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Imagine you are one of the ultra high net worth persons in India. You are among those who have at least $30 million each in wealth. There are about 11,198 of them, as estimated by property consultant Knight-Frank. This number is predicted to grow by 63% over the next five years. This will be the second-fastest growth in the world. With a long pipeline of initial public offers (IPO) this year, some of them from among the 100-odd unicorns waiting to list for public trading, the projection seems eminently believable.

Now rewind a month or two. You have heard of a blockbuster IPO that’s coming up, of an e-commerce company that connects hungry Indians with food from restaurants and kitchens. Its operations are spread across 500 cities of India, and it currently has 32 million average monthly users linked online to 170,000 restaurants. Never mind that in the past four years it has made a cumulative loss of 4,320 crore.

Your wealth manager advises you to invest 1 crore of your money in this IPO. A friendly non-bank financier will match your investment with a 99 crore loan, say for a period of 15 days at most. So you can then invest 100 crore in the IPO with this loan-against-shares financing. Such leverage is not unheard of, and is considered low-risk lending by the non-bank financial company (NBFC) world, since it is fully collaterized with shares that can be sold instantly.

IPO-financing during these exuberant times is considered very lucrative. It turns out that the food delivery e-commerce IPO issue got oversubscribed 38 times. So you get an allotment of shares worth only about 2.5 crore of the 100 crore you invested. But, on listing day, your gains were expected to be at least 25% (in fact it was a 66% pop). So you make a gain of about 62 lakh, from which you pay off the interest owed to your financier. Thanks to a very accommodative monetary policy, today’s interest rates are extremely low, and liquidity is in surplus. Your effective rate could be as low as 7%, which translates to an interest charge of about 25 lakh for those 15 days. You have made a neat profit of 37 lakh on an initial investment of 1 crore in just 15 days, i.e. between the IPO application and the stock’s day of listing. This seems like a no-brainer and everyone comes out a winner.

These are boom times, with at least a dozen IPOs lined up. Foreign private equity investors have just poured in nearly $8 billion during the last quarter, mostly in unlisted startups of the digital economy that are waiting to fly like unicorns. Once a company gets publicly listed, its value jumps several fold, offering an exit to private equity investors, and some stock offloading opportunities for other early investors and founders as well. As long as liquidity is plentiful and interest rates are very low, and leverage is the name of the game, this merry situation can continue.

From a partial equilibrium analysis (i.e. looking at the issue from a single investor’s perspective), consider a general equilibrium analysis. The issue of 9,000 crore worth of shares was oversubscribed 38 times, which means funds of 3.42 trillion were on the table. This is money going from financier ‘banks’ to the bank commissioned by the issuer to receive the application forms and subscription money. In the overall banking model, this entails large sums passing from IPO-financing ‘sponsor’ banks to receiving banks on the closing date of the IPO. Imagine 3.42 trillion getting locked up for 15 days or so. This can create funding pressure, and interbank rates can spike. Of course, money gets recycled from receiving banks back to sponsor banks. A reverse flow of money takes place during the refunding period. Facilities like ASBA (Application Supported by Blocked Amount) might smoothen payments, but can’t eliminate pressure on liquidity. In the pre-Lehman go-go days, IPO financing rose by more than 1,000% in places like Hong Kong. So long as there is underlying bullish sentiment, that there will be substantial listing gains, the merry-go-round of massive fund flows thanks to oversubscription can go on. But what if an IPO fails, or what if the financier has to sell shares to make up ‘margin money’? And what if such selling puts further downward pressure on stock prices? An ultra high net worth person may not mind losing a fraction of the total leveraged amount, but the systemic risk is high.

What does a central bank do? If interest rates are raised, then IPO funding loses some fizz because net profit gets slashed.

Is it fair to spoil the party? The Reserve Bank of India (RBI) is anyway caught between rising inflation and the need to provide liquidity and credit for growth. Real returns for depositors are negative, while borrowers who are funding their IPO bets with low-cost liquidity make merry. A former RBI governor once said that in his entire five-year term, no bigwig ever called or urged him to raise interest rates. Bank depositors are a large, diffuse and mostly silent mass. In the current context, with weak credit offtake and investment stagnation, it wouldn’t be wise to raise interest rates. Besides, RBI is committed to fund the fiscal deficit, with guaranteed purchases of government bonds, so as to keep long-term borrowing costs low. But it would be wise to keep an eye on interest rates at the short end, and on inflationary trends, domestically as well as worldwide, which have already prompted many other central banks to start raising rates. The unicorn IPO party is just starting in India, but the systemic risks to financial stability cannot be ignored.

Ajit Ranade is chief economist at Aditya Birla Group.

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