Franklin Templeton's fund liquidation shows government, RBI must hurry a financial sector package, says experts

Franklin Templeton liquidating six of its funds citing high redemption pressure and frozen debt markets is a crisis that may not stop at Franklin’s shores. Today, Bank of India’s mutual fund has severely marked down the valuation of its thinly traded corporate holdings. Corporate treasuries must have already pulled out sizeable amounts from fixed income mutual funds. As word gets around, retail investors may also get uneasy. According to the latest figures, about Rs 5 lakh crore of corporate debt instruments are sitting in various mutual funds.

The imminent danger to Rs 5 lakh crore of corporate bonds sitting with mutual funds when added to the travails of the Rs 30 lakh crore NBFC sector and the Rs 7 lakh crore housing finance sector, makes the Indian debt market problem a very large one. The NBFC and housing finance company (HFC)  travails didn’t hit the retail or lay investor. The Franklin liquidation does. Which is why RBI and government must realise there is no time for delaying a package.

So what should be the contents of this package. The three experts I spoke with HR Khan, former deputy governor of RBI; Srini Varadarajan, former deputy managing director of Axis Bank and Ananth Narayan, professor of finance at SPJIMR, had five suggestions that aren’t just good but unavoidable:

1. The most important need of the hour for the government is to set up, like in the US, an special purpose vehicle (SPV) where the equity comes from the government and RBI refinances or buys the SPV’s bonds. This corpus can be used as a line of credit to mutual funds, so they don’t have to liquidate when faced with redemptions. Indeed, the very announcement of a sovereign backed funding will reduce the redemptions. The members of the Association of Mutual Funds (AMFI), who also spoke on CNBC-TV18 had the same request - an SPV that promises a line of credit to mutual funds.

2. A similar SPV may be set up for NBFCs. Khan believes the RBI can even directly refinance banks who lend to NBFCs.

3. The RBI may look at allowing moratorium for NBFCs as well. The dithering by RBI and SBI, while legitimate, is too costly under the circumstances.

4. Another very important need of the hour is that RBI must allow AAA corporate bonds as collateral in its repos. This was first advised by the HR Khan committee in 2016 and strongly backed by the then RBI governor Raghuram Rajan. Khan, Srini and Ananth strongly argued this is an idea whose time has come.

5. Another idea, immediately implementable, is for RBI to tweak the TLTRO2 so that mandatory purchase of bonds of small NBFCs and MFIs is removed. Then banks may be more willing to lend to any NBFC. Better still, if the government promises to guarantee the first loss of small NBFCs and MFIs and indeed even of MSMEs below a threshold, banks may more easily fund them.

Any financial sector runs on trust and risk taking. Both are receding fast and only the sovereign can restore them. The delay in the government announcing any package for the financial sector so far is totally inexcusable. With Franklin’s fund liquidation, any further delay may be suicidal.