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May 2020

COVID-19 IMPACT ON INDIAN ECONOMY AND THE FINANCIAL MARKETS

By APURVA SHAH
Chartered Accountant
Reading Time 16 mins

INTRODUCTION: THE ECONOMIC IMPACT

It was mid-January when we started to hear stories about a virus in China which had locked down the entire Wuhan city, the epicentre of the virus. Its effect had also spread to other Asian countries and by 30th January, 20201 India reported its first Covid-19 case. After two and a half months of the first reported case, India is now in the second phase of lockdown. India took early calls to go for a complete lockdown and implemented strict guidelines due to the experience of other countries, the rate of transmission of the virus from one person to another and also the strain which this virus could cause on the healthcare system of the country.

 

Observers state that the lockdown slowed the growth rate of the virus by 6th April to a rate of doubling every six days, from a rate of doubling every three days earlier. The metric called R-Naught or R-Zero, estimates that the infection rates in India have fallen to 1.55 on 11th April from 1.83 on 6th April, further indicating that lockdowns could be helping2.

 

This article seeks to explore the consequences and impact of the current health crisis on the overall Indian economy and the Indian financial markets.

 

Looking back to the situation till a couple of years ago, India was going through its own economic slowdown:

(i) The primary reasons were the ‘shocks’ of demonetisation in 2016 and the introduction of the Goods and Services Tax (GST) in 2017.

(ii) India recorded the lowest quarterly GDP growth rate in the last decade of 4.7% in Q3FY203 and the growth outlook (pre-Covid-19) for FY21 was upwards of 5%.

(iii) The economy had started to show some signs of recovery when the index of industrial production (IIP) grew by 2% on a y-o-y basis in January, 2020. The manufacturing index also improved by 1.5%.

 

(iv) To boost the economy, the Finance Minister reduced the base corporate tax rate to 22% (effectively ~ 25%) for companies which do not seek to take certain exemption benefits. This led to earnings recovery for many companies and a boost to the stock markets as well.

 

What impact will the current crisis have on the GDP growth rate?3

(a) It has been estimated by various rating agencies that the advanced economies will contract by 0.5% to 3% in 2020 as against a global growth of 1.7% in 2019.

(b) China is estimated to grow ~ 3% in 2020, while India’s growth forecast for FY21 has been revised downwards and is estimated to be between 1.8% and 2.5% from more than 5% estimated before the lockdown was announced.

(c) Having said that, even a 2% growth rate is still good news for India. Due to the low base rate, the expected GDP growth in FY22 is expected to be upwards of 7%.

 

With what is now happening across the world (post the Covid-19 outbreak), including India, a slowdown in each and every economy is imminent. The extent of impact in different geographies will vary based on the severity of the virus, the stimulus packages by the governments to revive the economy and how fast a nation is able to commence its economic activities.

 

MEASURES TAKEN SO FAR BY THE GOVERNMENT OF INDIA

Though India has been very slow in announcing economic packages for industry, there have been three major announcements – two by the RBI (monetary policy) and one by the Finance Ministry (fiscal policy).

 

(1) On 26th March, Finance Minister Nirmala Sitharaman announced a Rs. 1.7 lakh-crore fiscal package for the poor, including cash transfers, free food grains and free cooking gas.

(2) On 27th March, the RBI announced a 75-basis points cut in the policy rate and a 100-bps cut in the cash reserve ratio for banks to inject liquidity in the system and provide moratoriums for loan repayments for three months (March to May, 2020).

(3) On 17th April, RBI freed up more capital for banks to lend, announced a fresh Rs. 50,000-crore targeted long-term repo operation to address the liquidity stress of NBFCs and microfinance institutions and hinted at the possibility of further rate cuts going forward. RBI also announced a Rs. 50,000-crore special finance facility to NABARD, SIDBI and NHB for onward lending to NBFCs in the space. The RBI Governor also announced that India would do ‘whatever it takes’.

 

To sum up, the government has first prioritised the containment of the virus and providing relief to the poorest sections of society. In the days to come, it will dole out sector- and industry-specific packages as well.

 

IMPACT ON VARIOUS INDUSTRIES

It goes without saying that the lockdowns will certainly have an impact on each and every industry in varying degrees.

S.No.

Industry

Impact

Likely nature of effect

1

Auto and auto components

High

  • Weak PV and CV demand due to liquidity shortage with NBFCs, economic uncertainties, weaker consumer purchasing power, likely NPAs in the sector
  •  Stuck with inventories of unsold BS-IV vehicles with the original deadline of selling them before 31st March, 2020

2

Aviation and tourism

High

  • Uncertainty over travel restrictions which can extend or remain restricted for a longer period of time, borders might remain closed
  • Loss of jobs and pay cuts
  • 102 of 137 airports managed by AAI have recorded losses to the tune of Rs. 1.6 billion
  • Estimated to render more than 50% of tourism industry workforce jobless in hospitality industry4

3

Agriculture

Low

  • Since agriculture is the backbone of the country and part of government-announced essential category, the impact is likely to be low on both primary agricultural production and usage of agri-inputs like seeds, pesticides and fertilisers
  • Agro-chemicals: Companies that depend on exports for finished goods sale and imports of raw ingredients will be impacted

  • Food exports: Major destinations like the U.S., Europe expected to grapple with Covid-19 for the next few months and Indian export-based companies will be impacted due to low consumer demand and port hurdles
  • The economic packages likely to be announced will provide relief to farmers and the allied sectors and, hence, the overall impact on agriculture will be low

4

Chemicals and petrochemicals

Medium

  • Weakening in crude oil prices and cascading impact on petrochemicals, coupled with uncertain domestic and global demand; petrochemicals prices are likely to remain low
  • Uncertain demand outlook and weak prices are expected to lead to weak market sentiments and delayed investments in the sector

5

Consumer, retail & internet business

Low to medium

Essential commodities:

  • Growth seen for essential commodities players, with possible margin improvements, unless there is price control by government
  • There will be increased pressure on supply chain for deliveries of products amidst the lockdown

Non-essential commodities:

  • Markets likely to crash due to low discretionary demand. Overdependence on imports could pose a threat
  • Industries facing severe challenges: Apparel, durables, restaurants and other on-premise services like gyms / salons, etc.

6

Banking and NBFC’s

Medium to high

  • Banking sector to be under pressure due to reduced off-take of loans in expected recessionary market conditions and cautious lending
  • Possibility of increased delinquencies post the moratorium period, and may also result in depressed NIMs in a low interest rate regime
  • Drop in transaction fee-based income due to lower cross-border trade

  • Affordable housing, two-wheeler financing, micro-finance and gold loans exposures to be adversely impacted

7

Insurance

Low

  • Fresh demand for health insurance and life insurance witnessed a surge in the current scenario
  • Renewals may get delayed due to shortage of money in the hands of policyholders
  • Usage of AI / ML / technology can assist in reduction of operating costs, increasing customer satisfaction and policy management

8

MSMEs

High

  • Many MSMEs to face closure of business if the lockdown continues for more than eight weeks due to heavy leverage costs and no production output for more than eight weeks

  • More than 114 million people are likely to get affected, with a dent in their contribution to GDP (~ 30-35% of GDP)

9

Transport and logistics

Medium to high

  •  Crude price reduction is likely to positively impact the transportation costs in the short term
  • Freight traffic volume is expected to slow down

  • Post-monsoon, the demand is anticipated to spike on account of accrued consumer savings as well as onset of festive season
  •  Lower utilisation of ports infra, road and rail infra, storage infra due to reduced cargo traffic in short to medium term

10

Healthcare and pharmaceuticals

Low to medium

  • Generic drugs are most impacted – reliance is high on imports (~ 70%) from China

  • Non-availability of labour, transport of ingredients and supply side issues could impact production volume

  • High exports demand for certain products over the short term – as developed countries(U.S., EU, etc.) look to stockpile medicines
  • Probable price controls of essential drugs
  • Online pharmacies – medicine delivery has been affected due to non-availability of delivery staff

11

Construction and real estate

High

  • The housing sector is expected to see muted demand with significant reduction in new launches

  • The existing demand for commercial real estate may either get curtailed or postponed till H2 of the current year
  • One of the largest employment generators in the country, it will have a multiplier effect on around 250 allied industries
  • There is a likelihood of the government providing relief to the sector in terms of relaxation for project delays in residential housing sector, easing financial stress by extending loan repayment, etc.

12

Overall imports and exports

High

  •  India’s merchandise exports slumped by a record 34.6% in March, 2020 while imports declined 28.7% as countries sealed their borders to combat the Covid-19 outbreak5
  • Business Process Outsourcing, one of the India’s largest exports, will be severely affected as lockdown measures, both in origin and destination countries, have forced offices to close. It will be further accelerated with the cost-cutting measures by the destination countries
  • However, it is likely that India’s balance of payments position may improve. Weak domestic demand, low oil prices and Covid-19-related disruptions are expected to narrow the current account deficit to 0.2% in FY21 and to keep it low in the following years

Source: KPMG report, news articles

 

 

Some general and overarching impacts on the overall economy could be:

(i) Unemployment – The unemployment in India has shot up from 7% to 23% in the last two weeks of March, 20206

(ii) Poverty – As per the estimates of the Indian Labour Organisation, more than 400 million people in India are at the risk of sinking back below the poverty line.

 

While the current lockdown will be ending on 3rd May and some relaxations have been offered post 20th April, if the number of infections surges, there could be further lockdowns. This could further affect the businesses and the economy and we should be prepared for the same.

 

 

THE IMPACT ON THE FINANCIAL MARKET

Let us now look at how the Indian financial markets have been impacted in the past during various crises – from the Harshad Mehta and Ketan Parekh scams to the Global Financial Crisis (GFC) and the recent China-US trade wars. Table 2 (next page) denotes the time required for the market (Nifty) to bottom out from its peak and then the time taken to reach back to its peak:

 

Peak

Trough (Bottom)

Peak to Trough

Recovery Month and  Value

Months to

Recovery

Month

Value

Month

Value

Months

Extent (%)

Month

Value

Mar-92

1262

Apr-93

622

13

-50.7

Feb-94

1,349

23M

Feb-94

1349

Nov-96

830

33

-38.5

Aug-99

1,412

66M

July-97

1222

Nov-98

818

16

-33.1

July-99

1,310

24M

Feb-00

1655

Sept-01

914

19

-44.8

Dec-03

1,880

46M

Dec-03

1880

May-04

1,484

5

-21.1

Nov-04

1,959

11M

Dec-07

6139

Nov-08

2,755

11

-55.1

Dec-10

6,135

36M

Dec-10

6135

Dec-11

4,624

12

-24.6

Oct-13

6,299

34M

Feb-15

8902

Feb-16

6,987

12

-21.5

Mar-17

9,174

25M

Aug-18

11681

Aug-19

10,793

6

-7.6

Apr-19

11,748

8M

Jan-20

12362

23-Mar-20

7,610

2

-38.4

??

??

??

Source: Nifty historical data

 

 

The Indian equities reached the trough (bottom) on 23rd March, 2020. The current down-turn is still underway and has shown the trough as on 23rd March, 2020.

 

What has happened to the Indian financial markets since the start of the crisis?7

  • The valuations have corrected significantly on a trailing PE basis – from a high of 29.9 a few months back to ~ 16-17 now. During the GFC, the Nifty PE had touched a low of ~ 11-12 trailing PE.
  • The long-term EPS growth has been 13% year-on-year and in the quarter ended December, 2019 the EPS growth was ~ 15%. This was mainly due to the tax cuts which led to recovery in Q3 FY20.
  • The long-term average of Nifty Earnings has been ~ 12.5% while in the last five years the average has fallen to ~ 3-4%. There was a marginal recovery in the last financial year but now the recovery has been deferred to FY22.
  • The benchmark indices – Nifty50 and the Sensex – have fallen ~ 25% year-to-date (YTD), 2020.
  • Within the large-cap, mid-cap and small-cap space, the fall has been as under:

•    small cap has fallen ~ 33%

•    followed by mid-cap at ~ 26% and

•    large cap at ~ 19% on a YTD, 2020 basis.

  • Nifty Bank has fallen the most during this crisis, plunging almost 50% and certain NBFCs falling more than 50% as well. The markets recovered somewhat in the first two weeks of April, 2020 and today the Nifty Bank is sitting at a 40% discount to its peak valuation.
  • While Nifty Bank has fallen significantly, Nifty Pharma has been the biggest beneficiary and is the only index with a positive YTD return of ~ 16%. The rest of the indices (sectors) have seen negative returns, the least negative being Nifty FMCG at ~ (-)5%.
  • In the credit scenario the investment grade ratings have fallen from 40% earlier to ~ 30% now. The downgrades are much higher in value – ~ Rs. 1,990 billion worth papers have been downgraded.
  • On the global front, the US Dow Jones has fallen by ~ 20% on YTD, 2020 basis, while most of the European markets have fallen upwards of 20% on YTD, 2020 basis. The China market has been the most resilient and has fallen only ~ 8% on YTD, 2020 basis.

 

Before the Covid-19 crisis, the banking and financial services were facing massive problems with the collapse of IL&FS and DHFL and the Yes Bank fiasco. In the current market scenario,

  • NPAs are likely to increase as the private banks, NBFCs and even micro-finance institutions have aggressively built their retail loan book and there will likely be massive layoffs
  • Further, these loans are majorly unsecured and there can be a slew of defaults, especially on the MFI side, and can also bring the mid and smaller NBFCs to the brink of collapse
  • Some of the new-age digital financial startups which simply opened the liquidity tap to trap the young earners with huge interest rates, may be forced to shut shop
  • However, the liquidity and moratoriums provided by RBI will come to the rescue
  • More clarity in this regard will emerge only after three to six months when the economic activity resumes
  • Meanwhile, credit off-take can be low for the next couple of quarters as companies rework on their capex plans due to weak demand and the uncertain global environment.

 

ANY SILVER LINING IN THE MIDST OF THIS CRISIS?

While all of the above sounds quite alarming, there are many positives in India’s current state of affairs:

 

  • Forex reserves: India has forex reserves to the tune of USD 476.5 billion as on 10th April, 2020 and in a worst-case scenario this will take care of 11.8 months of India’s import bills8.

  • Crude prices: The crude prices have fallen to record lows, lower than $10 per barrel as on 20th April, 2020. If India can import and store additional crude at this level, it will save huge import bills once normalcy kicks in and crude prices rise. Since 80% of India’s oil requirement is met through imports, a fall in crude oil prices can save USD 45 billion on crude oil imports9.
  • MSCI Index re-jig: Indian stocks are expected to see an inflow of more than USD 7 billion on account of a likely increase in their weight on the MSCI Index. FIIs have been net sellers and they have sold more than Rs. 30,000 crores in the last four weeks. Therefore, a re-jig of the MSCI index will bring in fresh FII inflows10.
  • Low inflation: The food inflation is on a declining trajectory and has eased ~ 160 basis points from its peak in January, 2020. The CPI inflation as on 19th March, 2020 was 5.9% and the RBI is confident of bringing it below 4% by the second half of 2020.
  • Normal monsoons: The Indian Meteorological Department has forecast a normal monsoon in 2020. This will benefit agriculture which is the backbone of the Indian economy.
  • Shift from China to other geographies: Many countries are envisaging a shift of dependency from China and also to shift their manufacturing bases from China to either their home country or to find a suitable alternative. Japan has announced packages for its companies bringing back manufacturing home. India can benefit a lot if some of this shift happens from China to India. It will significantly improve FDI flows into India.

FOOD FOR THOUGHT

The way the economy will recover or fall will depend on how the pandemic plays out. No doubt a vaccine is the need of the hour, but that will take a minimum of nine months to a year to develop and then to be distributed to every human being on the planet. While there may be some medicinal cure which could be developed, there will be uncertainties in the interim. During these times, the following possibilities could emerge:

 

  • Will there be de-globalisation? Will countries close borders – partially or completely?
  • Will India gain a lot of market share with a shift in manufacturing base to India?
  • Will there be a V-shaped, U-shaped, W-shaped or L-shaped recovery of the Indian and global financial markets?
  • Will there be disruption in existing industries – Will Information Technology be the new king? Will the pharma sector be the best performer index in the market?

 

We are fighting with an ‘unknown unknown’ phenomenon and only over time will we be able to get the answers to the above questions.

 

I would like to conclude with a quote from Joel Osteen – ‘Quit worrying about how everything is going to turn out. Live one day at a time’. This, too, shall pass and we will emerge as a stronger and better economy in the end. 

 

Disclaimer: The views, thoughts and opinions expressed in this article belong solely to the author; the data has been gathered from various secondary sources which the reader needs to independently verify before relying on it. The information contained herein is not intended to be a source of advice or credit analysis with respect to the material presented, and does not constitute investment advice

________________________________________________________

1   Ministry of Health, https://www.mohfw.gov.in/, News Articles

2   https://theprint.in/science/r0-data-shows-indias-coronavirus-infection-rate-has-slowed-gives-lockdown-a-thumbs-up/399734/

3   IMF estimates, Various rating agencies4   https://economictimes.indiatimes.com/news/economy/indicators/indias-tourism-sector-may-lose-rs-5-lakh-cr-4-5-cr-jobs-could-be-cut-due-to-covid-19/articleshow/74968781.cms?from=mdr

5   https://www.livemint.com/news/india/india-s-trade-deficit-narrows-to-9-8-bn-in-march-exports-dip-34-6-11586955282193.html

6   CMIE database, https://www.cmie.com/kommon/bin/sr.php?kall=warticle&dt=2020-04-07%2008:26:04&msec=770

7   Newspaper Articles, Nifty50 Returns

9   https://www.energylivenews.com/2020/03/24/india-to-save-45bn-on-crude-oil-imports-next-financial-year/

10  https://www.bloombergquint.com/markets/morgan-stanley-sees-71- billion-inflows-into-india-on-msci-rejig

 

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