Seatbelt signs on

“You can slowly open your eyes”

The doctor might suggest this advice on coming out of a prolonged period of visibility loss and it applies well to the current state of India’s economy. While the number of daily cases of COVID-19 infections in the country continues to grow, especially in the economically important urban districts, the government keeps cautiously unlocking the economy. Indeed, the initial data, such as power demand, freight movement and fuel consumption, suggest a slow, but steady normalisation of movement and economic activity.

Discretionary spending, though, still remains weak, as do indicators like credit growth, air traffic, motor vehicle sales and production. We expect to see signs of a pick-up in coming weeks, though a return to growth in consumer demand is unlikely until the final quarter of the year.

Sharp fall in unemployment

More fundamentally, the unemployment rate in the country (as measured by the Centre for Monitoring Indian Economic activity survey) dropped to 17.5%, 11.6% and 8.5% in the first, second and third weeks of June respectively, after clocking 23.5% in April and May. Also, many white-collared workers seemingly settled for pay cuts, rather than the feared job losses.

Blue-collared workers should also either slowly be absorbed back as the production resumes or could be supported under the “Garib Kalyan Rojgar Abhiyan”, the INR 0.5tn job guarantee scheme for migrant workers announced by the prime minister, Narendra Modi, on 20 June. A strong start to the monsoon season may also help to mitigate some downside risks to a demand-side recovery.

Of course, many businesses and workers are seeing little sign of a return to normal yet. There is also the debate on how much of this pickup in activities is due to pent up demand from the last three months of quarantine. Overall, we expect this recovery to be gradual at best.

Still walking a tightrope

While the world grapples with the risks of a second wave, India has still not started flattening the COVID-19 curve. With the number of cases rising, the country is in fourth position in terms of reported COVID-19 infections worldwide, according to John Hopkins University. Although, the recovery rate is high and mortality rate low comparably.

While we do not foresee another nationwide lockdown, localised containments may last longer. Signs of flattening, which looks some time away, are likely to be key to sustained recovery in economic activities, followed by the fears of a second wave.

The geopolitical risks took a detour down south with tensions flaring up at the India-China borders in June. While we believe this issue should ultimately be resolved through diplomatic interventions, along with rhetoric around economic and trade restrictions, any military escalations will keep the markets edgy.

Rating actions and policy space

Moody’s downgraded India’s sovereign rating in May to just above investment grade, aligning it with the other rating agencies. Fitch and S&P affirmed their ratings, although Fitch moved its outlook on India to “negative” from “stable” highlighting considerable risks to its forecast due to the rising number of COVID-19 cases in the country. While this is not our base case, any rating downgrade (below investment grade) can impact the flows and cost of fixed income into the country.

With limited space for fiscal action, the heavy lifting for any pandemic response continues to rest with the Reserve Bank of India (RBI). With inflation remaining well behaved, underpinned by lower fuel and food prices and a good start of the monsoons, RBI should have enough room to continue to support the economy. This may include lower rates, high liquidity and all conventional and unconventional tools to provide necessary backstop for government borrowing as well as credit growth.

Equities form higher base

Almost disregarding the negative news flow, equities continued their recovery path, forming higher support levels and seemingly ruling out some of the worst case (even apocalyptic) scenarios. While initial activity signs may have helped, visibility on corporate earnings still remains low.

Markets seem to be coming to terms with no, or even negative, earnings growth in the current fiscal year, rather focusing on the recovery path and resumption of the historical trends by 2022. In the coming months, the focus will likely remain on the quarterly earnings season to identify, and validate, the assumptions made on the resilience of selected businesses and their capability to capture growth in the new normal – both organically and inorganically.

While foreign inflows remain muted, some of the large corporates continue to attract much-needed equity risk capital through stake sales, rights issues and institutional placements, thereby strengthening their balance sheets. Some companies, and owners, also continue to buy back shares in their companies. Over the last few weeks, these placements crossed INR 1tn, taking these flows off the secondary markets.

Quality remains in vogue

With high liquidity, equity valuations remain rich, especially in the “quality” space, making it difficult to deploy incremental allocations. However, a combination of factors continues to favour quality, an investment style that cuts across both growth and value styles and by market capitalisation.

The ability of high-quality businesses to generate and redeploy free cash flows, attract risk capital, absorb any demand or supply shocks, attract lower long-term interest rates, provide the much needed backstop to their supply chains and grab market share make them attractive. Also, with inflation seemingly well under control, quality businesses should continue to protect their profit margins with lower input costs (labour, capital and raw material). Even in the longer term, stronger branding and distribution can make it more likely that any inflationary pressures are passed on to their customers.

Having some cash available to invest may prove handy in the current earnings season. With initial signs of reduced stress coming from some of the large banks, including lower opt-ins on loan moratoriums, we are more upbeat on the financials. We remain more constructive on defensive sectors like IT, pharma and consumer staples.

Opportunistic positions in the mid and small-cap segment, and in select plays across manufacturers of two-wheelers, metals and cement, can be best delivered through actively managed portfolios.

Diversification remains key

In fixed income, we retain our tactical preference for select high-quality and liquid assets up to five years in maturity. While the RBI has so far been able to manage the increased supply of gilts as well as the term and credit spreads, we believe that allocations to higher duration or to high yield credits are not worth it from a risk-reward perspective. For investors with the risk appetite, the next few months and quarters, however, could be a good time to hunt for some attractive mispriced credits and distressed assets.

In capturing the emerging trends in the “new normal” while mitigating low yields and high volatility, uncertainty about the government debt pile, deepening fault lines in the Indian credit market and inflation or even stagflation, potential options may require adopting a well-diversified portfolio.

Such a portfolio might include quality stocks, gold, bond opportunities, tactical ideas designed to take advantage of market situations and expectations as well as less correlated private assets.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

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