Risk pricing of AAA-rated paper, which was lower during low demand and high liquidity, has not moved up commensurately even though the credit demand has picked up and liquidity dried up, reflecting inadequate risk premium, according to State Bank of India’s economic research department (ERD).
The ERD opined that monetary policy has asymmetric transmission in Indian financial markets.
The ERD noted that the spread between AAA-rated corporate bond and 10-year risk-free Government Security (G-Sec) rates, which was around 120 basis points (bps) during March/April 2020, has declined significantly since then.
“This trend has continued even as the rate cycle changed direction since April’2022 and is now even significantly less than half of the average spread at pre pandemic level i.e. in FY20,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI.
A one per cent increase in repo rate has resulted into only 2 to 3 bps increase in 10 year AAA corporate bond spread, 3 to 4 bps increase in 5 year AAA corporate bond spread.
However, there has been around 31 bps decrease in spread of three-year AAA corporate bond, signifying that 3 year AAA corporate bonds are not priced with adequate risk premium and they could have been at least be priced at 26-43 bps higher rate, the ERD said.
A one per cent increase in repo rate increases CP (commercial paper) weighted yield by 120 bps for up to 31 day tenor, by 147 basis points in 31 days to 91 days, 178 basis points in 92 days to 180 days and surprisingly lower at 151 bps in 181 days to 365 days tenor.
“Our further estimates suggest that 180-365 days CPs are priced exuberantly and are under priced by up to 90 bps,” Ghosh said.
Bank credit
As far as bank credit is concerned, short tenor working capital loans of less than one year are given at even more finer rates in the range of 7-7.5% or even less.
It is to be noted that 10-year G-Sec is currently trading around 7.18 per cent, while 91 Day T Bill at around 6.85% and 182 Day T Bill at around 7.04%.
“The pricing for a corporate paper should generally be higher by at least 50-100 bps to cover the risk premium, over Government paper depending upon rating, tenor etc.
“Overall, our estimates reveal that at an annualised rate, some borrowers might have been able to save up to Rs 5000 crore because of lower CP rates largesse even if inadvertently ingrained in broader markets psychology,” Ghosh said.
This has resulted in better financial service ratio. For example, the interest coverage ratio of listed entities, ex-BFSI, improved by 60 bps in Q1FY24 as compared to Q1FY23 reflecting lower input cost including finance cost.
“Clearly, monetary policy has asymmetric transmission in Indian financial markets. Future conduct of monetary policy may look into this aspect , but the end result could be monetary policy signaling is now dictated more by fuzzy market peculiarities,” said Ghosh.