My father taught me that humans innately trust others because without it much of day-to-day life would not function. Societies build on such trust by creating contract enforcement mechanisms that incentivise fair play.
In the borrowing and lending space, credit agencies build on that trust by providing independent credit ratings to the borrowing programme of corporates. However, due to their shortcomings, the “trust” on the efficacy of such ratings has been low. Ant currently, it is at an all-time low due to hyper-risk aversion.
Consider the AAA (read as triple-A) rating which is explained as “Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk.
” Unfortunately, we have seen at least two AAA-rated instruments default in the last three years. Now, even an AA-rated instrument (which means Instruments with this rating are considered to have a high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk) have low credibility. And lower-rated instruments had even lower credibility even before the Covid outbreak.
The only companies that can manage to raise money cheaply are the public sector units, which are owned by the Government of India since it is assumed that the government will not let them default. In the current environment of hyper-risk aversion, there is very little chance for an A-rated instrument to get any funding at all. Funding for AA-rated instruments is also difficult, and if at all, comes at a very high cost. If this is the fate of large companies, it is not difficult to imagine the kind of difficulties being faced by the micro, small and medium enterprises (MSMEs) who are the backbone of the economy. Credit is the grease that keeps the wheels of the economy moving and this logjam will cost the economy dearly. On the other hand, banks are flushed with funds but prefer to sit on them. The availability of credit for MSMEs
has been an issue in the past as well, and the government had come out with a good scheme administered through SIDBI to provide some comfort to the banks to lend to the MSME sector.
The government, on its part, introduced a credit guarantee scheme of Rs three trillion for MSME on Wednesday, but it can further this move by charging a market-determined cost of such guarantee. Given the high cost of borrowings for the AA and A-rated companies, they should be more than willing to pay the market-determined cost of such guarantee.
This money can be used for the payment of supply bills raised by MSMEs
on the AA and A-rated companies. Once the MSME are assured of the payment of their supply bills, they will also be able to raise money. Best of all, the market-determined nature of the cost of such guarantees will ensure that the companies use this facility only till such time as the environment of hyper- risk aversion lasts. They are also incentivised to pay on time to be able to maintain their credit ratings. Ultimately, these are reasonably good companies with decent balance sheets that should be able to stand on their own after some time. The sector will benefit from this trickle-down trust effect.
What is needed now is quick action on the part of the government to restore some trust and risk-taking ability in the market. It must remember that even an accomplished finisher like Mahendra Singh Dhoni could not accomplish the task when he left it till the last over.
The writer is a Sebi-registered investment advisor