Much of our understanding of the complex modern economies and their underlying dynamics is built upon one fundamental hypothesis. The hypothesis that things that happen around us are dictated by the fundamental forces of supply and demand. Everything from why prices of onions rose in India at the end of last year, our unemployment rates, why are more start-ups involved in making the electric car, valuing our currencies, global trade, derivatives & swaps can be explained away with how the forces of supply and demand interact. The very concept of ‘value’ is premised on these very same forces of demand and supply.

The problem with this approach however is that, it assumes, that both demand and supply are independent variables, and as such, one could independently solve for the demand side of the problem, then the supply side of it and finally arrive at an equilibrium which would hopefully explain why the real world behaves as it does. None of that works now, in our Covid addled world, because the independence of supply and demand no longer hold. The SARS-CoV-2 binds both demand and supply in its vice-like grip and with it all modern economic theories we have built account for naught. The solution to, what is probably the greatest foe we have faced as humanity, lies purely in medicine and epidemiology. It does not matter how much you lower your interest rates, borrowing isn’t going to pick up. You could cut income tax rates and yet, it wouldn’t budge the needle on demand. As IMF’s Gita Gopinath, put in succinctly, “In the past if you lent the country money and told them to spend it, that would stimulate activity. But this time around, we actually don’t want people to go out and spend. We want them to stay at home”.

Our fiscal and monetary policy playbook is essentially useless. For now.

It is beyond the scope or capacity of any of us to predict how and when this will end. The current lockdown is unlikely to end on the 14th of April as been initially planned. How effective our lockdown will prove and what far reaching consequences it will have are too hard to predict at this point. Most of the companies which have come up with business updates are bracing themselves for a prolonged period of shutdown till at least the end of April. The United Sates is bracing itself for “saddest week of most Americans’ lives”. There is some evidence of Italy and Spain turning the tide, but it is hard to draw direct parallels to India considering the diverse demographics, response and healthcare infrastructure. The only thing we can say for certain is that like everything else before it, this too shall pass.

There seems merit, however, in examining what comes next after the pandemic. How quickly can we get back to our feet and get back to our growth path?

Setting the Scene

A good place to start this analysis just before the pandemic hit us. Coming off the back of 4.5% GDP growth rate -slowest in more than six years- in the September quarter, one could just begin to see signs of life. The higher frequency indicators like WPI, IIP, month on month fuel consumption were starting to pull back up. Manufacturing PMI had been on the climb since October to post an eight year high of 54.5 by January. Cement prices were picking up rising for the second month running in March, domestic air traffic was up 11% in November, rail freight traffic was up 6.9% in February, rural real wages were showing definite signs of recovery after hitting rock bottom in Dec’19, peak power demand was up in most large states in January — even after considering for cyclical factors.

Fig 1: Indian IIP for FY20

Structurally too, we were just coming through a prolonged period of sluggish earnings growth and a glut of overcapacity and unsustainable businesses (fig 1). While significant questions remain of the IBC and its effectiveness in cases like how it would deal with default of NBFCs, it has to its credit recovered ₹70819 crores of assets for the banks with a better hit rate (42.5% v/s 14.5 for SARFEISI) and faster resolution times (340 days v/s 4.3 years) per the economic survey data. The MSME industry too was, while kicking and screaming, beginning to accept life under the GST regime and the economy was just finally forgetting the demon of demonetization.

Fig 2: India has seen a prolonged earnings recession in it’s listed stocks

The Rock and the Hard Place

All that is now effectively water under the bridge. Any hopes one had of a rapid V-shaped recovery is fast turning into a fantasy. We find hard pressed to find any evidence to suggest things will get back to normal quickly. If you look at the commentary from leading private and public lenders, a significant chunk of retail borrowers are opting for the loan moratorium implying that once the economic activity picks up, a large portion of the income would go into repairing household balance sheets. This has a compounding effect in that, while banks are not getting income from their assets, they have to continue honouring their obligations. This in a country which has already been struggling to transmit the effect of lower rates to its borrowers. We find it hard to ignore what all the evidence points towards: the banking sector which was beginning to emerge from the shadow banking crisis precipitated by the ILFS saga has found itself in the midst of another fight for its survival. Things could get especially hard for the weaker lenders dogged by poor capital ratios and bad debt.

Behaviourally too one finds scant evidence that things will get back to normal quickly. China has been taking tentative steps towards restoring normalcy but on-ground evidence doesn’t seem promising. Wuhan witnessed a rash of protests from small shop and business owners over government interventions in easing their debt. Clashes also erupted in the Hubei-Jiangxi border over the easing of border restrictions. All these point to a simmering undercurrent that President Xi Jinping has to deal with. Theatres briefly opened up in Wuhan, and while reports suggest full houses, they had to quickly shut down due to public safety concerns. South Korea too reported 50% lower capacity utilisation of its public transport systems coming out of its blockade.

Real estate and construction sectors too are gasping for fresh air. On the back of record levels of inventory, slowdown in new project launches, residential sector witnessed a price moderation of about 5% according to a recent RBI study. Particularly hard hit will be the affordable housing sector due to the lower income potential of its target market. Anarock predicts unsold inventory to rise about 2% CAGR on the back of nearly 6.1 Lakh under construction units estimated to enter the market in the coming years.

One segment where you could expect the government to focus a sizeable chunk of its fiscal stimulus would be infrastructure projects. But the NHAI does not seem to be able to find a formula that works well for the state and the private player. This has resulted in an almost capricious swing between BOT, HAM and EPC models. Poor policy planning and lack of foresight from the NHAI means several industry majors like L&T, Ashoka Buildcon, KNR constructions and PNR Infratech, all nursing bloated balance sheets with several hard choices to make.

Fig 3: NHAI can not make up its mind!

Hope Springs Eternal

There is of course no point crying over spilt milk. That India is dogged by inefficiencies and bad management is news to no one. The only thing left to do is to make the best out of a bad situation- as is the case with most things in life. And here things may not be all that gloomy.

An important piece of the puzzle that is emerging is that the pandemic does seem to have some cadence to its virulence. Experts with much more knowledge of epidemiology all agree that the disease will hit a peak, and decline thereafter. This does seem to play out in Europe, America and most other countries. In this grand scheme of things India does seem to have been able to delay the onset of the virus to some degree. Now whether that is providence, the Indian summer or our relatively early and stringent lockdown is immaterial. What is of material consequence however, is that our cycle is projected to peak later than most of the first world countries. What this means is that unlike China which is faced with a situation where it wants to open up its manufacturing plants but finds no demand from the international markets, we would click on at a time when the world will have begun to put this nightmare behind it. Majority of the situations we will be facing, we will not be the first to encounter. We would also start figuring out longer term solutions to the pandemic both preventive and curative. People would be understandably hesitant to venture out right after the crisis. If we can device methods to rapidly identify contain and control the virus outbreak be it in terms of rapid, frequent and extensive testing or through tried and tested protocols which keep the spread of the virus to controllable levels, we could witness demand slowly come back. That requires time, and many iterations of trial and testing — something that our delayed cycle affords us more of, relatively speaking. With the best minds of the world engaged in finding a solution to this problem -even CERN has joined in making ventilators- there is little reason to doubt that we will eventually succeed.

A potential fallout of this coronavirus scare, coming right on the tailwinds of the US China trade war is that global supply chains could be rerouted for good. Already, both Foxconn and Wistron — major suppliers of electronic components to manufacturers like Apple, Xiaomi and Nokia have decided to increase their presence in India and several others like Flex Ltd. have indicated interest. Japan has just announced a policy measure where the government will subsidise companies to diversify their manufacturing bases outside China. Indian diplomacy under the NDA government has been more coherent and pragmatic with the world increasingly viewing India as a reliable and responsible trade partner. Case in point: its handling of the supply of key drugs like Hydroxychloroquine and paracetamol. If there ever was ever a time to turn the screws and leverage this to our benefit, it must be now.

The biggest role in all this will however be reserved for the RBI and how it manages to shepherd the economy back to health. For all the unfortunate circumstances around his appointment, the RBI Governor Shaktikanta Das has proven himself to be quite an able leader with the Reserve Bank coming up with some very creative solutions to problems under his leadership. More will be needed however, in addition to the 1.7-trillion-rupee package, that the government announced along with cutting the key lending rate. It is also expected to conduct more Dollar-Rupee swap and LTRO operations to help debts markets at a time when the yield premium for even AAA rated corporate bonds are surging over the sovereign rates. So far, these measures have been effective and much needed, but much more will be needed in due course of time. Compared to our global peers, the Indian stimulus has been muted and measured thus far both in size and scope. A larger arsenal is almost prerequisite for us to tide over this crisis. We can not let money considerations dictate the outcome of this war. We will have to take on some fiscal slippage, and as a nation, figure our way out of it. India is not in a poor position on this front, with a very rational fiscal deficit and a sizeable foreign exchange reserves of about 470 Billion USD, we have ourselves a war chest. With the oil prices expected to be well behaved in the foreseeable future, the stress on our foreign exchange reserves will also be lower. It is time to deploy this weapon.

Fig 4: Corporate bond yield premiums have spiked

Back in February, when RBI announced a slew of creative liquidity boosting measures to ensure the effective transmission of rate cuts, the governor said at the press briefing “The MPC may have been discounted, but do not discount the RBI”. Let’s hope you have a few more of those rabbits in your hat Mr. Das, we’re going to need it.