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By S Murlidharan Mar 14, 2023 10:31:28 AM IST (Updated)
While the SVB debacle would play out for the next few months, there are quite a few lessons to be learnt from it by the Indian investors. There are quite a few myths that need to be disabused. It is naively believed that a debacle in the debt market doesn’t rub off onto the equity market, writes S Murlidharan, a Chartered Accountant and business columnist.
A lot has been written on the Silicon Valley Bank’s debacle that started unfolding last week. That it has been financing quite a few Indian startups and how they would weather the storm now as it is no longer going to fund them have been the Indian concerns. With these concerns in mind, the Union Minister Rajiv Chandrashekar is convening a meeting of such beneficiaries to know if they could be left high and dry.
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While the SVB debacle would play out for the next few months, there are quite a few lessons to be learnt from it by the Indian investors. There are quite a few myths that need to be disabused. It is naively believed that a debacle in the debt market doesn’t rub off onto the equity market. Quite the contrary. The sub-prime crisis of 2008 with its epicentre in the US brought a pall of gloom to the entire world including Indian bourses.
More recently, the short sales of Adani bonds in the US by Hindenburg sent the Indian equity market into a tailspin particularly of the Adani group shares. Anything adverse happening with a company affects its equity the lodestar. It is good that the Indian government has taken the SVB debacle seriously and not shrugged it off as none of its concern. SVB has had deep relationship with Indian startups and any adverse happening could rub off on to the Indian equity market. Quick clarification would steady the bourses.
Many financial pundits recommend bonds to the equity investors especially to those who have been singed in the primary market as well as in the rough and the tumble of the bourses. This is not entirely correct. Bonds after all are not risk-free especially if they are traded in the market as SVB’s experience shows---it had to incur a hefty loss of $ 1.8 billion when it sold the bonds. Holding them on to maturity lessens this risk but could place undue burdens on the investors if the maturity is a long period away.
It is well-known that the market prices of bonds and the ruling interest rates are inversely related. Suppose a company issues bonds of the face value of Rs 100 carrying 10% interest per annum for ten years. Three months after the successful issue, let us say the 10-year interest rate of treasury bonds (the benchmark rate) is slashed to 8%. The bond price would increase to Rs 125 (ballpark figure) as by buying the bonds carrying higher coupon than the prevailing rate the buyer stands to gain for which he has to pay a price. On an investment of Rs 125, he is going to get Rs 10 which translates to a 8% yield. On the contrary should the rate of interest be hiked to 12%, the bond price would tumble to Rs 83.33 (ballpark figure) as by buying bonds carrying lower coupon rate, the buyer stands to lose and he must be compensated for this potential loss with a lower price. In other words, the bond prices adjust to levels where the interest therefrom yields the prevailing rate of interest on the investment.
SVB failed to see the writing on the wall. It had invested heavily in bonds. And the US Fed has been hiking the interest rates relentlessly over the last one year or more. Each successive hike would have brought down the value of the bonds it was holding pro tanto as in the above example. Perhaps it miscalculated. It might have thought the US Fed would stop the rate hikes but that hope did not square with the US Fed’s prognosis----inflation wasn’t still under control and it needs to make loans dearer and thus reduce the money supply sloshing around resulting in inflation.
Also Read: Silicon Valley Bank collapse | Will there be an impact on Fed's decision, economists evaluate
Debt funds in India have been beckoning the middle class with the promise of savouring benefits of the inverse relationship between bond prices and interest rates. Many have fallen to the bait forgetting that it cuts both ways. They thought fixed income schemes were too staid and a bit of risk-taking by flirting with bonds would do no harm. It is another matter that in India bonds aren’t on offer or available for trading on a scale comparable to the US. Be that as it may. The lesson is always for the future.
BTW there is a vignette emerging out of the unfolding and evolving SVB saga. Federal Deposit Insurance Corporation of the US financial system provides cover upto $ 250,000 per depositor as against the measly Rs 5 lac cover provided by its counterpart Deposit Insurance Corporation of India. Earlier in India the protection was for an even more measly Rs 2.5 lac but the PMC Bank collapse brought the government to its senses. One hopes this is work in progress and depositors are not driven to opening multiple bank accounts just to heighten the amount insured.
— The author, S Murlidharan, is a CA by qualification, and writes on economic issues, fiscal and commercial laws. The views expressed are personal.
Read his previous articles here
(Edited by : C H Unnikrishnan)
First Published: Mar 13, 2023 5:15 PM IST
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