Market Outlook- March 2020

Contributed By : Navneet Munot, CFA , CIO, SBI Funds Management Pvt Ltd and Chairman, CFA Society India

Market Outlook
Coronavirus dominated headlines through the month and global risk assets sold off sharply as the spread of the disease outside China led to fears that disruption for the global economy could be more severe than earlier estimated. The long-dated US bond yields have plunged to record lows consequently. The 30-year US treasury yield at 1.67% now is almost 100 bps lower than the level touched in December 2008!! Financial markets globally had so far been helped by concerted monetary accommodation from central banks even as the economy had yet to show signs of meaningful pickup. The Coronavirus shock perhaps just acted as a trigger for a market anyway waiting for correction. While it is too early to estimate the exact impact, it is very likely that policy action will have to stay very growth supportive. Yet growth continuing to struggle even with all the monetary accommodation only suggests that monetary policy has hit its limits. This only reaffirms our belief that fiscal policy will have to play a major role going forward to take the global economy out of this prolonged slump.

Looking beyond the short-term, this episode may just add to the list of reasons for the rest of the world to reduce over-reliance on China. While there has been truce of sorts between US and China of late, it is highly unlikely that the trade wars and tech wars will deescalate meaningfully. Moreover, demographics will continue to deteriorate for China and put pressure on the availability and cost of labour. This implies that global supply chains will have to readjust, and manufacturing should shift away from China to other countries. While India isn’t the only choice, and there are strong contenders in Vietnam, Thailand and Bangladesh amongst others, India should fancy its chances as an alternative to China given the many unique advantages it has. In that context, US President Trump’s recent visit to India holds immense symbolic value even as nothing concrete may have come out of it immediately.

Size works in India’s favour. India provides a large supply of cheap labour and is a big local market at the same time. Yet we can’t just count on size and demographics as panacea to all our problems. Countries that do well tend to have three things in common first, a strong institutional framework that deals with sanctity of contracts, dispute resolution, enforcement of law and the likes. Second, strong focus on innovation and education, and third, a robust social security net. Of these, we are making significant progress on the third point but need to do a lot more on the first two.

A lot of financial resources are needed for continued social welfare spends which will have to be garnered through focus on the first two points. We need to keep pushing the envelope lest we fall in the middle-income trap. We need to ensure that we have adequate institutional capacity, on judicial, administrative or regulatory fronts, to match our growth ambitions. The developments around GST, IBC, the significant improvement in ease of doing business, etc are in the right direction but we need to do a lot more on execution and dispute resolution. The troubles of the telecom sector, with Vodafone Idea still struggling for survival, are far from over as remains the case with stressed NBFCs too. We need speedy and decisive resolution to these issues to revive confidence amongst foreign investors on our institutional capacity.

We also need to up our game on innovation and education. Not just is our R&D expenditure meagre at 0.6%-0.7% of GDP, we also need more coordination between business, academia and government agencies on research. As the quest for global supremacy leads to a race to indigenize technology, particularly between the US and China, the world could be staring at this century’s ‘Sputnik’ moment. The pace of technological evolution and consequently disruption could increase manifolds. Action on climate change risk will potentially lead to more innovation too. It becomes imperative against this backdrop for India to keep pace. Following China’s example, we should incentivize Indian talent abroad to return to the country. Right education and skill development similarly are vital to reap the demographic dividend and assume even more significance in the wake of the ongoing tech revolution.

All this being said, we have indeed travelled quite a distance over the past few years in putting the right framework to build on. Post GFC, there was a prolonged period of persistent negative real rates, with the latter part of this period marked by excessive capacity creation, rampant lending by banks coupled with heightened policy
uncertainty. This lay the seeds of a macro-economic crisis which hit a climactic peak in 2013, with the trough on economic activity recorded that year too.

To correct this, we did an administrative, regulatory and judicial overreach, kept real rates high for too long, embarked on fiscal tightening, acted to clean up the economy all at the same time. We also undertook structural reforms such as GST and IBC during this period which had a bearing on near term growth. A related consequence was a slowdown in the real estate sector which in turn impacted growth through both job creation as well as wealth effect. And to top it all, all this coincided with global slowdown and severe technological disruptions. It is therefore no surprise that we landed in the situation we are in today. GDP growth data (Q3FY20 at 4.7%) and fiscal deficit numbers for the period Apr-Jan 20 (128.5% of budgeted for 2019-20) released yesterday point to an extremely challenging state of affair. Yet, we shouldn’t get overly pessimistic about the current slowdown. Just as the blind optimism on continued 10% GDP growth a decade ago proved unfounded, we believe the current pessimism may turn out to be excessive and misplaced too.

We have achieved macro stability with current account and fiscal deficits under control, rupee largely stable and foreign reserves comfortable and rising. Inflation expectations are down, and cost of capital has declined too as manifested in the continued decline in g-sec yields. Banking system has been repaired with NPA clean-up, PSU bank recapitalization and consolidation, and most importantly the IBC framework in place for stress resolution. There were pockets such as NBFCs where there was a bit of bubble creation but now that space is getting cleaned up too. Both availability and cost of capital should therefore improve. In addition, steps such as global bond index inclusion, full tax exemption to sovereign funds for infrastructure investments, etc should continue to attract foreign capital.

On the other side, reforms such as GST and corporate tax cuts, improvement in ease of doing business, and the formalization of the economy and financialization of savings should all help the supply side too. Similarly, we have also made significant strides on food production. Public sector units haven’t done well but with the government now intent on strategic divestment, they can turn value creators over time. The government’s focus on supply side reforms has allowed the RBI to be more accommodative to revive demand. Recent moves such as Operation Twist, sector specific relaxations for Real Estate and MSMEs, and long-term repo operations (LTROs) suggest the RBI has taken a leaf out of global central banks‘ book and is intent on doing ‘whatever it takes’ to revive the economy.

In the near term, in addition to the various policy measures for reviving growth, a pick-up in rural economy, aided by better acreage and rise in global food prices, should help too. Gold price rise will help with positive wealth effect as should financial markets even as real estate continues to be a dampener. While job creation and income growth through supply side measures will happen at its own pace, focussed approach on real estate and infrastructure is vital for near-term demand revival. A scrappage policy for the Automobile sector will likely be a big boost. More importantly, after the reforms of the past few years, we need to avoid any further disruptions or friction of any sort to ease the economy and businesses into adjusting to the new way of doing things. Issues such as in those in the telecom sector should be quickly resolved.

Overall, developments around the extent of spread of Coronavirus, and the economic disruption it causes will continue to keep financial markets volatile, both globally and in India. Yet eventually this could prove a blessing in disguise for India as the disease forces a quicker rethink on global supply chain reorientation in a bid to reduce over-reliance on China. India stands ready to benefit from this shift given the strong reforms of the past few years, provided we continue following up with policy certainty, adequate institutional capacity and right execution.

While the global situation is worrisome, we hope mankind to quarantine any differences and inertia and work together with a much bigger zeal to not only overcome the current challenge but also achieve the ambitious Health and well-being goals for 2030 as set out in UN SDG 3.

Amidst heightened volatility, words of wisdom from the sage of Omaha are pertinent for investors- Be fearful when others are greedy. Be greedy when others are fearful.