By: Tavaga Research
With indications of global and domestic headwinds and a heightened sense of uncertainty in the air , Indian economy stands to face large scale adverse consequences , if a disruption in the economic activity on account of the pandemic continues in the ensuing days.
With all the major world economies in lockdown, commercial activity in countries accounting for more than 50% of the global GDP has seen a spiraling collapse. The global impact is anticipated to be more severe than any of the past recessions
In the long run, the key to survival for firms as well as for the economy to revive, lies in adapting to a new environment, in view of the crisis, to come up with a response strategy, that should possibly accelerate emerging trends.
The major reason for a pandemic outbreak such as this to turn into a global crisis is globalisation and interlinks existing between financial markets on so many levels. The first lagging indicator that takes a toll is the GDP growth rate which declines on account of a disruption in the economy. In the present context ,a worldwide recession is almost a certainty with Global GDP expected to decline twice as much as during the 2007-2008 crisis. According to a CEBR report , a fall of 3% in 2020 and a subsequent rise of 8% in 2021 in GDP growth rate is expected for India .
The below trajectory describes the course of the GDP curve from 2000-2020. Notice the sharp falls during the period 2008-2009 and an expected decline during 2020
An impending recessionary period and ongoing economic impact caused due to the pandemic outbreak calls for a strict and prompt response from both the Central Bank and Government authorities, in order to expedite the disruption caused.
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The monetary and fiscal policies need to be catered for specific sections of the economy that have been hit the hardest. The primary goal of the authorities would be to mutually work towards enhancing the liquidity in the markets and increasing the credit supply for the small businesses and farmers. Monetary policies should be aimed towards facilitating increased emergency funding for state and central governments which has partly been accomplished.
Although the Central Bank and Fiscal Authorities have a heavy task up their sleeve, there are multiple other factors that are at play in this battle against a recession, to revive the Indian economy.
Adoption of New Technologies and Increased IT spending by India Inc
With nearly 40% of businesses looking to increase expenditure on enhancing their IT infrastructure in a bid to operate their business activities seamlessly amidst the rush to shift towards remote working ;it is imperative to look at the technology areas for allocating the additional IT spend into,some of which are:
- Additional Hardware
- Softwares and licenses
- Remote support tools
- Better cloud services
- Increased Internet bandwidth
With an increased emphasis on the work from home movement and disaster recovery plans , technology brands providing value through their products to support business ,will reap the maximum benefits .
The below statistics shows the expected percentage increase or decrease in the organisational IT budget for 2020 as compared to previous planned .
Another point to ponder upon would be the flexibility of certain sectors of the economy to shift to internet-based platforms. Going forward, people would prefer online doctor consultation over clinics and hospitals. Accordingly, we should see a boost in teleconsultation and telemedicine.
With school / colleges beginning to move their classes online , there is bound to be a surge in remote learning tools ;and technology firms with high-quality products would be coming up with platforms to ease the process . This is also a booming time for Ed-Tech platforms and online education, with consumers gearing up to test the efficacy of online learning during these times.
Transmission of monetary policy : Important Role for the Private Banking Sector
Prior to March 2020, the effective transmission of past reductions in policy rates and last year’s sharp cut in corporate tax rates was improving .But with the onset of the economic shutdown and a slackening credit growth,which is expected to decline further ,the private sector banking system needs to jump the gun and initiate a smooth transition of the 75 bps cut by RBI by transmitting the effect to term deposits and lending rates.
Compared to a reduction of 121 bps in the weighted average lending rate (WALR) by Foreign banks between February 2019 and February 2020, there has been a decline of around 42 bps in the WALR during the same period for Private sector banks. With the Central bank having already unleashed it’s artillery , aggressive liquidity management measures have been taken ; but it remains imperative to allow the transmission to the bank loans sanctioned in the retails and SME segments. With a promise for better transmission by PSBs ,there continues to be a significant difference between public sector’s and private sector’s repo linked lending rates.
While SBI offers around 7.05% on its repo linked lending rate , major players in the private banking sector offer somewhere in the range of 7.5-9%. It remains to be seen as to how the current scenario materializes and what proportion of the retail customers shift to the public sector banks.
Role of FPIs and FIIs in the Indian financial markets
Most economists and experts have joined the chorus in vocalizing their combined awe at the outperformance of both the Nifty and Sensex indices (Nifty surged 13% YoY as on Dec-19, whereas Sensex climbed 15% YoY during the same period) as compared to the economy where India’s GDP growth plunged to six-year lows in the April-June and July-September quarters of 2019-20 with most experts predicting that full year growth will struggle to cross 5 percent.A major contributing factor is the steady inflows by FIIs accounting for more than Rs 1 lakh crore in Indian stocks during 2019-2020, making it their best such infusion in six years.
The below trajectory demonstrates the ferocity as well as the intensity of FII selling in a short period of Feb- March 2020.
Also ,another factor which is going to dictate the FIIs flows is the heavy premium of MSCI India over MSCI EM with the valuation gap well above the mean to signal a sellloff. It needs to be seen that ,how the FIIs and FPIs shift their interests in the Emerging Markets. The Dalal street success story in the previous year has been largely boosted by an overweight on Indian equities as compared to other EM players. The FII sentiments is going to be contingent a lot upon the reforms , stimulus packages as well as policy changes by the Finance Ministry as well as the RBI to accommodate recovery in uncertain times like this.
Stability of oil prices
With the pandemic outbreak already wreaking havoc on demand for travel and transportation; there has been an increased supply of crude oil partly owing to Saudi Arabia’s retaliation to Russia’s refusal to curb oil production . All these factors combined have led to pretty hefty plunges in the price of Brent Crude : a 25% decline to $50 per barrel by early March and a subsequent fall towards $34 by March 9 .
In recent turn of events, the WTI crude benchmark- a type of oil generated in US oilfields tanked to negative $38 a barrel; although India won’t get to reap any benefits out of it. The variant of oil purchased by India is dictated by a basket which is a weighted average cost of Oman, Dubai, and Brent Crude.
For India , this may be a boon to pull out the economy from the current slump and waive away fears of inflationary pressures in the coming months. Although the Indian basket hasn’t seen a sharp decline recently, there’s bound to be a fall. But,this won’t translate to a commensurate dip in retails prices of petrol and Diesel.The government is desperate for tax revenues right now and the only way to make an extra buck would be through increasing taxes on oil.
According to Petroleum Planning and Analysis Cell(PPAC),the March average of Indian basket was lowest in 15 years at $33.86 a barrel.
A lower current account deficit ,and a marginally higher expected GDP growth are benefits which needs to be exploited in times like this. According to estimates,50 bps of GDP or $15 billion for every $10 per barrel decline in crude prices and reduction in inflation by 30 bps for every $10/barrel fall is to be expected.
A few key points to be noted are:
- The current global shutdown of economic activities has rendered a disruption in daily demand of nearly 30 million barrels per day
- With the WTI crude benchmark falling into negative territory owing to plummeting demand and excess supply of the commodity; leading to lack of storage facility , oil may well become a worthless commodity.
- Despite better prices on offer ; a sluggish demand across the country has led to it’s tanks on full capacity with no further requirement
- India could leverage this opportunity to procure cheaper oil but a weaker currency can potentially trim down lucrative gains.
- A smart move by the government to better it’s current account deficit would be to ramp up its storage infrastructure for Crude oil and lower the applicable taxes on petrol and Diesel to exploit the lucrative prices of oil amidst the current scenario .
The following plot demonstrates the trajectory of oil prices over the last few quarters leading up to the current scenario.
India has been a net importer of crude ,importing around 84% of it’s national demand .
Simply put ,the current oil price drop is a boon in disguise for Indian economy and would help boost it’s Current account deficit . Along with it low oil prices should essential help cool down inflation’s with RBI quarterly data on household inflation expectations implying a decline of 10-20 bps in the median inflation expectations
The below infographic demonstrates the historical relationship between Oil prices and GDP growth
Structural reforms and proactive initiatives taken by the Real estate sector and the Private Banking Sector
Rating Agencies like Moody’s have already downgraded the Outlook of the Indian Banking sector from stable to negative.The credit flow in the economy was already stagnated by liquidity constraints in the Banking and Non-Banking financial sectors.Amidst the erratic volatility catching up on the global financial markets in the wake of coronavirus crisis, credit supply to retail as well as institutional segments has been curtailed on account of a heightened risk aversion leading to more liquidity pressure on small private sector lenders, effectively constraining their lending capacity.
A report published by S&P ratings estimates an additional USD 300 Billion spike in lenders’ credit costs as well as an additional USD 600 Billion increase in NPA. The same report also suggests a spike of around 1.9% in the Non Performing Assets Ratio following the economic slowdown .
That being said ,the fragility and vulnerability of the banks’ asset quality depends in part on the proactive measures taken by the government and other regulatory policy responses. Government and regulatory authorities have already rolled out liquidity injection packages as well as loans aimed at industries and regions which have been hit the most.
While RBI’s quiver has already unleashed measures like a 75 bps repo rate cut , a reduction in cash reserve ratio,as well as future plans of targeted long term repos operations(TLTRO) ; it’s important to see the practical implementation of these policy responses and the significant fiscal costs incurred
. Also, the lending capability and operational performance of NBFCs need to be monitored by assessing and improving the businesses of the MSMEs who have limited cash buffers.
Along with the banking sector ,the commercial real estate sector has taken a hit ,with real estate related construction activities been put on hold starting March 21 in most metro cities .A lack of immediate response and sensitivity towards the sector may eventually lead to a lot of developers going bankrupt. An estimated plunge in the range of 20-30% is been forecasted during 2020 owing to the pandemic caused lockdown and halt on activities in the Indian commercial real estate sector.This is largely due to the restructuring and re-strategizing of business plans on the part of MNCs and domestic businesses to optimise operational costs and limit expansion plans.
Going forward, it is imperative that the government announces certain measures to relax lending norms to the sector such as reducing the risk rate for the sector or for that matter allow for refinancing in an existing project that may be stuck.
Also ,a shift in focus towards Tier 1 and Tier 2 cities from the traditional metro oriented development model needs to be a priority for the real estate sector to minimize the loss of business and improve it’s cash positions.
The realty sector associations have already proposed a one time restructuring package as well as a GST stimulus package to the Government. Further development on this front needs to be assessed carefully .
The below figure evidently shows the hit taken by realty sector stocks during the period 2019-2020.
Although the above-mentioned factors will prove to be the most important with respect to the detrimental impact of the pandemic outbreak and the induced lockdown on India’s economy,it goes beyond saying that a multitude of other equally poignant phenomenon will drive the due course of the response and resilience of the economy.
The country’s ability to ramp up its health infrastructure, establish a seamless supply chain of medical equipments, and build up robust medical facilities will explicitly lead to containing the contagion and minimising its effect on the economy. The flexibility of the manufacturing sector to adapt itself towards the manufacturing of necessary medical equipments will boost the manufacturing sector in times of a slump .
Investors should keep in mind that uncertain scenarios dictate one to be precarious and be prudential when it comes to investing in the right assets. With the current index levels in the market as well as a distressed outlook on India Inc’ fundamentals;one needs to realize that a long term investment strategy and risk-averse portfolio allocation is the key to capitalize on the downturn.
India and it’s History of Combat against Crisis
India managed to contain the repercussions of the 2008 global Financial Crisis by loosening it’s pockets beyond the then permitted limit . The Government crossed the Fiscal Responsibility& Budget Management Act mandated 3% fiscal deficit limit ,leading the Fiscal deficit to breach the 6% mark.
An already slowed down economy fuelled by increasing trade deficits and dwindling private consumption and investment; the only vehicle left to possibly revive the economy is Government spending.
With fiscal deficit having already jumping around the 10% mark ,accounting for off- budget spending; the Indian Government potentially needs to pump fiscal stimulus packages and improvise on future taxation regime to boost the national demand.