Covid-led record defaults cloud India's resilient equities, bonds

Firms have defaulted on at least Rs 5,700 cr of domestic bonds this year, while Sensex hit 3-week high amid optimism on US vaccine support

Credit markets are sounding warnings for other asset classes amid India’s unprecedented surge in Covid-19 cases.

Firms have defaulted on at least Rs 5,700 crore ($763 million) of domestic bonds this year, the most on record for a similar period. Traders expect more. They’ve pushed spreads on A rated local corporate bonds over AAA notes to a 17-year high, a grim sign for the small businesses that tend to have those weaker ratings and that form the bedrock of the $2.7 trillion economy.

That all suggests the need for further caution in the equities and government bond markets, which have held up better despite volatility. While the defaults are largely among smaller, often unlisted borrowers, they add to challenges for policy makers already grappling with one of the world’s worst bad debt ratios. On top of that, the Covid outbreak risks fanning inflation as local curbs disrupt supply chains, threatening to limit central bank options for juicing the economy.

“One can’t expect there will be good news on the economy, good news on earnings and stock prices will go up,” said Sunil Subramaniam, managing director of Sundaram Asset Management Co. “It is undoubtedly, going to be a volatile period for the market.”

Equities

In recent days, equity and government bond investors have focused on more optimistic signals as the government has refrained from broad national lockdowns. India’s S&P BSE Sensex Index rose to a three-week high Tuesday after a U.S. decision to offer vaccine support, and continued up Wednesday.

But there have been mounting concerns. Despite the recent rally, Indian stocks are lagging their Asian peers this month after outperforming for four straight quarters.

And while some long-term investors including Fidelity International and Invesco have said they are seeking opportunities to add stocks, sentiment broadly has soured among global equity funds. Foreign investors sold a net $1.2 billion of Indian shares this month through April 26, on course for the worst outflow since March 2020.

Government Bonds, Rupee

India’s central bank was able to tame yields with its announcement of a QE-like bond buying program earlier this month. That’s sent the yield on the benchmark 10-year sovereign bond down about 12 basis points in April, set for the biggest retreat in six months. The rupee has rebounded in the past few days as well, coming off its weakest against the dollar since August earlier this month.

But yields have been volatile, with traders nervous about the possibility of more government spending to mitigate the impact of the pandemic. Finance Minister Nirmala Sitharaman has raised the possibility of bringing forward planned borrowing.

Jitters about the supply of government notes have already resulted in underwriters being forced to rescue bond auctions and the central bank having to cancel some.

Meanwhile, concerns about the economic impact from the Covid resurgence have left the rupee down about 2.1% in April against the dollar despite the recent rally, set for the worst drop since March last year.

Credit

The corporate bond market has been flashing other red lights.

Credit-default swaps for State Bank of India -- considered a proxy for India’s default risk -- widened to a 9-month high this week, before dropping back Tuesday after the news about the U.S. vaccine assistance, CMA data show.

“Markets are getting cautious on the credit side as economic growth is seen slowing down, raising concerns distressed debt may rise,” said Vikas Goel, managing director and chief executive officer at PNB Gilts Ltd.

SBI Funds Management Pvt., India’s biggest asset manager, has said they are watchful on the financial sector as relief announced by authorities such as a debt moratorium has hidden the true picture of the stress the pandemic has exerted. Across industries, some borrowers are finding it harder to tap the credit market. Issuance of local-currency notes graded A and below fell to a 10-year low of Rs 1,800 crore in April.