We laid out our key worries for the economy in our CIO letter of Mar 23 – financial stability, a spiralling growth shock and risk aversion from banks choking credit. In this edition of the newsletter, we look at the important cues for the economy and the equity markets. The progression of COVID-19 and the tenure of the lockdown are the most important factors. We, however, are also looking at the policy responses, both monetary and fiscal, as well as the global economic cycles as key markers for the economic recovery.
Covid-19 and lockdown progression: The progress of COVID-19 is, of course, the most important variable. Rapid progress would put enormous pressure on the medical infrastructure. This would, in turn, raise the risk of the national lockdown extending beyond April 14 or, at least, be lifted with very heavy restrictions. The longer the shutdown lasts, the deeper would be the economic slowdown and the more delayed the recovery. It would also strain government resources and limit its ability to combat the economic slowdown.
Fiscal measures from the government: Fiscal support will be necessary to recover from this growth shock. The shape and size of that fiscal package will be an important lever for bringing the economy gets backs on its rails. The government, so far, has announced an income support package for specific sections. We believe that this should go further, mainly for humanitarian reasons but also to help economic stability. Moreover, we believe a fiscal boost may also be necessary, either through fiscal support to specific employment-generating sectors, or through aggressive spending. The best way, however, is a large cut in indirect taxes – that helps both aggregate demands, lowers costs to consumers and helps producers get back on their feet quickly.
Monetary policy measures: The RBI unleashed a range of monetary measures on 27 March following an out of turn MPC meeting. This included rate cuts, an EMI holiday and targeted liquidity injections to encourage banks to lend more. These were well-thought through measures and went a long way in easing nervousness in market participants. More importantly, there seemed to be an underlying tone from the RBI governor that any pockets of stress within the financial system would see a timely intervention from the central bank. This has helped calm the nervousness in the money and financial markets to a significant degree.
Bond market sentiment: The bond markets are waiting for their own set of signals. The opening up of specific securities to FPIs could pave the way for India to be added to global bond indices: this would be a key support factor. On the other hand, a fiscal stimulus would see a spike in government borrowings – that, however, could be offset by increased monetisation of the deficit. Enhancement of ways and means limits would be an important metric to track.
Risk appetite of the financial sector: Banks will have to start lending within a short period of time. The lockdown will strain the balance sheets of large corporates and SMEs, and bank finance will be necessary to help contain that damage. Once economic activity picks up, there will be continued demand for working capital finance to fund that growth. A likely NPL spike, however, could have exactly the opposite effect. The government, regulators and bank boards will have to step in to create an environment of counter-cyclical behaviour.
Global recovery: India’s linkage to the global economy should not be underestimated. A deep global recession will not do the economy any favours. Also, while low oil prices are a huge benefit to India, excessively depressed prices brings its own set of collateral challenges that hinder growth. The counter-intuitive reality is that a modest recovery in oil prices from current levels may be a net benefit to the economy.
We wish you and your loved ones safety and good health.
Head of Research
Alchemy Capital Management Pvt. Ltd