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India is not one of the most attractive emerging markets right now

Hugo Erken, Senior economist & country analyst for North America, Mexico and India.
We have to be mindful. The situation is like catching a falling knife as the current measures are extremely damaging to the global economy. Forecasting at this moment is difficult due to the huge amount of uncertainty. It feels like shooting at a moving target with a blindfold on. Nevertheless, we have some figures to hold on to as a number of weeks ago we started a scenario analysis. In this scenario analysis, we tried to replicate how the virus is affecting different parts of the global economy.

We have made assumptions on, e.g., exchange rate movements, lockdowns in countries (via lesser hour worked per worker), global trade disruptions, adverse consumer and investor sentiment and behaviour and negative productivity effects. When wrapping up that assessment, the virus was only spread extensively in China, Italy and South Korea. However, we felt things could easily turn for the worst and have also calculated an adverse pandemic scenario. We have adopted that one as our baseline scenario.

We expect global growth to level off to 0.7 per cent in 2020 (before corona we estimated 2.9 per cent). We expect China’s growth to edge to zero in 2020 (pre-corona: 5.7 per cent). Most countries will end up in recession, with Japan -2.5 per cent (pre-corona: 0.5 per cent), Italy -1.9 per cent (pre-corona 0.1 per cent) and Germany -1.2 per cent (pre-corona 0.6 per cent). For India we expect growth of 3.6 per cent in calendar 2020 (pre-corona 5.7 per cent). In terms of fiscal 2020/21 this is 4.2 per cent of growth, which coincidentally is pretty much in line with what BofA just released.

We again have to stress that our forecasts are surrounded with much uncertainty and there are several downward risks. Yet, there are too many unknowns at this moment to make a meaningfully estimate of the economic impact at this point in time.

Some risk scenarios: 1) the current health crisis could become a financial crisis as well. A financial crisis can result from the simple act of firms and individuals hoarding capital rather than spending, breaking the flow of money through the economy. There are already some signs that both threaten to happen simultaneously – prompting extraordinary central-bank actions that are still barely keeping a lid on the problem. 2) Prolonged lockdowns. If this is the case elsewhere, or worse given the different prevailing political systems, then this will increase the economic impact exponentially. The European Central Bank (ECB) said that one month of lockdown in the Euro Area will shave-off 2.1 percentage points (ppts) off of annual economic growth. If we use our pre-corona estimate for the Euro Area of 0.9 per cent y/y, a lockdown of one month would result in economic contraction of 1.2 per cent in 2020, which is pretty much in line with our forecast. However, a prolonged lockdown of three months, for example, could plunge the Euro Area into a recession of almost -5.5 per cent. 3) In a prolonged shutdown scenario, a rise in food and medicine scarcity can also not be ruled out. Although it seems likely that food safety would be one of the main priorities of governments, this is not easily achieved in a crisis where others are experiencing the same problems.

For India, our forecast assumes that the virus will spread in India as well, but we don’t assume India will be the next virus hotspot in Asia. We do not rule out that this is a possibility (given high demographic density and health care which is less abundant than in many Western economies). In that case, we might see substantial rebound effects across Asia (even touching ground in other parts of China). In all these scenarios, we also have to go back to the drawing board.

We would argue the coronavirus is increasingly a simultaneous supply and demand shock. Central banks alongside fiscal policymakers are asked to intervene and act. But obviously this is a problem they can help pave over the crack, but they can’t fix the root source. Again, currently financial markets mostly judge their actions to be indicative of the scope of the problem, rather than offer a real solution.

India, like other EM’s, is bearing the brunt of the global flight to safe assets. The rupee has plunged in March and we continue to expect volatility in EM financial markets. Our EM Vulnerability Heatmap shows that India at the moment is not one of the most vulnerable EM’s, but also not one of the most attractive.

There are some structural issues that the Modi government needs to fix in order to push economic growth again to acceptable levels (after the current crisis) and attract a sufficient amount of overseas investment. First, the labour market problems will continue to put downward pressure on participation rates and are hampering a better division of labor across different industries. Second, there are unresolved balance sheet problems in four segments of the economy: infrastructural companies, the banking sector, non-banking financial companies and the real estate sector, as former Chief Economic Advisor Subramanian has argued. These problems will likely continue to put a brake on credit growth and investment. Finally, we expect the average annual contribution of total factor productivity (TFP) to be lower than the past five years. This is partly caused by an anticipated growth slowdown of inward foreign direct investment (FDI), against the backdrop of a reversed globalising trend and India’s increasingly protectionist stance and of course reshoring of globally scattered supply chains, which have proven to be very vulnerable due to Covid-19. This will all pose challenges to India as investment destination.

Having said that, there is a possibility India might also benefit from the last-mentioned threat to some extent. International firms have found out the hard way just how vulnerable their globally integrated supply chains are. This was already becoming clear due to US-China trade tensions but has been exposed to the full by the COVID-19 virus outbreak. The disruption of international trade may prompt international businesses to diversify their production across several countries. Firms want to rely less on China as their only manufacturing hub might shift (part of) their production to other countries, such as India. The extent of this potential upside is difficult to assess.


(As told to Puneet Wadhwa)

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