75%. with continued stance of withdrawal of accommodation
• Projected CPI inflation at 4.5% in FY25.
• Maintaining the GDP growth for FY 24 at 7%.
• Rural demand, improving employment and sustained momentum should boost private consumption.
• Private capex cycle recovery becoming broad-based, the government continuing to invest, banks’ balance sheets being sound, rising capacity utilisation and business optimism.

Other key announcements

• RBI planning review of Liquidity Coverage Ratio for banks
• Banks are required to maintain LCR OF 100% in the form of high-quality liquid assets (HQLA) to meet 30 days’ net outgo under stressed conditions. These assets include cash, short-term bonds, and other cash equivalents.
• Need to redefine LCR after US-based banks Silicon Valley and Signature Bank faced massive withdrawal of funds within hours by clients using digital channels.
• The RBI noted that, sometimes, large number of depositors tend to withdraw deposits from a given bank at a given point in time and the existing model of estimating likely outflows from CASA during the 30 days needs review.
• UPI access provided for prepaid payment instruments (PPI) through third party apps.
• Presently, UPI payments from PPI can only be through the web or mobile app provided by PPI issuer. PPI wallet holders do not have to be completely dependent on the issuer of the PPI wallet and thus have been made interoperable.
• A scheme for the trading of sovereign green bonds on the IFSC is being launched.
• Mobile App for Retail Direct scheme – for participation of retail investors in g sec market being introduced. This is likely to improve retail participation.

2.2 Did RBI kill currency derivatives trading?

Otherwise, how does one explain stopping of 70% of trades in the $5 billion day currency market through its directive issued on January 5, 2024, effective from April 3, 2024. The directive advised stock exchanges to ensure that participants have an underlying contractual exposure for undertaking Exchange Traded Currency Derivatives [ETCD] and reiterated that ETCD is only for hedging.

There was recent market turbulence sparked by uncertainty over the need to prove that trades were being done for hedging purposes. As a breather, RBI on Thursday provided an additional month to comply with its directions by extending the date to May 5. Since RBI has clearly reiterated that ETCD to be used only for hedging, all security agencies have advised clients to unwind positions wherever they are not backed by contractual exposure before the extended period of May 5, 2024.

Where was the confusion?

• With the aim of ease of doing business, RBI had in 2014 permitted traders entering into ETCD for $10 mio, without producing documentary evidence.
• This was later enhanced to $100 mio. where traders can undertake hedging trades without producing underlying contracts as evidence.
• RBI has reiterated now that while presence of underlying contracts was always required, only submission as documentary evidence was waived. This was mistaken by players who jolly well undertook ETCD without having any contractual underlying exposure.

What is the position now?

While larger players like foreign portfolio investors are largely unaffected by the developments, retail players, proprietary traders and brokerages have been rapidly squaring off positions due to inability to comply with the provision for ensuring existence of valid underlying contracted exposure. Retail players and proprietary traders make up the bulk of the volumes for exchange traded currency derivatives.

As hitherto, participants with a valid underlying contracted exposure can continue to enter into ETCDs involving up to a limit of $100 mio without having to produce documentary evidence (but necessarily have underlying exposure).

Impact

• It is known that derivatives market is driven by speculators than by people for hedging. In NSE for example, the derivative to cash volumes stands at > 400 times. If you move out speculators, there would be no price discovery as the depth would not be there with limited players for hedging. If SEBI insists that all equity derivatives should be to hedge underlying cash exposure, the market would be dead!!
• Signals a wrong message to international investors – as it cannot be said RBI was not aware that 70% of players don’t have underlying exposure for the past 10 years!!
• May be RBI wanted to contain the volatility recently witnessed and did not want to exhaust its reserves to protect the exchange rate till new Govt is formed.

Moral is more than the communication, interpretation by players is the key for implementation of directions by Regulators and RBI/SEBI/IRDAI may have to ensure that there is no ambiguity.

2.3 – A great beginning under CDS

Last week saw first Credit Default Swap [CDS] trade worth Rs. 25 cr in India between SBI and Stanchart. CDS are derivative instruments that provide a form of insurance against the risk of default of the issuer of a bond.

Why is this considered important?

• First such transaction after RBI issued fresh guidelines for the instrument last year.
• This landmark transaction marks a pivotal moment in credit risk management and underscores the growing sophistication of financial instruments in the Indian market.
  • Despite record bond issuances aggregating Rs. 9.77 lakh cr during FY 24, share of BBB and below rated issuances still constitute 17.3% and AAA and AA rated issuances dominate the market with 81%.
  • Unless CDS market evolves in India it may be challenging to enhance issuance under lower rated instruments which is essential to enable access to bond market by SMEs.
  • In 2023, the estimated size of the U.S. CDS market was over $4.3 trillion, 3 times larger than $USD 1.3 trillion junk bond market.

The first transaction has happened on REC Bond which is AA rated and we only hope that market soon evolves for undertaking swaps in low rated securities.

The timing of CDS commencement could not have come at a better time when the corporate credit profile has shown significant improvement as seen from the ratio of upgrades to downgrades during Oct-Dec 2023, for all rating agencies compared to pre pandemic levels viz. FY20 and reduction in defaults as released last week.

• For Crisil, the rating improved to 1.79 compared with 0.77
• for ICRA improved to 2.10 compared with 0.60
• for Care Edge improved to 1.92 compared with 0.64
• for Ind Ra improved to 2.70 compared with 0.59
• The number of instances of defaults dipped to 5 in FY24, compared with 22 in FY23 and 42 in FY22.

# 3 Capital Markets

3.2 SEBI on Monday launched the upgraded version of SEBI Complaint Redress System -SCORES 2.0. SCORES is an online system where investors in the securities market including AIFs lodge their complaints through web URL and an app. It was launched in June 2011. To provide context SEBI resolved more than 3000 complaints lodged in Dec 2023.

• SCORES 2.0 now offers a two-tier review process: the first level involves review by the designated body, with SEBI stepping in for the second level if the investor remains dissatisfied. To ensure adherence to timelines, investors have the option to auto-escalate complaints if designated bodies fail to respond promptly.
• SCORES 2.0 integrates seamlessly with the KYC Registration Agency database, simplifying investor registration processes within the platform.

Upgraded version is an attempt to strengthen the investor complaint redressal mechanism by introducing auto-routing of complaints and monitoring such grievances by designated bodies. This would be more user friendly by making the process more efficient through auto-routing, auto-escalation, monitoring by the ‘Designated Bodies and reduction of timelines.

3.1 NSE on Wednesday, announced the introduction of four new indices in both the cash and futures and options segments, commencing April 8.

• Nifty Tata Group 25% Cap comprising 10 companies and is determined using the free float market capitalization from Tata Group companies like TCS, Tata Motors and Titan.
• Nifty500 Multicap India Manufacturing 50:30:20, comprising 75 constituents, with allocation of weights across large caps 50%; mid-caps 30% and small caps 20% based on their free float market capitalisation. Among the top 10 constituents by weight in this index are Reliance Industries, Sun Pharmaceutical Industries, Tata Motors, Maruti Suzuki India, Mahindra & Mahindra, Tata Steel, Bajaj Auto, Hindalco Industries, JSW Steel, and Cipla.
• Nifty500 Multicap Infrastructure 50:30:20, comprising 75 constituents, in similar fashion like the above. Among the top 10 constituents of this index, notable entities include Larsen & Toubro, RIL, Bharti Airtel, NTPC, Max Healthcare, Power Grid Corp, UltraTech Cement
• Nifty MidSmall Healthcare comprising up to 30 stocks, drawn from the Nifty MidSmallcap 400 index, chosen based on their six-month average free-float market capitalization.

By separating within the broad group of mid and small caps, it is hoped that huge volatility being witnessed could get addressed.

3.2 India incorporated 16.3% more companies and 62.7% more limited liability partnerships (LLPs) in FY24 than a year before, showed the data released by the Ministry of Corporate Affairs (MCA) on Tuesday, reflecting growing optimism about the country’s growth prospects over the medium to long term despite external headwinds. A record 1,85,314 companies were incorporated in FY 24 as against 1,59,339 a year before. No of LLPs that were registered last fiscal touched an all time high of 58,990 against 36,249 a year before.

# 4 Economy

4.1 India’s services sector in March, displayed robust growth, with the HSBC India Services Business Activity Index reaching 61.2, indicating one of the strongest growth rates in over thirteen years. The HSBC India Composite PMI Output Index rose to 61.8 in March from 60.6 in February, the second-strongest growth in over 13-and-a-half years.

• Factors such as robust domestic demand and favourable economic conditions contributed to increased new business, including exports.
• Finance and insurance sectors stood out with notable increases in output and sales.

India’s manufacturing activity reached a 16-year high in March, hitting 59.1, propelled by new orders, increased inventories, and higher job creation, according to a survey by S&P Global.

Despite the positive outlook, there are downside risks, including higher global crude prices and the potential for rising defaults due to increased unsecured loans.

4.2 As per its South Asia update released last Tuesday, World Bank has indicated Indian economy.

• likely to grow at 7.5% in FY24,
• likely to return to 6.6% over the medium term.
• Activities in services and industry to remain robust.

# 5 PE/VC report

5.1 Key take aways from McKinsey Global Private Market Review 2024 released last week.

• Fundraising fell by 22% from the prior year to just over $1 trillion by the end of 2023. Private markets fundraising in 2023 was the sixth-highest annual haul on record, despite the decline.
  1. Fund raise by Buyout funds stood out with increase of 29% in FY23 compared to negative growth in other asset classes.
  2. Top 5 fund managers captured greater share of 16% PE fund raising, followed by next 10 at 8%.
• Private markets assets under management (AUM) grew by 12% to $13.1 trillion as of June 30, 2023
• Institutional investors have steadily increased their allocations to private markets.
  1. PE allocation increased to 10.1% from 8.5% in 2022.
  2. Private credit allocation improved to 2.7% from 2.1% in 2022.
  3. Other asset class reduced – Public equity from 43.2% to 39.8%, Fixed Income from 30.9% to 29.9%,
• While PE tops returns across asset classes with top quartile return of 24% with median return of 16% The performance gap between top- and bottom-quartile PE funds is wider than for other asset classes
• Private debt continued to pay dividends in 2024, with stable performance and an expanding footprint.