On 8 June, India began the first phase of re-opening its economy after more than two months of Covid-19 lockdown with hotels, malls and restaurants allowed to re-open in areas not designated as containment zones. While many countries around the world are relaxing lockdown measures, the key difference for India is its number of new cases is still rising at a rate of around 10,000 a day.
The lockdown has already had a high economic cost, which has been compounded by weak social security structures and low levels of fiscal stimulus. But relaxing lockdown restrictions poses a substantial risk of an increase in infections, which will delay economic recovery and leaves Indian equities looking expensive.
India was relatively early in imposing a lockdown on 24 March, just a day after the UK. Whilst the number of cumulative cases in the UK at that time was more than 5000, India’s total had only crossed 500, with daily cases still below 100.
However, India’s healthcare facilities are scarce compared to the enormous size of its population. Furthermore, most of the intensive care facilities are concentrated in metropolitan areas and larger cities whereas rural areas tend to provide only basic care. The early lockdown was not sufficient to prevent a significant outbreak of the virus and India’s total number of cases has now surpassed UK to be the fourth highest in the world.
India’s growth was already slowing even before the impact of Covid-19 containment measures. Real GDP growth had halved to 4.1% in the fourth quarter of 2019 compared to 8.2% in the first quarter of 2018. Growth for the first quarter of 2020 slowed further to 3.1% and economists forecast second quarter GDP to fall more than 10% year-on-year, with some forecasting close to a 20% decline.
The problem is exacerbated by a migrant crisis. India’s urban centres rely on millions of migrant workers and when the lockdown started without any notice, many were left without any means to support themselves. With public transport also shut down, many walked hundreds of kilometres to reach their homes in the rural areas. According to independent research and survey company CMIE, India’s unemployment rate increased to 23.5% in May from 7.5% before the lockdown after 122 million jobs were lost.
Unlike countries such as UK and Australia, which put together generous income support schemes for unemployed people, India’s social security net is much weaker. More than 80% of workers in India are employed in the informal/unorganised sector, making it difficult to provide legal and social protection.
Overall, India’s fiscal response has been weak. While it announced a headline stimulus package equivalent to 10% of GDP, most of this was accounted for by credit and liquidity support; actual fiscal stimulus amounted to less than 1% of GDP.
The main reason for the muted fiscal response is that India cannot afford to spend more without risking a credit downgrade. Fitch yesterday downgraded India’s outlook to ‘Negative’ citing weak economic growth prospects and rising government debt. India’s fiscal deficit for the year ended March 2020 rose to 4.6%, much higher than its budget forecast of 3.8%.
There are other factors that will hamper economic recovery: the migrant workforce is unlikely to be willing to return rapidly; the virus may spread rapidly in rural areas now that many workers have returned home from urban areas; and the financial sector remains under pressure.
The shadow banking sector has still not recovered from the credit squeeze induced by the collapse of Infrastructure Leasing and Financial Services in 2018. Although significant liquidity has now been made available to the finance sector, it is still struggling. The public sector banks have problems of high non-performing loans and a lack of capital. Private sector banks, though relatively strong, are unwilling to lend and take on more risk in this environment.
Earnings estimates for the MSCI India Index (for the year to March 2021) have only been downgraded by 25% since the start of 2020, and generally analyst estimates have proved too optimistic for the past several years. In our view, valuations still look expensive; the 12-month forward price/earnings ratio for the market is almost back to its peak of around 19x. Even on the price/book measure, India is trading at 2.3x – just 10% below the last five-year average.
These valuation measures put India at a premium of between 25% to 50% to the wider region. India has underperformed the Asia Pacific ex-Japan index significantly by over 20% in US dollar terms over the past year. Given the economic risks associated with a premature relaxation of lockdown measures and the optimistic consensus earnings forecasts, we do not expect this performance to reverse any time soon.
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