India – Haven in the Unfolding Crisis Globally

Recently, there has been a lot of turmoil in the world. Within the last few weeks, two major banks have failed – Credit Suisse (Europe) and Silicon Valley Bank (USA). The splendid growth which many of the banks were enjoying because of the ~0% interest rate disappeared rapidly in just a year.

US FED hiked the interest rate by 25 basis points in the last meeting (ninth hike in a row) – this was not a surprise. What surprised us and may be many other market folks was the stance that they announced. Chairman Powell quoted:

“We no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation; instead, we now anticipate that some additional policy firming may be appropriate”

What we decode from this statement is that FED believes that inflation is still high and there are bleak signs of recovery.

The textbook definition of inflation is “too much money chasing too few goods”. Now, this all started post Covid. Take the USA for example – It printed trillions of dollars just to revive from the shock of Covid. Now we understand that the US dollar is a globally accepted currency, but no one can keep calm inflation for too long. Current inflation in the USA is something no financial model would have expected as they have not seen such high rates in a long history.

We are seeing inverted yields in the USA – Government’s 10-year bonds are at 3.29% versus the 2-year bonds which now trade at a yield of 3.6%. Investors are asking for more in the short term given the chaos compared to long-term bonds. In market parlance, this is the start of the market downturn in the offing.

India, on the other side, managed Covid way better than other countries. Be it in financial terms (Government didn’t let the fiscal deficit go out of hand) or healthcare (managed to vaccinate 2nd largest population). The inflation in India is slowly coming down but is still above RBI’s target range. It seems that there may be some rate hikes going forward. But on a relative basis, our inflation seems to be under control.

Indian Banks – Succumb to Global Failure?

There have been a lot of questions in the market currently, especially regarding the stability of Indian banks. Given the global failure, this seems to be a logical question. But, if we dig down a bit deeper into the balance sheets of Indian banks, we can conclude that Indian banks are much stronger.

Let’s take an example of the recent failure of Silicon Valley Bank (SVB). SVB’s depositors (the ‘Liability’ side) consisted mainly of startups that deposited the cash they received from investors. SVB invested this money in US Treasury bonds and mortgage-backed securities (MBS) as Held-till-Maturity (HTM). This meant that the bank aims to hold these bonds until maturity and would carry these assets at par value without the need to revise prices amid the ongoing rate hike action.

SVB was earning the spread just like a normal bank. But in 2021 greed took over and the bank shifted to invest in longer-term securities in its search for higher yield (the ‘Asset’ side).

In the last 1 year, US FED hiked rates to ~4.5% from ~0%. VC funding dried up + US treasury bonds and MBS purchased by SVB plunged (as rates go up, bond prices go down). Now in this kind of situation, startups started withdrawing their cash to fund their operations. To meet the cash needs, SVB first sold off its “available for sale” securities at a loss (as the price had fallen alongside rising rates). Further withdrawal of money (post SVBs announcement of raising equity capital) exacerbated the situation and then it needed to sell its held-to-maturity bond portfolio and recognize a $15bn loss.

SVB is a classic case of bank-run due to an “Asset-Liability Mismatch (ALM)”. India faced the same situation in 2018 – the IL&FS, Indiabulls crisis etc. which led to a liquidity crunch.

Cut short to the current scenario, below, we have collated the data of the top 25 banks in India and their exposure towards Held till Maturity (HTM) investments. The highest HTM% are with Central bank 26%, UCO Bank 25% and PNB 23% – all being public sector undertakings. Kotak leads here with the least HTM% at 9% and 6 other banks with <15% of HTM%.

Bank NameNet HTM
(Rs Cr.)
Total Assets
(Rs Cr.)
HTM as % of
Total Assets
Source: Narnolia Financial Services Ltd

We have recently seen a clean-up in the NPAs. We feel that we are much more resilient. The credit cycle is just starting with some short-term headwinds (which will eventually subside). But the long-term trend is intact and with the NPAs issue behind us, we are very confident about the positive prospects of the banking business in India.

FII Outflows – Waiting for the Waves to Settle?

India saw massive outflows for 2 years now. We have seen a lot of supply-side issues post Covid. Few of the widely known: China’s lasting lockdown, the Russia-Ukraine war, Semiconductor shortage, Container shortage etc.

On the contrary, demand doesn’t seem to be an issue. Let’s take capex as an example – Cement, Chemicals, Steel companies etc. are expanding capacity. JSW Steel adding 5 MTPA, Bhushan Steel: 1.5 MTPA, NMDC Steel: 3 MTPA, JSW Vijayanagar: 5 MTPA etc. Ask yourself a question: Why would promoters expand given the global uncertainty? Because they see demand growing. They are running the business and are investing day/night in the same field. Of course, fluctuations will stay in the market but that is the essence of business. Indian promoters are consistent with the belief that the long-term prospect is still positive.

*FY23 data is till 27th March 2023
Cash segment data
Source: Money control

You might ask – If promoters are so bullish about their businesses, then why investors especially FIIs are exiting? Well, there’s a catch here. Investors are prone to Mr Market’s games. They change their perspectives with the stock prices. Apart from this, FIIs have certain mandates to follow. They can’t concentrate their investments into a particular country – rebalance the portfolio based on the valuation comfort (In CY22, India out- performed other global indices. India’s concentration might have increased in the over- all portfolio level – FIIs might have booked some profits) etc.

Global turmoil might have led FIIs to shift some allocation to cash/short-term investments. Imagine there’s a financial issue at your home – Would you lend money to your neighbors? Rather you’ll take out money which you already gave to your surroundings.

DIIs (supporting our view) are taking contrary positions. FIIs sold 4.76 lac crores in FY22 and FY23 combined whereas DIIs bought 4.73 lac crores.

What do We Envisage?

We believe that the current FIIs outflows are going to continue for some time. Current global turmoil doesn’t seem to settle as of now – there might be some more cockroaches which haven’t come to the surface yet.

We might see more consistent interest rate hikes by FED (and some hikes by RBI too). Although, we foresee that the Indian economy is much more stable if we compare it with global majors. India taught the world that “printing money” every time is not the solution to every crisis question. One has to take short-term pain for long-term stability – it’s a whole economy we are talking about – It won’t be hunky-dory always.

Not only banking but, the Indian economy as a whole seems to be resilient. International Monetary Fund (IMF) forecasts India’s GDP growth to be ~6.1% in 2023. Post-2023, the growth rate is expected to be ~6.8% in 2024.

Surely, there are short-term headwinds. But we believe that India’s growth story is intact and we are here for the multi-year growth that India will relish.

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