Economic Package – Impact on Markets

The economic package from the government seems to have disappointed the markets and the Nifty has corrected 6 % (as of May 18, 2020) from the peak of May 13, 2020. The package has focused and delivered on two key areas – preserving financial stability and initiating structural reform. The markets were disappointed by the lack of an immediate fiscal stimulus which, we believed, was hampered by revenue constraints. Our approach to the market remains unchanged after this announcement. On the one hand, we see an opportunity to invest in strong market leaders across sectors from a 2-3 year perspective, and that has been reinforced by some of the structural reform. We are, however, mindful of the near-term risks to earnings and the broader market. We, therefore, remain cautious in our stock-picking and cash deployment.

Structural reforms: The proposals on agricultural reform are path-breaking and could transform the sector with multi-year dividends for the economy. We expect structural efficiency gains on the back of the measures proposed, which should benefit the farmer, consumers and the overall eco-system (except for existing rent-seekers). Implementation will be key, but the statement of intent itself is politically bold and in the right direction. The rationalization of the PSU sector is the other step that could be transformative. Like agri reform, it could deliver structural efficiency and productivity gains for the economy.

Financial stability:The RBI and the government have been decisive in ensuring that the financial markets have remained functional. The liquidity accommodations were transformative but the direct interventions in stressed markets have also helped. The SME loan guarantee is another step in that direction, though the efficacy will depend on how it is structured.

Lack of stimulus: The net stimulus in the package was approximately 1% of GDP, which left the market disappointed. The increased allocation to MNREGA is an important measure but may not fully address the blue-collar distress that has resulted from the post-COVID lockdown. We believe that the government is constrained by fiscal objectives, which have already been hamstrung by an expected shock on revenues.

We are still dealing with unknown risks for corporate earnings. The extent of demand destruction is yet to be fully assessed, and we are unsure of where the impact could be long-lasting. There are also nuances like down-trading and geographical redistribution that are yet to be fully understood. Moreover, the supply-side constraints may not go away soon. The lockdown could last longer than envisaged, and pockets of extreme labour shortage will remain a challenge for manufacturers.

The risk is acute for banks and NBFCs. The asset quality cycle is expected to worsen across both corporate and retail, which would affect even the high-quality names. The issue is compounded by revenue pressure as the high-ROA segments like unsecured retail are linked to discretionary consumption. This stress is temporary, but the continued lockdown and potential extension of moratoriums (or other regulatory forbearances) mean that the extent of earnings damage is unknown. This sector, therefore, is likely to remain under pressure till visibility emerges.

In that context, we think it would be facile to assume that every company would go back to normalized earnings in FY22. The strength of the franchise and the balance sheet are necessary conditions, but the recovery in demand will also be a factor in assessing long-term earnings recovery. Our focus on market leaders stems from the belief that they will gain market share when the economy recovers, hence the earnings bounce-back will be quicker. We continue to pursue this strategy, while trying to diversify our sector exposures. Given the risks to the system, we may be holding excess cash for longer than we used to.