India’s Covid Course Correction Cry

As the world watches with horror the humanitarian crisis in India, the macro-economic and financial market impact of the second Covid-19 outbreak carry their own scares. Local business leaders are calling for a nationwide lockdown Prime Minister Modi is resisting.  Just over a month ago public and private sector research was bullish with massive vaccination production ability and marked economic rebound in the January-March quarter. The IMF, ADB and private analysts were projecting GDP would grow by 12%+ this year and that long-needed banking sector clean-up and reform would move ahead.

Now growth forecasts are cut while inflation is expected to rise on supply chain disruptions. After contracting 8% in 2020, according to the IMF, the economy will not turn in a double-digit rebound.  The central government’s debt and deficit will also soar, and early last month the Reserve Bank pledged to buy up to USD 14 billion of government bonds this quarter to keep borrowing costs low and support economic recovery. The RBI had been purchasing the securities in the secondary market and the ramped up purchases briefly buoyed investors. Within weeks as Covid cases spiked, the government several times failed to sell the full amount on offer after the central bank rejected traders’ demands for higher yields. 

Foreign portfolio investors have been net sellers in the bond market since the start of the year with outflows of USD 1.5 billion in April alone on deficit worries.  The general government deficit is again to be in double digits, after a 14% gap last fiscal year while the debt/GDP ratio is expected to top 90%. Unlike other markets, however, it is almost all held domestically, with foreign investors accounting for about 2% of the local bond market under a longtime ownership quota. On the corporate side, bond defaults have topped USD 775 million so far this year. In the medium-term, foreign allocation is expected to rise when Indian government bonds are added to major emerging markets indices and become Euroclear-able.

After pouring some USD 36 billion into Indian stocks from October through March, foreign investors sold more than USD 1.2 billion in April, sending the rupee down nearly 2% despite a rebound late in the month after foreign governments committed to sending pandemic assistance.  On the MSCI Index the market lost only 1% in dollar terms in April.  While still in positive territory for the year, up over 3%, it lags most Asian emerging markets after outperforming for nearly a year.  Additional outflows will be cushioned by the RBI’s USD 600 billion in FX reserves as foreign holdings stood at a record high of USD 555 billion at end-March.

Prior to the second wave, analysts focused intently on the banking sector.  In FY 21, which ended in March, credit growth stood at a record low of 5.6% and was set to worsen despite the fall in the cost of borrowing the past year. Banks are risk averse on rising non-performing assets which will escalate even more. Local ratings agency Incra estimated that nearly 10% of bank loans turned bad in the last fiscal year, with total NPAs at more than USD 100 billion. The Indian Banks’ Association has identified 102 large corporate loans it wants to sell to the new National Asset Reconstruction Company, a bad bank, which has received government approval but is not yet operating.

For now, the Covid crisis dominates global attention.  Stocks, bonds, and the rupee will continue to be volatile and likely fall further. In addition, investors fundamentally question Prime Minister Modi’s future after his Hindu nationalist BJP party failed to win a key state in Sunday’s elections. In power since 2014, Modi’s popularity has plummeted in recent weeks with citizens furious that he held super-spreader campaign rallies rather than deal single-mindedly with the pandemic.  While he does not face elections until 2024, business community wavering support over reform progress may readily translate into permanent reputation damage. This scarring as another legacy is exactly opposite the early misplaced euphoria over virus defeat with negligible case counts. Investor sentiment too will swing toward extremes until the tragedy’s full policy and performance missteps are corrected in a future mea culpa of exaggerated success never experienced with unified tax and currency note confiscation bungles.

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