Dalal Street May Come Under Stress After Negative Cues from Wall Street

  • Market Overview
  • Editors Pick

Telecom and Banking package/structural reform may be incremental, but may not be monumental and maybe too little & too late

India’s benchmark stock index Nifty (NSEI) closed around 17585.15 Friday, stumbled over -200 points from record-high 17792.95 as India’s Dalal Street comes under stress after a record rally on negative cues from Wall Street. India’s Nifty jumped another fresh lifetime high early Friday after rallying over +1.50% in the last two days as Modi admin bailed out both telecom and banking sector, especially indebted Vodafone–Idea (VIL) and its lenders; SBI (NS: SBI ) and Indusind Bank which have around Rs.10B and Rs.4B loan exposure with VIL. The Indian government also unveiled details of the much-awaited Bad Bank, the super ARC of India. Subsequently, banks soared, helping Nifty to scale another new lifetime high.

But Nifty stumbled on negative global cues ahead of Friday’s quad witching (simultaneous quarterly expiration of stocks and indices in futures & options), which involves heavy trading volume (rollover and arbitrage opportunities). Wall Street was already under stress for multiple reasons like Goldilocks progress of U.S. employment and elevated inflation, which may prompt the Fed to announce the inevitable QE tapering by Dec’21 and liftoff (gradual rate hikes) by Dec’22. As Fed has already acknowledged substantial further progress on the inflation front for QE tapering condition, the factor is now not inflation, but the progress of employment.

Apart from taper tantrum and liftoff concern, the risk trade was also affected by China’s Lehman moment (possible debt default by Evergrande by 15th Sep, the Lehman day), ongoing Chinese regulatory crackdown, especially on techs, deleveraging effort, and trade/cold war suspense with the U.S. (as per respective domestic political compulsions).

Also, lingering suspense over Biden’s $4.7T fiscal stimulus and tax hikes plan is affecting the stimulus savvy Wall Street sentiment. Biden’s Democrat colleagues led by Manchin & Co (moderate Democrats) have serious objections over the huge fiscal stimulus, which will inevitably cause hotter & persistent inflation, negative for the U.S. economy, low earners (vote bank), and Biden’s 2022 mid-term election prospect. Biden’s popularity is sinking amid the allegation of inflation, economy, COVID vaccinations as well as Afghanistan mismanagement (economy, COVID, and foreign policy). The market is also concerned that U.S. may even technically default on its debt service obligation in an unprecedented event if the U.S. debt limit is not increased by Congress on time amid the yearly ritual of debt limit political drama.

Overall, India’s Dalal Street outperformed Wall Street not only for the week but for the last 3-months (June-Sep/till date) as Nifty jumped almost +11.60% against, while Dow Jones edged up only +0.28%. The Indian market was supported by the appeal of 5D (democracy, demography, demand, deregulation and digitalization) against China’s growing regulation and call for ‘equal prosperity’. The Indian market was also boosted by signs of endemic (growing herd immunity due to natural infections and vaccinations), almost full reopening of the economy and targeted fiscal stimulus and structural reform coupled with easing of elevated inflation (although core inflation remains sticky around +6%).

In any way, India’s PPI is increasing at an almost double rate that of CPI, and both indices now converging (catching up). Thus we may see headline CPI much above +6.00% RBI target in the coming months, especially after the winter season (when vegetable prices again go up) which may prompt RBI for its desi QE tapering (GSAP) and reverse repo rate hike with a shift to neutral monetary policy (from present accommodative) by Feb’21 (after expected Fed QE tapering announcement by Dec’21).

The Indian market was also boosted by Telecom stimulus/reform package and bad bank/super ARC plan, which was officially unveiled on 15th September:

Cabinet approves major Reforms in Telecom Sector

Telecom Reforms to boost employment, growth, competition, and consumer interests

Liquidity needs of Telecom Service Providers addressed

The Union Cabinet, chaired by Prime Minister Shri Narendra Modi, today approved a number of structural and process reforms in the Telecom sector. These are expected to protect and generate employment opportunities, promote healthy competition, protect the interests of consumers, infuse liquidity, encourage investment and reduce the regulatory burden on Telecom Service Providers (TSPs).

In the backdrop of the outstanding performance of the Telecom Sector in meeting COVID-19 challenges, with a huge surge in data consumption, online education, work from home, interpersonal connect through social media, virtual meetings etc., the Reform measures will further boost the proliferation and penetration of broadband and telecom connectivity. The Cabinet decision reinforces the Prime Minister’s vision of a robust Telecom Sector. With competition and customer choice; Antyodaya for inclusive development and bringing the marginalized areas into the mainstream and universal broadband access to connect the unconnected. The package is also expected to boost 4G proliferation, infuse liquidity and create an enabling environment for investment in 5G networks.

Nine structural reforms and Five procedural reforms plus relief measures for the Telecom Service Providers are as below:

Structural Reforms

  • Rationalization of Adjusted Gross Revenue: Non-telecom revenue will be excluded on a prospective basis from the definition of AGR.
  • Bank Guarantees (BGs) rationalized: Huge reduction in BG requirements (80%) against License Fee (LF) and other similar Levies. No requirements for multiple BGs in different Licensed Service Areas (LSAs) regions in the country. Instead, One BG will be enough.
  • Interest rates rationalized/ Penalties removed: From 1st October 2021, Delayed payments of License Fee (LF)/Spectrum Usage Charge (SUC) will attract an interest rate of SBI’s MCLR plus 2% instead of MCLR plus 4%; interest compounded annually instead of monthly; penalty and interest on penalty removed.
  • For Auctions held henceforth, no BGs will be required to secure instalment payments. The industry has matured and the past practice of BG is no longer required.
  • Spectrum Tenure: In future Auctions, the tenure of spectrum increased from 20 to 30 years.
  • Surrender of the spectrum will be permitted after 10 years for spectrum acquired in future auctions.
  • No Spectrum Usage Charge (SUC) for spectrum acquired in future spectrum auctions.
  • Spectrum sharing encouraged- additional SUC of 0.5% for spectrum sharing removed.
  • To encourage investment, 100% Foreign Direct Investment (FDI) under automatic route permitted in Telecom Sector. All safeguards will apply.

Procedural Reforms

  • Auction calendar fixed - Spectrum auctions are to be normally held in the last quarter of every financial year.
  • Ease of doing business promoted - a cumbersome requirement of licenses under 1953 Customs Notification for wireless equipment removed; Replaced with self-declaration.
  • Know Your Customers (KYC) reforms: Self-KYC (App-based) permitted. E-KYC rate revised to only One Rupee. Shifting from Prepaid to Post-paid and vice-versa will not require fresh KYC.
  • Paper Customer Acquisition Forms (CAF) will be replaced by digital storage of data. Nearly 300-400 crore paper CAFs lying in various warehouses of TSPs will not be required. Warehouse audit of CAF will not be required.
  • SACFA clearance for telecom towers eased. DOT will accept data on a portal based on a self-declaration basis. Portals of other Agencies (such as Civil Aviation) will be linked with DOT Portal.
  • Addressing Liquidity requirements of Telecom Service Providers

The Cabinet approved the following for all the Telecom Service Providers (TSPs):

  • Moratorium/Deferment of up to four years in annual payments of dues arising out of the AGR judgment with, however, by protecting the Net Present Value (NPV) of the due amounts being protected.
  • Moratorium/Deferment on due payments of spectrum purchased in past auctions (excluding the auction of 2021) for upto four years with NPV protected at the interest rate stipulated in the respective auctions.
  • Option to the TSPs to pay the interest amount arising due to the said deferment of payment by way of equity.
  • At the option of the Government, to convert the due amount pertaining to the said deferred payment by way of equity at the end of the Moratorium/Deferment period, guidelines for which will be finalized by the Ministry of Finance.
  • The above will be applicable for all TSPs and will provide relief by easing liquidity and cash flow. This will also help various banks having substantial exposure to the Telecom sector.

Overall, the telecom package will benefit both VIL and Bharti Airtel (NS: BRTI ) in terms of cash flow savings for around $200M over the next two FYs. And it will also help VIL from the relaxation of spectrum holding norms (proposal to combine all sub-GHz spectrum bands for calculation of 50% spectrum cap in any service area); since the previous regulations would have compelled the merged entity to give up 45.4MHz of excess spectrum holdings across all service areas.

But the big question is whether VIL promoters (Vodafone (LON: VOD ) and Idea) will infuse fresh equity capital in a business/sector (Indian telecom), which they think is not viable. VIL has to pay the AGR/SC amount after 4-years of the moratorium. There is also a question mark about customer trust in VIL and whether VIL will be able to generate enough revenue to sustain and pay back the government due (disputed AGR). Thus although the telecom package is a big relief for VIL and its lenders like SBI, Indusind Bank, all will depend upon VIL promoters, whether they will put capital.

VIL now owes around Rs.54.754B to the Indian government followed by RCOM (Rs.24.194B), Tata group (Rs.12.601B), and Aircel (Rs.12.389B), totalling almost Rs.1.05T. Total telecom sector debt was around Rs.3.85T as of Mar’21 against revenue of Rs.2.74T. In India, the Telecom business is now only suitable for players, having a very deep pocket and can burn cash to remove competition. Thus, RI-JIO and Bharti Airtel have become two major players in the Indian telecom sector and customers are now deserting VIL.

Eventually, VIL’s telecom assists may be acquired by R-JIO and Bharti Airtel and the Indian government has to recapitalize PSBs for telecom loan loss either directly or indirectly. The government policy of ‘milking’ telecom companies and subsequent entry of R-JIO with a disruptive business model may be quite risky as it’s now a virtual duopoly between R-JIO and Bharti Airtel, while government-owned BSNL has also lots of problems.

On 15th September, the Indian government also unveiled details of the much-awaited super ARC (Bad Bank), to deal with a large amount of legacy NPAs:

  • Cabinet approves Central Government guarantee to back Security Receipts issued by National Asset Reconstruction Company Limited for acquiring of stressed loan assets
  • ARC was announced in Union Budget 2021-22
  • NARCL proposes to acquire stressed assets of about Rs. 2 Lakh crore in phases within extant regulations of RBI
  • The Union Cabinet, chaired by Prime Minister Shri Narendra Modi, has approved a Central Government guarantee of Rs.30,600 crore to back Security Receipts (SRs) issued by National Asset Reconstruction Company Limited (NARCL) for acquiring stressed loan assets. This is in line with the Budget announcement for the FY 2021-22.
  • The SRs issued by NARCL shall be backed by a sovereign guarantee of the Government of India. The Gol's guarantee shall be for Rs.30,600 crore and shall be valid for five years. Gol's guarantee can be invoked by NARCL for meeting the shortfall between the face value of the SR and the actual realization upon resolution/liquidation. NARCL shall be liable to pay an annual guarantee fee.

Benefits:

The NARCL - IDMCL structure will assist in the consolidation of debt, currently fragmented across various lenders, thus leading to faster, single-point decision making including through IBC processes, where applicable. It will incentivize quicker action on resolving stressed assets thereby helping in better value realization. India Debt Resolution Company Limited (IDRCL) will engage market expertise for value enhancement. This approach will also permit freeing up of personnel in banks to focus on increasing business and credit growth. As the holders of these stressed assets and SRs, banks will receive the gains. Gol's guarantee will also enhance the liquidity of SRs as such SRs are tradable.

Background:

The government's 4 R strategy of Recognition, Resolution, Recapitalization and Reform has led to a turnaround in the performance of Public Sector Banks (PSBs). High levels of provisioning of legacy NPAs have presented an opportunity for additional measures for faster resolution. The Union Budget 2021-22 had accordingly announced the Government's intention to set up an Asset Reconstruction Company (ARC) along with an Asset management Company AMC to consolidate and take over the existing stressed debt and thereafter manage and dispose of it off to buyers for value realization.

The National Asset Reconstruction Company Limited (NARCL) and India Debt Resolution Company Limited (IDRCL) have since been set up by banks. NARCL proposes to acquire stressed assets of about Rs. 2 Lakh crore in phases within extant regulations of RBI. It intends to acquire these through 15% Cash and 85% in Security Receipts (SRs).

NARCL has been incorporated under the Companies Act and has applied to the Reserve Bank of India for a license as an Asset Reconstruction Company (ARC). NARCL has been set up by banks to aggregate and consolidates stressed assets for their subsequent resolution. PSBs will maintain51% ownership in NARCL.

IDRC is a service company/operational entity which will manage the asset and engage market professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake and the rest will be with private-sector lenders.

Existing ARCs (28) have been helpful in the resolution of stressed assets, especially for smaller value loans. Various available resolution mechanisms, including IBC, have proved to be useful. However, considering the large stock of legacy NPAs, additional options/alternatives are needed and the NARCL-IRDCL structure announced in the Union Budget is this initiative.

Resolution mechanisms of this nature which deal with a backlog of NPAs typically require a backstop from Government. This imparts credibility and provides for contingency buffers. Hence, the GoI Guarantee of up to Rs 30,600 crore will back Security Receipts (SRs) issued by NARCL. The guarantee will be valid for 5 years. The condition precedent for invocation of guarantee would be resolution or liquidation. The guarantee shall cover the shortfall between the face value of the SR and the actual realization. GoI’s guarantee will also enhance the liquidity of SRs as such SRs are tradable.

The NARCL will acquire assets by making an offer to the lead bank. Once NARCL’s offer is accepted, then, IDRCL will be engaged for management and value addition.It will incentivize quicker action on resolving stressed assets thereby helping in better value realization. This approach will also permit freeing up of personnel in banks to focus on increasing business and credit growth. As the holders of these stressed assets and SRs, banks will receive the gains. Further, it will bring about improvement in bank’s valuation and enhance their ability to raise market capital.

Insolvency and Bankruptcy Code (IBC), strengthening of Securitization and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI Act) and Debt Recovery Tribunals, as well as setting up of dedicated Stressed Asset Management Verticals (AVMs) in banks for large-value NPA accounts have brought a sharper focus on recovery. Despite these efforts, a substantial amount of NPAs continues on the balance sheets of banks primarily because the stock of bad loans as revealed by the Asset Quality Review is not only large but fragmented across various lenders. High levels of provisioning by banks against legacy NPAs have presented a unique opportunity for faster resolution.

The GoI guarantee will be valid for five years and the condition precedent for invocation of guarantee will be resolution or liquidation. Further, to disincentivize delay in resolution, NARCL has to pay a Guarantee fee which increases with the passage of time.

The capitalization of NARCL would be through equity from banks and Non-Banking Financial Companies (NBFCs); it will also raise debt as required. The GoI guarantee will reduce upfront capitalization requirements.

NARCL is intended to resolve stressed loan assets above 500 crores each amounting to about 2 lakh crore. In phase I, fully provisioned assets of about Rs. 90,000 crores are expected to be transferred to NARCL, while the remaining assets with lower provisions would be transferred in phase II.

The Indian Finance Minister Sitharaman said:

The government-backed Bad Bank will help cleaning up PSB’s balance sheets and free up growth capital for them to support economic activity---this will result in banks’ balance sheets and books being cleaner, transparent, they will now be able to stand on their own and do business. They have proved it because banks are going out and raising resources (from the market). A guarantee helps in improving the value of security receipts, their liquidity and tradability. For the SRs (security receipts) to hold on and have their value intact; there is a need for the government to backstop---that’s why Cabinet has given clearance to provide a guarantee—

The Indian government further clarified that the guarantee is in the form of the ‘contingent liability and does not involve any immediate cash outgo for the Central government--conditions have been built in the structure to ensure a speedy and time-bound resolution.

The FICCI said:

This will ensure that a secondary market gets developed for such Securitized Receipts and banks will be able to trade the same. Second, there is an inbuilt incentive structure within the overall framework that will drive both banks and NARCL to ensure the resolution of the bad loans within 5 years. Such elements have been missing in the functioning of the existing ARCs and hence we feel that large assets that have hitherto been left unaddressed will see resolution going ahead.

Overall, PSBs will sell around Rs.2T legacy NPAs to NARCL in phases and will receive 15% cash (i.e. Rs.300B) and 85% SRs (tradable). The guarantee shall cover the shortfall between the face value of the SR and the actual realization, subject to an overall limit of Rs.30.60B. Thus PSBs may get around Rs.330.60B; i.e. around 16.53% of the total NPA of Rs.2T (legacy) minimum. The Federal government is now keeping a provision for Rs.30.60B as possible cost (fiscal grants) to bail out PSBs, where the government is the promoter.

The government-backed NARCL will ensure either resolution or liquidation of those stressed assets within 5-years. NARCL will be owned by PSBs and guaranteed by the Federal government. The Indian Government has also registered India Debt Resolution Company Ltd. (IDRCL) which will manage the asset and engage market professionals and turnaround experts. Public Sector Banks (PSBs) and Public FIs will hold a maximum of 49% stake and the rest will be with private-sector lenders.

This legacy NPAs worth Rs.2T has already been written off by the PSBs, but may or may not be waived off yet. The upfront 15% cash payment will help PSBs in terms of cash-flows, but there may be very little probability of any resolution rather than the liquidation of such underlying stressed assets. Now, there is also a severe lack of buyers of such stressed assets even at 85% haircut. Thus it’s safe to presume that PSBs may not get more than 16.53% for such legacy NPAs worth Rs.2T from the government (NARCL) by the next 5-years. And PSBs have to arrange their capital requirement from the market. Someone has to pay the NPA bill and the Indian Federal government is now buying the legacy NPAs with almost 83.47% haircut and that too with borrowed money as the PSBs bailout amount of Rs.300.60B will be eventually added to the budget/fiscal deficit of the Federal government gradually within next 5-years.

Bottom line:

Overall, both telecom and banking reform (bad bank) may be too little and too late; no doubt these reforms are incremental, but may not be monumental.

Technically, whatever may be the narrative; Nifty Future now has to sustain over 18050 levels for 19250-19625 levels; otherwise sustaining below 18000-17875 levels (by Mar’22), Nifty Future may target 15600-15180 levels. Similarly, Bank Nifty Future now has to sustain above 38300 levels for 38650 and above that 43800-45400 (by Mar’22); otherwise sustaining below 38200, may slip to 34300-33500 zones.Nifty

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