Indian Markets sharply recovered in April with Nifty up ~ 15%, tracking the rally in global indices helped by the narrative that some countries are coming out of lockdown. Due to the sudden collapse in energy demand, and the huge temporary oversupply situation coupled with lack of storage, sent WTI (West Texas Intermediate) oil futures into a negative territory. At the time of writing this piece, the number of Covid cases globally stood above 3.3 mn but the trend of new case addition has stabilized at 80k /day. In India, despite the extension of nationwide lockdown, number of confirmed cases / deaths rose to ~60k / 2k respectively with majority of cases coming from the developed western / northern parts of India. Earlier, the Indian Prime Minister had extended the nation-wide lockdown until May 3, which was subsequently extended for another 2 weeks albeit with considerable relaxations permitted in areas considered less dangerous. During the month, RBI came out with the second round of monetary stimulus wherein they cut Reverse Repo by 25bps to further discourage banks from parking funds with RBI and opened another TLTRO (Targeted Long-Term Repo Operations) window.

In terms of India’s domestic economic activity indicators which were already exhibiting weak trends, were hit significantly in March (towards the end) and April month due to nationwide lockdown. In flow related trends, both FIIs (Foreign Institutional Investors) (-$0.15bn) and DIIs (Domestic Institutional Investors) (-$0.1bn) were net sellers during April. In terms of sectoral indices; during the month, all sectors showed recovery (post a sharp drop in March), with Healthcare, Auto, Oil & Gas and Metals relatively outperforming whereas FMCG, Consumer durables, Realty and Bankex underperforming the BSE Sensex index.

After the sharp correction in March followed by an equally strong recovery in April, Indian markets presently appear to be evenly poised. While it may take materially poor data regarding the progress of the virus globally and within India for market to retest recent lows, it’s a little difficult to argue for significant upside in the near term either, given valuations have very quickly turned fair after having become cheap in March. As of April, the Nifty trades at ~19x trailing earnings, which is a modest discount to its long-term average of 20x. With earnings visibility for FY’21 quite unclear at this stage, market movement in the near future can at best stay confined to a narrow range. Govt fiscal policy support and vigilant monetary authorities, however, may ensure market volatility too stays subdued.

In view of the still developing impact of the pandemic both globally and in India, growth and earning's outlook for the economy and corporate sector remains highly unpredictable and sets back our expectation of a modest cyclical economic recovery by at least two quarters. Markets will keenly watch the extent and nature of the economic recovery as many parts of India gradually emerge from a lockdown of over 40 days.

At present we believe that while global and local economic activity will stay significantly disrupted, it would settle down in the next few months. We are of the opinion that more market and economic stabilization measures will be necessitated to instill economic and market normalcy. Policy measures to support leveraged sectors of the economy such as NBFCs, real estate, telecom etc. are still awaited.

Many earnings-based valuation determinants can likely throw up incorrect conclusions in the near term due to dislocation in earnings. Today, investment decisions that discount near term earnings profile but are justifiable based on long-term intrinsic or franchise value of enterprises attract our attention. For the medium term, we do take a more constructive stance on the economy and markets as a whole, but we remain measured in our conduct with regard to portfolio choices. We keep our growth expectations muted while simultaneously increasing the bar on quality of businesses and balance sheets as our guide to our choice of investments.

The economy and the financial markets are bearing the uncertainty due to the lockdown. The lockdown has resulted in income and earnings of approximately 80% of the economy to stagnate. The aftereffects of this income and earnings loss is showing up in various forms and the stress is palpable.

It has impacted both the organized and the unorganized sector. The drop-in revenue has led to a sharp drop in the aggregate demand with the economy. Financial positions are getting weaker as borrowers are unsure about their ability to repay a loan when the debt becomes due for repayment.

The announcement of moratorium by RBI in March has been timely. It has pushed the immediate problem of repayment into the future. We will not be surprised if the moratorium gets extended or some variation of the moratorium gets announced. The very announcement of moratorium from the RBI Governor underscores the extent of actual scare in the credit markets. The risk aversion amongst the bankers has slowed down fresh credit disbursement and the moratorium is going to slow it down further. The NPA levels within the financial sector is expected to reflect the growing stress of the economy.

Recently the government has come up with a plan of additional spending of Rs. 4.2 lakh crore on account of Covid 19. What remains to be seen is in what manner the government plans to spend the money and how soon. The economic hardship is slowing down the demand and the overall GDP growth is expected to be sharply moderate. The private consumption has also ebbed.

On monetary side, RBI has been reducing the repo and reverse repo rate and has infused tons of surplus liquidity into the banks.

However, the rate reduction has not transmitted entirely into lower loan rates and bond yields since the banks have not pruned the deposit rates yet to reflect the entire drop in repo rate nor have, they invested the surplus cash in productive assets. Hence the bond prices are still cheaper.

Going ahead, the drop in demand across the economy is expected to soften the headline inflation sharply albeit some disruptions in the supply chain particularly in food and healthcare. The dislocation of migration workers is also expected to lead to disruptions at some point in time leading to some spikes in inflation. However, all of these will be from the supply side and not from demand. Hence the rate reduction cycle is expected to continue till the time there is pick up in loan growth and surpasses deposit growth. Eventually the economy will revive only if the money starts rolling and gets spent.

Foreign investors have been net sellers of Indian debt in April’20 too. They have sold close to Rs 13,000 crore last month (about 1/5th of March’20). The yields have softened by ~20bps in April’20 after spiking up by about 30bps intra-month (due to FPI selling pressure and fears of additional borrowing by government and distress in the credit market leading to forced liquidation of high-quality assets in order to raise cash).

Outlook

• We expect both growth and inflation to slow down sharply over the next few months
• Even after the lockdown is lifted (the date is always a big uncertain) we do not expect the economy to return to its previous rate of growth any time soon.
• It would require a huge fiscal and monetary stimulus to recover. The government recently has announced additional borrowing to address the problems due to the pandemic.
• Infusing liquidity into the banks and expecting the banks to start onward lending at a cheaper cost seems to be a tall ask at this stage. The risk appetite of individual banks is diverse and clearly dissimilar from the expectation of RBI to revive the economy.
• Expect few more rounds of rate reductions and much bigger quantum of liquidity infusion. The OMO(Open Market Operations) and LTRO of much larger quantum may continue.
• After the net selling by FPIs (Foreign Portfolio Investors) slows down, and the market participants overcome the initial shock of the big increase in govt. borrowing, we expect that the demand from the domestic banks (led by huge surplus cash with them) to start pushing the yields lower for both sovereign bonds and blue-chip AAA credits.
• Over the medium term we expect the GDP growth to remain slow and inflation to remain soft. Hence, urge investors to get invested before the yields start to reflect the rate reductions of RBI.
• Investors are advised to invest in high credit quality funds particularly during this period of stressed credit environment.
• Investors ideally should also get invested into debt funds before the foreign inflows pushes down the yields. The March’20 RBI announcement of an additional ‘Fully Accessible Route’ for investment into government securities by non-resident investors without any restriction will help in bringing down the borrowing cost of the government and bridging the fiscal gap. Going ahead, once normalcy returns most of the government’s borrowing requirements can be met from inflows from non-resident investors. Domestic investors should readjust their debt holdings into relatively longer duration funds before yields start to soften due to foreign investor demand.