Trust Deficit is the Problem of Indian Financial Markets

India’s financial markets are facing a 'trust deficit' and disruptions due to defaults by a major non-banking finance company which could put a strain on weaker firms, S&P Global Ratings said Wednesday.

Spreads have widened, and short-term borrowing costs have spiked since Infrastructure Leasing & Financial Services (IL&FS), an infrastructure  development and finance company with a high domestic rating, defaulted on loan repayments in August and September. Corporate governance concerns are adding to risk aversion.

“India’s financial markets are facing a trust deficit. The disruption could put a strain on weaker companies as well as finance companies,” S&P Global Ratings credit analyst Geeta Chugh said. In its report titled ‘A look at whether India Inc can handle the liquidity crunch in debt capital markets’, S&P said rated Indian companies are relatively well-positioned to withstand the stress in India's debt capital markets that ensued after a major default.

“While liquidity stress has begun to gradually ease, we expect tougher conditions could linger for months. Indian companies including nonbank finance companies (NBFCs) are vulnerable to spiking interest rates because they have increased reliance on short-term debt, after years of relatively good financing conditions for shorter-dated paper,” S&P said.

Rated Indian companies are better positioned because they tend to have manageable short-term obligations and good liquidity.

Nevertheless, costlier or restricted financing could delay some growth plans and hurt profitability.   “Bank asset quality could come under pressure because of the IL&FS default. On the other hand, banks will benefit from more risk-based pricing and reduced competitive intensity,” S&P said. IL&FS is one of India’s leading infrastructure development and finance companies, was highly rated domestically, and has institutional shareholders including the State Bank of India and Life Insurance Corp of India. Its default has disrupted debt capital markets, and led to particular concerns on NBFCs.

“NBFCs and housing finance companies are the most exposed to liquidity challenges because they borrow heavily from mutual funds and have significant reliance on short term borrowings,” S&P Global Ratings credit analyst Deepali Seth-Chhabria said.