India’s December quarter GDP numbers, announced on February 28, are irrelevant at worst and a sideshow at best now. The threat of a global pandemic tends to concentrate the mind and push out other concerns.
The markets had initially hoped that the virus would be confined to China. When the spread of the virus killed that fond hope, they clung to the belief that the recovery would be V-shaped. Indeed, there was some talk of the markets looking through the epidemic episode, perhaps in the same way as they have been looking through a slowdown in the global economy to the good times yet to come.
There is, though, one respect in which this virus-induced crash is different. Central bank injections of liquidity cannot cure the disease, nor will they arrest its spread. As we have never tired of reiterating, the markets had run-up on a gush of liquidity unleashed by central banks around the globe. They have run up, as we have pointed out ad nauseam, far ahead of the ‘fundamentals’. They had gone up in the belief that central banks had the markets’ back and would rush to their rescue at the slightest wobble. That hope still exists, which is why the markets are now clamouring for a Fed rate cut in March and two more rate cuts this year. Central banks in China and some other Asian countries have opened their purses. Governments too are doing their bit — Hong Kong is planning to give all permanent residents above 18 a hand-out of HK$10000.
But no stimulus, whether monetary or fiscal, can work as long as entire cities are shut down when supply chains are disrupted, when ships aren’t allowed to enter ports and when airlines cancel flights. The stimulus can’t work if workers don’t turn up and factories and shops remain shut or are only partially open or if the supply of raw materials and the movement of finished goods is disrupted. You cannot address a supply-side shock by trying to stimulate demand. The stimulus will do nothing for the economy as long as the epidemic keeps spreading and governments impose restrictions and quarantines to try and prevent it going viral (an appalling pun, I agree). Moreover, a stimulus is already happening, as commodity prices have fallen and bond yields have come down.
Any loosening of monetary policy further could, therefore, support only the asset markets, as it has been doing for so long. But is that good enough reason for more rate cuts? Surely, after the liquidity fuelled binge in the markets, it’s time to pay the bill? That is what Richard Fisher, former Dallas Federal Reserve president meant, when he asked, ‘Coming off all-time highs, does it make sense for the Fed to bail the markets out every single time?’
Nevertheless, it’s very likely that central banks will once again ride to the rescue. For several reasons: one, they have done so for far less reason; two, they will say it is necessary to keep confidence up; and three, it takes several months for a monetary stimulus to be effective, so cutting early may help the economy recover once the impact of the virus ebbs -- of course, that will also fuel the mother of all market rallies then. More importantly, central bank action may be needed to ensure that small businesses do not fold up and that banks relax their norms for classifying loans as bad.
Let’s not forget that the past few years have seen a huge build-up of debt in many economies, which has kept many zombie companies alive. A huge number of less than investment-grade and the lowest-rated investment grade bonds have been issued to take advantage of the loose financial conditions and the OECD has recently warned that ‘default rates in a future downturn are likely to be higher than in previous credit cycles.’ The shock from the epidemic could bring home all those chickens to roost.
The only bit of good news is that the number of new cases is dropping in China, but it’s early days yet and who’s to say that once the restrictions are relaxed it won’t flare up again. The Hobson’s choice is between making sure the virus has been stamped out and letting the economy suffer till then or try and get the economy moving soon and risk a recurrence of the disease, which could lead to the recovery becoming W-shaped. Xi Jinping has opted for the latter course, with his insistence that the 2020 economic targets for China should remain unchanged.
What about India? Coronavirus loomed large in our stock analyses this week, as we discussed its impact on the Indian pharma sector’s value chains -- looking at the broad drug categories which have the potential to get hurt from the coronavirus induced factory shut down in China and at key bottlenecks in logistics. We also considered how bad things could get in the Indian consumer durables industry, which too depends on China for many parts and components. Like many investors, we too were lured to look at safe haven gold during the market meltdown.
The GDP data, announced on Friday, indicate that the Indian economy continues to be very weak. The second advance estimates for the current fiscal year keep real GDP growth at 5 percent, the same as in the first advance estimates. But there’s a twist -- the GDP growth rate for 2018-19 had been revised down from 6.8 percent to 6.1 percent. So the second advance estimate’s 5 percent growth rate is on top of a 6.1 percent growth, while the first advance estimates 5 percent growth rate was on top of a 6.8 percent growth. In other words, growth is now estimated to be weaker than earlier.
The December quarter real Gross Value Added (GVA) data show year-on-year growth of 4.5 percent, down from a growth of 4.8 percent in the September quarter. That indicates business activity slowed down even further in the December quarter. And that’s not the entire picture. If we leave out ‘Public Administration, Defence and Other Services', or the government sector, then private sector real GVA growth in the December 2019 quarter has been a measly 3.7 percent.
We have a weak economy, stressed balance sheets in several sectors, very low credit growth, hardly any investment growth, stagnant exports, trouble in the telecom and power sectors, high market valuations and now we have the impact of the coronavirus and risk-off markets.
Simply put, there is no reason to believe that the worst is behind us.