India’s cyclical recovery will likely be pushed back, although in our base case we don’t expect the recovery to be completely derailed.
Lockdowns have commenced in states that have been badly affected, such as Maharashtra, Delhi and Karnataka. These local lockdowns could be extended for weeks until new cases start to slow.
So far, nationwide restrictions have not been imposed, but economic disruption is nonetheless significant. Mobility in transit and working venues (related to production activities), which once recovered to around 90% of pre-COVID levels, recently dropped to 50-60%. Mobility in retail and recreation venues (a consumption indicator) also went down sharply to 50% of pre-COVID levels.
With a more services and domestic demand oriented economy, India is relatively more impacted from rising cases than other parts of Asia that can ride the global boom in manufacturing exports.
For now, our base case is that the current wave will push back the cyclical recovery by about a quarter, but that it does not derail the recovery altogether. We also assume that vaccination efforts will eventually put the economy back on a more sustained recovery trend.
The risks, however, are more skewed to the downside. There are two things to watch:
First, how long will this wave persists? So far there is no consensus prediction from the scientific community as to when infections could peak and to what extent the outbreak could spread to other parts of the country. J.P. Morgan’s Investment Bank (JPMIB) currently anticipates the infection rate could be passing a peak and India’s daily cases will soon fall below 300K. Vaccination progress will be a key factor in controlling the outbreak and bringing about a recovery. So far, 9% of India’s population have received at least one dose of a vaccine. This is far from sufficient. JPMIB expects a stepped up vaccination effort that will allow India to get to 60% vaccinated by Q4 this year.
Second, is policy relief available? India already deployed a 20 trillion rupee (equivalent to 10% of GDP) package of fiscal and monetary measures last year to counter the economic fallout from the extensive nationwide lockdowns during the first wave. With price pressures creeping higher on the global as well as local front, and consolidated government debt standing at 83% of GDP1, the policy space for further stimulus is relatively restrained. That said, while the fiscal trajectory is challenging in the medium-term, if more government spending (and central bank support) are deemed necessary to boost the recovery it will take precedence over the long-term goal of fiscal consolidation.
Beyond India, there are potential wider implications.
First, there is some risk of transmission to the rest of Asia. Singapore and Hong Kong have both found the “double mutant” variant that was first detected in India in locally transmitted cases. Singapore tightened social distancing measures as a result, which took the city-state one step back in its phased reopening that began in June 2020, while Hong Kong ordered the quarantine of hundreds of residents.
Elsewhere, imported cases of this new variant have also been reported. However, Asia is generally handling this wave with heightened vigilance, which many hope will bring it to a swift end.
Second, India has a significant impact on global supply and demand. The Indian economy is not very trade oriented – it accounts for less than 3% of global trade (and runs a trade deficit). But it has a bigger influence in certain industries. India is the world’s largest exporter of rice (with around 30% market share). It is also the world’s third largest exporter of cotton (over 10% market share – it also imports cotton, but by a much smaller amount) as well as sugar (9%). Thus, severe supply disruptions could put further upward pressures on agricultural prices, which are already rising.
On the import side, India is the world’s third largest oil importer, accounting for around 10% of global demand. Within the manufacturing sector, an area of potential impact could be in medicines and pharmaceuticals. India is the world’s third-largest pharmaceutical producer in terms of volume. Indian firms provide 20% of the global supply of generics2, meeting 40% of generic demand in the U.S. and a quarter of that in Europe3. It also contributes to 62% of the global vaccine supply4, and is a key supplier of COVID vaccines itself.
Third, the COVID resurgence in India highlights the fragility of the COVID recovery in emerging markets. Compared with developed markets, EMs have generally gone slower in the vaccine rollout, they have weaker healthcare infrastructure, and limited macro policy space. Most emerging markets (except for Russia and China) do not have their own vaccines, and less wealthy emerging markets (i.e., developing economies) cannot afford expensive contracts and thus their recovery from COVID will be more at risk of virus disruptions.
Many emerging markets have also eased their monetary and fiscal policies by a lot, and do not have room to ease more aggressively to cushion the economy. So either way, more stop-starts and less policy space the second time around will slow the return to trend growth for many emerging markets.
In terms of Indian assets, the market reaction has been aligned with our view that the shock will be temporary. We continue to stay constructive as value cyclical sectors, especially financials – which we believe will outperform in the current reflationary environment – make up a large share of major Indian equity indices. If cases peak, vaccinations accelerate, and strong global growth provides a supportive backdrop, the cyclical recovery will likely continue as this wave eases. That said, there are clear risks.
In addition, the COVID situation in India, as well as a recent resurgence in Thailand, the Philippines, and Malaysia, is exacerbating the North-South divide in Asia. This divide was already wide due to the semiconductor boost to Northeast Asia and the tourism drag on Southeast Asia.
There are still many reasons for investors to like Asia – including higher growth, a rising middle-income class, and leading positions in the global value chain – but with a desynchronized cycle, it is more important to be selective. This indicates an advantage for active management.
1 Bank for international Settlements. Data is as of September 30, 2020. Note: consolidated government debt comprises central state and local government and social security funds, but excludes public enterprises.
2 Indian Department of Pharmaceuticals: Annual Report 2019-20. Data is as of 2019.
3 India Brand Equity Foundation: Pharmaceuticals. Data is as of 2019.
4 KPMG: Global Supply Chain Reconfiguration. Data is as of October 6, 2020.
All market and economic data as of May 10, 2021 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
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