Price correction, not default

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: Fixed Maturity Plans (FMPs) continue to stay in the news. A number of investors have sought redemptions, even at the cost of having to pay a hefty exit load. Any mention of a real estate paper in the portfolio spooks them. While everyone agrees that risks in the real estate sector have gone up substantially in the recent past, the expectation is that property prices will correct, not that borrowers will default. Default may be the last event in the cycle, after other options have been exhausted, and that includes allowing prices to correct. A default is likely to kill both real estate borrowings from the formal sector, and FMP as a product option. The real estate sector has very few options for short- and long-term borrowings, and defaults will shrink the window that has just opened. While most agree that real estate borrowers may have stretched their borrowings and projects a bit too far, price correction is seen as a plausible option to ease some stress, rather than a straight default that represents a snapping point. If the reluctance to let prices drop persists, default may become inevitable and prices will anyway tumble after that event.

Lose-lose for liquid funds and NBFCs

Along with FMPs and real estate developers, the other groups in stress are the liquid funds and non-banking finance companies (NBFCs). For a long time now, mutual funds have emerged as the dominant providers of short-term finance to NBFCs. Over 90 per cent of commercial paper (CP) issued by this sector is bought by mutual funds. The attractive yield is the bait, apart from the fact that there is an access premium, even for a highly credit-rated borrower. NBFCs do not have access to the markets that mutual funds can access, with retail fixed deposits dying a quiet death in the late-1990s.

The liquidity crunch has led several liquid funds to reduce their exposure to CPs and CDs, and this has triggered a shortage of funds for NBFCs. The proposal to ask NBFCs to raise perpetual debt could not have come at a more inappropriate time, when lenders have shied away from the markets. NBFCs do not have a deposit base, and if their access to wholesale debt market through mutual funds is also cut off, their businesses are likely to come under tremendous stress.

Credit crunch likely to worsen