'Policy reforms need to avoid lasting impact of pandemic' | Economic Times

By Anand RadhakrishnanIt is in a crisis situation that the best lessons are learnt. The Covid-19 pandemic has exposed the fragilities of the strongest of the economies and in the bargain, it highlights the need for rapid response by governments to contain emergencies of massive proportions. Globally, the success of response by governments to combat the pandemic has been driven by two main factors – (i) speed of response and the (ii) magnitude of resources deployed. Prompt and substantial stimulus packages announced by most developed economies - including USD 1.8 trn CARES Act and CARES 2 (anticipated) in the US, USD 855 bn package for European Union, and USD 559 bn package for China among others, are yielding results as can be seen in the Q2CY2020 GDP numbers (moderate contraction versus emerging markets), with expectation of recovery from Q3CY2020 onwards. As the economies world over continue with gradual resumption of the economic activities, various high frequency indicators (HFIs) point towards a moderate yet continued sequential global growth trend in the third quarter. HFIs in China (services sector indicators), US (retail sales, manufacturing and services) and Europe (retail sales, industrial production) are either trending closer to or have exceeded pre-Covid levels. Comparatively, emerging markets including India in many ways face tougher economic challenges from the pandemic, given the limited social safety cover, healthcare capacity and less scope for aggressive macro policy easing. The stimulus package (around USD 270bn) announced so far in India came with a delay and was stifled by the already precarious fiscal situation. Monetary stimulus presently stands contained in light of higher inflation levels. While these measures, however limited, are meant to offer short-term placebo, policy reforms to enhance long-term growth drivers (private investments through infrastructure boost, consumption demand improvement, focus on exports) would be needed to avoid lasting impact of the pandemic on economic growth.India’s real GDP contraction by 23.9% YoY in Q2 2020 (vs. 3.1% YoY in Q1 2020), primarily led by slump in investments, is severe. On the positive side, recovery in economic activity continues MoM as lockdowns are partially being eased. Further relaxation in lockdown rules in September should aid recovery. An uptrend in HFIs is encouraging. Government consumption has risen and net exports are contributing positively. The industrial activity indicators and unemployment rate are improving. Pace of contraction in industrial HFIs (power demand, E-way bills, GST collection) and consumption HFIs (auto sales) is lowering. Agriculture sector is gaining strength (normal monsoon, greater sowing area, fertilizer consumption). Google mobility indicators related to recreation/retail have been improving across states.The swift actions by central banks raising hopes of recovery along with better-than-expected second quarter earnings lifted the investor sentiments and fueled the global equity markets rally. Global liquidity driven bounce back rally in US (39%), Germany (23%), developed Asia (~20% - China, Taiwan, Korea and Japan) during the April-August 2020 period attempted to make up for the equity slump during Jan-March 2020 period. Meanwhile, Indian equities which have followed suit, gaining 21% (BSE Sensex) during the same period, continue to be led more by global liquidity even as corporate earnings growth expectation for the forthcoming quarters largely remains muted. The corporate earnings growth disruption shown an uneven trend across sectors with some discretionary sectors impacted more than the staple/tech/utility-oriented businesses. Except healthcare and technology, most sectors face pressures of demand slowdown. The rural sector demand recovery, however, provides a silver lining.Companies have responded to the challenge with meaningful cost reduction efforts, focusing on core businesses, exiting unrelated ones, deleveraging and conserving capital. In some sense the pandemic has hastened the imperative to improve and get healthier among corporates.The significant rise in global liquidity led by the easy monetary stance of the central banks has been fueling riskier asset classes such as equities. It remains to be seen how this excess liquidity finds its way out of the global system without greatly disrupting price trends in various asset classes, unlike during the taper tantrum period (2013). The US and European regions are witnessing a second wave of infections which could potentially hamper the current pace of pick up seen in economic activities even as policy makers continue targeting the affected zones with localized measures. That said, the expectation of relatively speedier recovery in global economies could augur well for Indian exports – one of the key growth drivers for the economy even as consumption makes a gradual comeback.(Anand Radhakrishnan is Managing Director & Chief Investment Officer – Emerging Markets Equity - India at Franklin Templeton.)