The meltdown

The spread of coronavirus and turmoil in energy markets have combined to create a perfect storm across the global system. Equity indices have gone into a tailspin, with foreign portfolio investors fleeing to the safety of hard-currency bonds. In one way, the YES Bank crisis just provided a trigger for jittery investors to start selling. Indian equities have been considered overvalued for several years, given the economic weakness and poor earnings growth. A couple of weeks ago, the Nifty 50 was trading at a price-to-earnings ratio of 27 while earnings growth was barely in double-digits.


However, the speed of the correction has caught even hardened investors by surprise and it isn’t obvious what policymakers around the world can do to alleviate the current concerns. The lockdown of China meant the inevitable disruption of multiple global supply chains. Now large parts in the rest of the world, including many nations such as Italy, Japan, South Korea, and the US are headed into partial or complete quarantine. There is one silver lining, at least for India, in the falling price of oil. That takes some of the pressure off the rupee since it guarantees a smaller trade deficit. However, even cheaper crude oil may not be an unalloyed blessing; it could mean lower remittances from non-resident Indians working in the oil-dependent economies of the Gulf, and also difficulties getting ideal valuations for the disinvestment of Bharat Petroleum Corporation. Another silver lining may be the so-called demographic dividend. The bulk of the deaths caused by Covid-19 around the world have occurred in the age category of 60-plus and the bulk of India’s population is well below that. However, there is no coherent strategy visible on the ground to carry out the massive task of screening and testing large populations.


Apart from health care, on the economic side of things, the US central bank, the Federal Reserve, has responded to the crisis with a large out-of-turn policy rate cut. The People’s Bank of China has also cut rates. The European Central Bank, which already has a negative policy rate, will make a policy statement on Thursday, and it would indicate the measures it is taking to maintain growth. However, monetary easing is unlikely to prove a perfect antidote to an epidemic and to the negative supply shock that disease has created. Consumption demand will also certainly be affected, given the tens of millions who are sitting at home. Global growth estimates for 2020 have already been pared, and they will surely be pared again, as the disease spreads. Even if the advent of warm weather in the Northern hemisphere does halt the spread of the virus, the global economy will take a while to recover from the disruptions already caused.


Indian investors living through this scenario will have to tread carefully in a situation where firm projections are impossible. They may have to adjust their expectations downwards. At some stage, the global economy will start on a path of recovery and the markets will also fall enough for valuations to become attractive. Investors should take extremely considered calls. While the nature of the crisis is transitory, coming days and weeks could be painful.


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