As the Covid 19 crisis blew out in India in March this year there was significant economic disruption due to the closure of the economic domestically as well as various restrictions that came up on cross border trade. The “Recovery” from the shutdown in some sectors has been much better than expectations while others continue to languish. This is despite the fact that the aggregate demand that comprises GDP remains subdued.
The global response to the Pandemic across most major economies from the monetary authorities was to push huge amount of liquidity into the system and push rates down as much as possible. This has led to a situation where, today nearly 69% of the $ 6 Trillion debt of Eurozone countries yields negative returns. Yields on German 10 year bunds last week was -0.62%. This was also done in India by the RBI and MPC combo where huge liquidity was pushed in, debt moratoriums announced and interest rates reduced. The second response was Fiscal where in many of the major economies direct fiscal support was provided to affected and unaffected people and businesses across the board. The maximum stimulus came about in countries like the USA, UK, Japan and most other economies. The combination of Fiscal and Monetary response prevented a possible depression in the global economy even as there was a wait on for Covid to be controlled and normalcy to return.
In India the Fiscal response was largely missing as whatever little real fiscal stimulus was given was effectively taken away in the form of duty hikes on Petrol and Diesel and as such real stimulus was one of the lowest among most large economies. However even with that we have seen some sectors bounce back in terms of performance very strongly. Many of the FMCG, food and health segments obviously did well as people were locked down and these areas came into focus. However some other areas of demand like Autos, home improvement products, certain consumer durables etc have bounced back very strongly.
The main reasons why I think this is happening is overall expenditures have come down for most of the people as discretionary expenditure on travel, entertainment, eating out, holidays, clothes etc or even children tutions or spending on their hobbies came down substantially. This has combined with the reduction in interest rates and easy liquidity and made buying of consumer durables significantly viable for many people. As such while the overall aggregate demand is still down significantly there has been a shift in consumption patterns which have benefited a few sectors. Many people would have spent a lot of money during the summers on overseas holidays, all that expenditure got saved.
It is also relevant that for many people, especially those employed by the government and PSU’s there has been no reduction in income however their expenditures came down substantially. As such the impact of the slowdown has been very variable across sectors. There have been significant salary cuts and layoffs across many sectors however some high employment sectors like Technology companies have been very resilient and seeing decent growth. The rural economy has also held up well due to good production, decent prices of agricultural products, good sentiments due to monsoons as well as large cash transfers to the rural part of the economy.
Monetary policy has become largely ineffective in many developed economies like Europe and Japan due to poor demographics and high unemployment rates especially in Europe. However in countries like India where population is still growing, demographics comprise largely young people the impact of monetary policy in reviving demand is real and that impact has been seen.
However on the other hand spending by the Central and State governments has come off, capital expenditure cycle which was on the verge of revival pre covid has again gone back by atleast 12-18 months and the external trade scenario remains extremely uncertain. Given the conservative approach of the government with regards to Fiscal Stimulus we are unlikely to see any huge economic recovery anytime soon. Going back to near pre covid levels is not growth but just a reversion to mean. Getting back to 5-6 % growth, leave aside 7-8% growth is extremely unlikely if not impossible in India for the next few years.
The government is trying to use the Atamnirbhar campaign to push revival of manufacturing in India. This is being done largely by restrictions on imports which will effectively increase the cost for consumers in India. There have been some announcements on Production Linked Incentives which could create some aggregate demand however will be too less and too far out in my view.
There is also a second wave of Covid which is now playing out in many European countries and possibly the USA which could again impact demand revival. We have seen new shutdowns being announced in the USA, UK, France, Italy etc. Monetary authorities have already taken interest rates as low as possible and the huge fiscal stimuluses have taken the overall debt burden of many of the western economies to a Debt to GDP of over 100%. Just yesterday the credit rating of the UK was downgraded by Moody’s. This could happen across the board over the next few months. India’s rating profile is also at risk unless and until there is a growth revival as Debt to GDP even without a huge fiscal stimulus will cross 82% this year (just for the centre). Policy Makers in India have not been bold enough to capture opportunities that have been presented to them.
CORRELATING MARKETS AND THE ECONOMY
Based on expected revival of the economy stock markets have rallied substantially overseas as well as in India. Many markets like the Nasdaq are at all time highs already contributed by the upmove not only in FAANG stocks but also many Biotech companies. Valuations of the markets in India, despite many financial stocks still being 30-50% lower than peak prices have gone upto 32-35X earnings based on what projections you make. Such valuations were last seen in 1999 and 2007. For many stocks people are just buying momentum without looking at valuations. “Valuations don’t matter for high quality companies” dictum is at play (haven’t we heard this before?) Well, valuations always matter. In this scenario now we have two kind of plays in the market, extremely cheap stocks relative to long term growth prospects and on the other hand extremely expensive stocks relative to growth prospects. As such I expect that the overall indices might not do much from here till end of 2021 but stock specific opportunities will be huge. Also given the valuations it will be pertinent to hold some cash in hand as there will be significant drawdowns in between for sure and those will be opportunities to deploy cash.