India: Higher oil, tighter norms to exacerbate credit crunch

  • The government’s extraordinary takeover on 1 October of the Infrastructure Leasing & Financial Services (IL&FS) board stems the risk of contagion as it will ensure the lender has adequate liquidity to avert further defaults.
  • But liquidity will remain tight due to rising interest rates, a weakening rupee and growing investor risk aversion, resulting in funding challenges for non-banking finance companies (NBFCs).
  • The rupee’s fall to fresh lows, as we expected, will keep markets jittery about the impact of high oil prices on India’s twin deficits and inflation; the government today cut fuel taxes, as we had predicted, and this will result in fiscal slippage.
  • The Reserve Bank of India (RBI) will feel compelled to tighten monetary policy; we expect a 25 bp rate hike tomorrow.
  • The oil price impact and IL&FS’s troubles are a one-two punch for India’s already battered financial sector.
  • No major lender will be allowed to fail, but regulations will be tightened further to tackle deep-set structural faults in the sector.
  • This will delay India’s investment revival and ultimately impinge on consumption demand as well.

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