India Update: COVID-19 Response and Economic Outlook
India's government is taking incremental steps toward re-opening its economy, starting by bringing production and manufacturing facilities back online.
What should investors expect from Indian equity markets going forward? In our latest Perspective, we address this question from several angles, starting with a discussion of the country's response to the COVID-19 pandemic. We also explore the current macroeconomic environment and share our views on opportunities for investors.
Saving lives and livelihoods in the face of a global pandemic
India's government acted quickly to close its international borders and impose a nationwide lockdown, moves which the World Health Organization commended as “tough and timely actions to stop COVID-19.” In discussions with family and friends living in India, we hear that controls on movement have been quite strict, with many residents in big cities limited to an assigned two-hour window during which one household member is permitted to venture out for essential purchases.
We believe the early, severe lockdown was necessary in order to buy time and flexibility to bolster the nation's health care infrastructure as the pandemic unfolded. India's health system is generally regarded as overstretched—for example, the World Bank reports India had only 0.9 physicians per 1,000 people in 2018, compared to 2.8 in the United Kingdom. Since the social distancing measures have gone into effect, significant efforts have been directed toward growing testing capabilities as well as increasing containment, isolation and ICU (intensive care unit) capacity.
In recent weeks, the government has gradually expanded its focus from saving lives to also saving livelihoods. India is largely a country of daily workers: At the bottom of the pyramid are many people who earn today, eat today and repeat the process tomorrow. The stringent lockdown has ground the economy to a standstill, seriously impacting the livelihoods of people who depend heavily on daily cash earnings to support their families. We are observing a growing realization that, if the lockdown continues, the cost of the economic downturn may create a major humanitarian crisis in India. As a result, the government is taking incremental steps toward re-opening the economy, starting by bringing production and manufacturing facilities back online, which enables many people to begin earning daily wages once again.
Assessing the macro landscape
The government recently announced a sizeable rescue package of both fiscal and monetary support. The stimulus package is larger than many expected, showcasing the boldness for which Prime Minister Narendra Modi is known. The central government, as part of fiscal measures, has announced a credit guarantee scheme worth US$40 billion aimed at incentivizing banks to lend to MSMEs (micro, small, medium enterprises). In very risk-adverse environments, banks become hesitant to take on credit risk and are slow to lend to consumers and businesses. To counteract this issue, the government's credit guarantee scheme is designed to help incentivize banks to increase their lending.
Pre-pandemic, the macroeconomic environment in India was showing signs of promise. After a sequential slowdown in GDP growth in 2019, the government announced corporate tax cuts to boost the economy and spur job growth. Although the announcement was positively received, the anticipated economic improvements had yet to materialize. Since the arrival of COVID-19, the Reserve Bank of India (RBI) has been active in its efforts to support the economy. The central bank cut repo rates to reduce the cost of capital and rolled out multiple measures to provide liquidity and reinforce the financial system. Additionally, the RBI announced a three-month moratorium period on loans to support consumers and corporations during these difficult times.
Taking the long view
In the near term, much uncertainty remains in terms of the potential impact of the coronavirus on the India's economy. The current situation of experiencing an instant nationwide economic shutdown is unprecedented in scope. Accordingly, we will continue to watch how the situation evolves. However, stock prices already reflect a good deal of uncertainty. The dramatic decline in stock prices in the first quarter may have been overly pessimistic in our view. For long-term investors, we believe current valuations represent an attractive entry point. Small caps stocks, a key segment of the Indian equity market, are currently trading at a deep discount to large caps. In our view, an all-cap approach to investing in Indian equities can help capture opportunities.
When we consider the mid- to long-term outlook for India, we feel optimistic. To the extent there is a shift in global supply chain dynamics, India is poised to benefit. In fact, we are already seeing notable progress on several fronts that should result in increased foreign investment. When companies consider locating their supply chains in India, they frequently face two major hurdles: land and labor. Land acquisition can be a cumbersome and time-consuming process in India—but the government is taking steps to change that. Modi's administration is working to help corporations procure land. The central government is also partnering with states to create programs to support transparent, speedy land acquisition. More action on this front would represent a big step forward in India's ability to attract foreign investment. In terms of labor, changes in laws at the state level are driving momentum toward a more unified national labor code, creating another catalyst for drawing global companies to India.
When identifying potential investment opportunities, we tend to focus on earnings growth as a starting point for analysis. Naturally, we also consider valuations in context. Domestic savers in India face serious headwinds in the real estate market, so their money is increasingly directed to equity markets, which is heavily influencing the supply-demand dynamic of equity prices. Because of this, relying on historical valuations alone may provide an incomplete picture. We choose to start with earnings growth and then consider valuations contextually. While the near-term outlook for earnings growth remains volatile, we believe India's outlook will improve in 2021.