Deconstructing the Indian economy: A long walk to redemption

The pall of gloom on our economy is deftly camouflaged by a stubborn stock market that refuses to reveal the catastrophe around us. The Indian workforce is over 500 million strong, 75-80% of which come from the unorganised sector. Of this total, nearly 50% have been without work for the last two months. A bulk of them are daily wage earners who do not have staying power to last more than a week. Naturally, to sustain themselves they attempted to flee to the safety of their villages—that too without any means of transport. The response of the Central and state governments in comprehending, acknowledging and taking action to this man-made crisis has been even more distressing. To make matters worse, muddled communication relayed by state governments has now set the Indian economy back by a minimum of five years.

Acknowledging a crisis is the first step in solving it. Although leadership requires instilling confidence by making credible and deliverable commitments, the actions of our government, especially the finance ministry seem anything but that.

Our government has been in a state of denial for the last 24 months (since mid-2018) that there is a demand collapse crisis brewing in India, and that is why corporates despite being given massive corporate tax cuts will not undertake fresh capacity creation. All our policy responses have been supply-side actions including the latest ones announced. When consumption falls due to a lack of purchasing power, how does giving sops and bailouts to suppliers solve the situation? An SME facing an existential threat is not going to take more debt on its pad unless it sees potential in the future.

The gravity of the situation begins to sink in as Banks declare 30% of their total loans under moratorium. This is the first in a stress test situation. Nine million trucks in the country (80% on financing) have been sitting idle for two months, and face serious cargo challenges in the remaining year. Leading NBFCs have conceded that 50% of retail collections have challenges for the same period. The response of our regulator is to turn a blind eye to it for six months. It would be better to recognize the NPA and for the regulator to say that we underwrite for a six-month default risk. With at least 25% of the Indian workforce (110-150 million people) looking at a bleak future of re-employment, the risks in the consumer sector have escalated rapidly, and we could have asset repossessions happening in the last quarter of this calendar year. The irony is that a six-month delay in paying housing loan EMIs could lead to adding between 9/30 more additional instalments dependent on the tenor of loan and interest rate. No one however is telling the poor borrower the truth.

It is a little known fact that in the US there are only two AAA-rated companies i.e. Microsoft and Johnson & Johnson. Even the US government does not get a AAA rating by its rating agencies. In India, 276 companies get AAAs which makes our rating standards a mockery. It is no surprise that we saw a serious crisis in debt mutual funds with Templeton defaulting on INR 26,000 crores redemptions. Caveat Emptor prevails and its time mutual fund subscribers became aware of real risks as opposed to meekly following the advice of their wealth advisors.

We have multiple agencies; both inside and outside government who refuse to come to terms with the elephant in the room- a falling GDP. The US accepted that its April-June GDP would fall by 35-40% while a segment of the country did not go into lockdown. It would be a fair assessment to make that the Indian economy will also tank by at least 25% within the same period. It is unlikely that the next three quarters will see the economy match the preceding year’s GDP. A best-case scenario is thus, a 10% fall in GDP. Strangely however, we still have agencies clinging to a +/- 2% forecast, which reduces a percentage point per month, perhaps in fear of annoying the ruling dispensation. This is a great disservice to the nation as policy responses remain significantly mismatched.

A similar occurrence appears within the national budget and fiscal deficit predictions. As stated on 1/02/2020, a projected deficit of 8 lac crores and a borrowing of 5.5 lac crores will come to pass. In reality, we can assume that post the COVID impact:

• Direct tax collections will be lower than the previous year by 3 lac crores (against a growth assumption of 3 lakh crore by the government)
• GST will go down by 5 lakh crore (50% states)
• The proposed divestment of 1 lakh crore will not transpire

Essentially, it is a 10 lakh crore revenue shortfall against the drawn budget. The forecasted hike in borrowings will rise by 10 lakh crore at least before any stimulus can occur.

 The challenge put before policymakers can be broken down into simple statements:

• 250 million unemployed daily wagers will have to be provided with work under the MNREGA/ similar schemes for the next 200 days to keep the peace. This could be the largest exercise of building infrastructure since China in the 1980s. The government will have no choice but to take the spend on its pad.
• People need to be fed. The country has enough of a stock to last 18 months. To further resolve this, we need to administer a “free staples” (wheat and rice) program on a war footing that has strict penalties for non-implementation. The last thing we need as a nation is certain death from hunger versus a low probability of death from Covid-19. As the food stocks are considered to be a sunk cost, no fresh cash has to be spent.
• The aggregate cases of infections worldwide are beginning to stabilize. The case count has been steadily increasing as 4% of people tested are infected, and the mortality rate is roughly 2% of those infected. These statistics are remarkably lower in number than the mortality rates of other infectious diseases that impact our population perennially. In spite of that, we have never shut down our economy before. Government policy whilst being caring in implementation needs to respond to reality.
• With a dramatic fall in global trade and a likely relocation of supply chains from China, the question that arises is how does India maximize the opportunity? The tax cuts announced earlier coupled with the most recent announcement of the labour and land changes are all good steps, however grossly inadequate to gain a major advantage. Industries relocate when complete supply chains relocate. The electronics industry in India is a last mile assembly shop with low skill, low value-added workforce. It is imperative for us to attract the semiconductor makers, the touch-screen manufacturers, the battery manufacturers to set up mega projects in India. Tax incentives need to be tailored for key industries than for geographic locations. Responses from the fiscal policy need to be opportunity specific.
• Lastly, the bubble around the start-up sphere in India and the world over, funded by irrational valuations and cash injections has burst. Softbank declared a $17 Billion loss having paid to the valuation model, the same model that valued Uber at nearly $100 Billion pre-IPO. Every day there are news reports of large Indian internet companies shedding employees. Around 15 unicorns will shut down within 6- months globally. This will also tangibly destroy the Private investment bandwagon that a lot of Indian business leaders and CXOs had climbed upon. It is suddenly dawning upon a generation of young people that earning a profit and generating cash flow is essential in business, and salaries will have to rapidly realign with the brick and mortar sector.
• The devastation in commercial real estate prospects caused by COVID 19 is very real. Work from home is a success, and organizations are already planning to reduce space requirements sharply. Between stressed retail housing with large unsold inventory, and now a declining demand for commercial too, the Indian services story is crashing down like a house of cards.
• IT Services, Pharma and Healthcare sectors seem to be the only ones who have not seen major dents. The IT industry was prepared with outstanding contingency planning and Pharma has come out as a beneficiary of the crisis. However, hospitals, especially the new ones are facing the brunt with a decline in non-Covid patient revenue. A segment of OPD patients may have been experiencing the placebo effect.
• The response from the Finance Ministry has been faint. The heavy lifting has shifted to the Reserve Bank of India. About 55 % of the PM’s package of INR 20.9 lakh crore acts as a liquidity alleviation exercise by the RBI. However, this entire input by RBI is only an incremental/ replacement debt input. The fiscal side funded contribution lies under 15% of the 20 lakh crore, while the rest serves as credit enhancement activity. Suddenly the Mudra Miracle of advancing nearly INR 4.5 lakh crore to nearly 3 crore plus micro borrowers is off the front page. Perhaps, the realization that the lock down has dented the livelihood of these entrepreneurs has resulted in a major write off and needs to be recognized. Will it require another large lending program to revive these fledgling entrepreneurs? It is a real tragedy that a Black Swan event such as this hit a great idea so early in its inception.
• There have been heroic stories of our Healthcare warriors who have bravely stood up to these stressful times. Civil society and religious organizations have tirelessly worked to partially alleviate the needs of the hungry.

 A Cry for Action

Our economy is contracting rapidly as macroeconomic inter-linkages are sharply coming into play and there is a crying need to shake off this slumber. The problem simply is demand. The answer lies in creating purchasing power in the hands of the retail consumer to get a working capital cycle restarted. Long term solutions will not work in this scenario. A change in government think-tanks and policymakers is desperately needed. Their thinking is steering us toward disaster, and as a country, we have worked far too hard to go down this path. A leader is effective when he gets unfiltered market feedback. The PM has been outstanding on foreign relations and taking tough domestic decisions, but now he needs to zero in on the economy and the poor on his radar.

Now let’s address the anomaly that is the Indian stock market. With the economy having been shut for over 70 days, cashflows of major industries are down, many looking at their first-in-a-lifetime-losses, demand contractions, mounting NPAs being camouflaged by the RBI declaring a 6-month moratorium on recognizing bad loans, Banks refusing to lend and parking nearly 8 lac crores with the RBI (earning approx 3.5% on this money). And yet the indices rebounded 35% from the lows made on March 18, 2020! It is clear that the Sensex and Nifty no longer represent the real economy. Five private banks are nearly 25% weightage of the Nifty, and five IT companies another 15%, add HUL and ITC another nearly 10%, Reliance 10% and Airtel 3%. Equity mutual funds have to invest 65% of the money in equity at all times and cannot sit on cash. They will never refund money to investors out of greed, as the belief is that suckers can be found at will. To manage the price of 15 companies, Nifty will be in a determined range. If policymakers look at this range to determine their success or failure in public discourses, it spells doom for the wider economy.

Despite the many announcements of commencement of phase 3 clinical trials on multiple vaccines globally for the coronavirus, a product that can be made available to the masses is still 12 months away in usage terms. So is the world going to stay shut down for that long? Can crude at $30 a barrel save the oil-producing economies? Will the US-led coalition forming on taking action against China have serious economic repercussions on world trade? With China taking over the reins of Hong Kong directly, will Hong Kong survive as a regional financial hub?

We shall be watching these developments very carefully.

(Sanjit Paul Singh is Managing Partner, S&S Associates)