Adjusting to the new normal in the Indian economy
Six months into the COVID-19 crisis in India, the rate of spread of the virus is showing little signs of relenting. Daily reported cases remain high – in the 70,000 – 100,000 range over recent weeks – with total confirmed cases moving closer to the 7 million mark. While the crisis is still very much about safety and protecting lives, the Indian economy has come a long way from the stringent lockdown days of April and May.
Implementing the tightest lockdown globally resulted in a commensurate impact on economic growth. India’s GDP contracted by 24% sequentially during the April – June quarter (Q1 FY21) – the steepest decline reported among large economies. While most areas of the economy saw considerable dips, government spending (up 16%) and agriculture (up 3%) were positives, supported by enhanced borrowing at the central and state level to fund food security, public healthcare, and employment schemes. Restrictions on movement and economic activity have eased considerably since June over a phased ‘unlock’ program that continues into October and addresses supply-side constraints to a large extent. Despite the stop-start nature of operations, most industries are now operating at 70% (or higher) of pre-COVID levels. Business stability and confidence are gradually improving.
Details on the $266bn or Rs. 20tn economic package, worth c.10% of GDP, highlight a more foundational role for the government which in principle revolves more around laying the right cricket pitch for businesses to smoothly bat on during these uncertain conditions. Majority of the support has been announced in the form of relief measures, credit guarantees, and easing of regulatory constraints while direct fiscal contribution amounts to 20% – 40% of the package, per various analyst estimates. This structure is influenced by the drying up of revenue sources for the government – tax collections YTD FY21 are trending 30% lower YoY while divestment targets of $25bn for the full year are unlikely to be met. However, the government has loosened the fiscal strings considerably and expanded its FY21 borrowing plan to $160bn (from ~$100bn) to support the economy. Analysts estimate FY21 fiscal deficit to reach 7% – 8% levels vs the 3.5% target pre COVID-19.
Crisis situations in the past have led to some of the most impactful structural policy reforms in India including the agricultural and milk reforms in the 1970s and economic liberalization in 1991. In September 2020, the government implemented structural changes to agriculture and labor laws in India, as promised in the economic package. Farm reforms are a step towards a market-driven agriculture economy and eliminate constraints around the role of middlemen and regional boundaries for selling farm produce. Labor reforms subsume multiple old laws into 4 simplified labor codes and ease constraints that previously disincentivized small business expansion. Changes to the land laws are likely to be introduced soon.
The nature of the economic package measures has led to a prominent role for the RBI on structuring and implementing various schemes. On the other hand, the RBI continues to provide support through its regular policy levers. RBI’s monetary policy committee has reiterated its accommodative and growth-friendly policy stance on rates, maintaining repo, and reverse repo rates at 4.0% and 3.35%, respectively. The accommodative stance is against a backdrop of rising inflation which has limited the RBI’s ability to flex its interest rate muscle after the last cut in June. High food inflation due to poor harvests and unfavorable base effect since early 2020, and a sharp rise in prices across the board due to supply chain breakages during the lockdown have resulted in consumer price inflation (CPI) breaching RBI’s 6% upper limit persistently over the last 9 months. However, with surplus monsoon rains in 2020 and a reversal of the base effect, food inflation is expected to ease in the coming months. This could potentially open a window for further rate cuts.
The RBI-sponsored term loan moratorium for borrowers ended on 31st August 2020 after a 6-month period. However, to ease borrower concerns and manage stress in the system, the RBI announced a restructuring window for corporate and retail loans till 31st December 2020.
Additionally, the RBI has supplied liquidity worth Rs. 4tn through open market operations and cuts in cash reserve ratio requirements. In the recent policy review meeting in August, the RBI announced additional liquidity for housing finance, microfinance, and small non-banking finance companies. Net liquidity in the system continues to be high at Rs. 3tn.
Surplus liquidity and low-interest rates in both domestic and foreign markets have driven strong capital flows into the Indian equity market. The broad equity market index, BSE 500, is up 5% YoY and 54% from the YTD lows at March-end (around the start of the lockdown), belying business and economic fundamentals. Foreign portfolio investors (FPI) have infused funds worth $13bn over May-August 2020 reversing their sharp pullback witnessed during March – April 2020. However, FPIs remain wary of Indian debt (and emerging market debt in general) and have pulled out $6bn since April 2020.
The extent of GDP decline in Q1FY21 was a negative surprise – market expectations were for a 15% – 20% dip. Analysts estimate gradual improvement going forward, given the cascaded nature of the ‘unlock’ program, with focus expected to shift from containment to revival. Global agencies like Fitch and Moody’s now estimate a 10% – 12% GDP decline in FY21, expecting growth momentum to improve in the back half of the fiscal year.
While the broader growth picture continues to have shades of uncertainty, multiple green shoots are becoming visible. The Indian festive season, which drives around 40% of annual sales, is due to start late October and retailers are gearing up for servicing pent up consumer demand. This is evident from the large e-Commerce players’ – Amazon and Flipkart – buildup to their annual festive sale. Monthly automobile sales figures have also started to pick up from July onwards, especially in sub-urban and rural India. Manufacturing firms largely expect capacity utilization to recover in Q3FY21 (October – December 2020). Capital heavy investments, like residential real estate, are also seeing strong buyer activity, especially in the affordable housing segment, helped by low-interest rates and discounts from developers. Sales of consumer staples are recovering fast, benefitting from rising in-home consumption and rural resilience amid a wipeout of contributions from the hospitality sector. Supply constraints have eased and development in demand drivers would be key to evaluate in the coming months.
Financial services players were categorized as the biggest casualties due to the double whammy from economic de-growth and deteriorating loan book quality post the moratorium. However, private banks have managed to raise large pools of capital from the markets, elevating their capital buffers to 15-year highs – a strong mark of confidence in the banking system. While NPAs are expected to rise in FY21, banking and non-banking financial companies are reporting strong collection efficiencies (up to 80% in September) and have been aggressive on provisioning. As confidence and balance sheet comfort improves, lenders are likely to resume loan disbursements post Diwali in November 2020.
As businesses and the economy settle into this new normal, there is a strong push towards mitigating COVID-19 related disruptions and challenges and reviving the engines of economic growth.
India Manufacturing – Opportunity in a Crisis
The ancient Indian teacher, philosopher and royal advisor, Chanakya, is credited with being the architect of the Mauryan empire, which grew to rule over more than 2 million square miles by c. 150 BCE. Alliances and opportunism lay at the heart of his success. When relations between the powerful kingdoms of Nanda and Parvataka soured, Chanakya stitched an alliance with Parvataka to defeat Nanda, and set his protégé Chandragupta on path to founding one of the largest empires on the Indian subcontinent.
More than 2000 years later, the Modi-led government in India finds itself at similar cross-roads. With supply chains disrupted worldwide and anti-China sentiment on the rise in the wake of COVID-19, companies are actively evaluating alternatives to sourcing from China. India has sensed an opportunity and is keen to make inroads to a space it hopes China will vacate sooner rather than later.
China has been the world’s factory over the past two decades, contributing 13% to world exports. However, the COVID-19 pandemic and sweeping measures to contain it have disrupted global supply chains, bringing factories to a screeching halt and leaving supermarkets with rows of empty shelves. Companies like Fiat Chrysler and Hyundai were forced to halt production as they could not get parts from China. The current outbreak is prompting companies to make their supply chain more resilient by increasing inventories, empaneling alternative suppliers and accelerating technology adoption.
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SCP’s Fellowship Program
We are excited to welcome Malav Simaria as our most recent SCP Fellow.
Malav has a bachelor’s and master’s degree in technology from IIT Bombay and has been part of the Deal Advisory team at KPMG and the Equity Research teams at Edelweiss and J.P. Morgan. Following his fellowship with SCP, Malav will be pursuing his MBA at Columbia Business School, USA.
