How coronavirus could impact Indian economy, financial markets

Moneycontrol

February 24, 2020

How coronavirus could impact Indian economy, financial markets

While coronavirus may not have impacted the country directly as much, but the Indian economy, which is just about showing some signs of recovery, may not escape unscathed. The green shoots could get nipped in the bud.

India's annual trade with China is ~$90 billion--India imports goods worth $75 billion and exports goods worth $15 billion. On account of factory closures in China, supply chains would get disrupted and this could result in shortages, especially of electronic goods and medicines.

A lot of pharma companies rely on APIs (active pharmaceutical ingredients) sourced from parts of China that are worst affected by the virus outbreak. We may see a temporary contraction in imports till the time some semblance of normalcy is restored in China.

Trade deficit prints may be lower for the next couple of months. We may see the price of consumer durables inch higher. This would drive core inflation higher, which is showing signs of bottoming out.

This, in turn, could make it more difficult for the MPC to provide further monetary policy stimulus. January's core inflation print came in at 4.2 percent compared to December’s 3.8 percent.

Fall in global crude prices on account of an anticipated slowdown in demand would also result in a lower import bill. The sectors that are likely to be impacted on the export front are diamonds, leather and petrochemicals.

Imports are likely to contract more than exports and therefore, from a current account perspective, the outbreak could actually be rupee-supportive.

However, from a capital account perspective, a big global risk-off could result in outflows from Emerging Markets (EMs) triggering a flight to safety. Outflows from the domestic debt and equity may put pressure on the rupee.

Offshore fundraising by Indian corporates is also likely to slow down, as raising money onshore has become cheaper after the LTRO announcement by the RBI (corporate bond spreads have got compressed).

Therefore, we may also see a slowdown in ECB related inflows over the medium-term. The rupee tends to be more sensitive to hot money outflows in the shorter-term rather than current account dynamics.

Though the rupee may outperform, it may not be immune to the contagion if other Asian currencies weaken. Currencies of countries that have stronger trade linkages with China such as Taiwan, Korea and Thailand are likely to come under more pressure than the rupee or the Indonesian Rupiah.

China has unleashed a slew of stimulus measures, monetary as well as non-monetary, to help the economy tide over the outbreak. Other Asian central banks, too, have responded by cutting rates.

Developed market central banks are already running accommodative monetary policies. In the absence of a real pick-up in the economic activity, we may continue to see liquidity chase select assets and this may soften the blow to financial assets to some extent.

However, in case of an extreme risk-off, liquidity would be comfortable residing in safe havens such as the US treasuries and gold and it would not be surprising to see risky assets get badgered despite abundant liquidity if the virus does not relent.

Since the outbreak is likely to result in a supply-side shock, we may see economic activity rebound very quickly as soon as the virus strain becomes less active. This is expected to happen as temperatures begin to rise and as the summer sets in.

We may see a V-shaped recovery similar to the one we saw post the SARS outbreak in 2003. Chinese industrial production and retail sales had rebounded sharply after SARS.

The slowdown will manifest itself in the data for the current quarter but economic activity should pick up from next quarter on.

Though a run-away move is unlikely in the rupee at this stage, we expect it to remain under pressure till the outbreak subsides. It would be premature to press the panic button at this stage.

We expect the broad 70.70-72.50 range to hold. We expect the RBI to smoothen volatility intraday. A panic move is likely only on a break as well as a close above Rs 72.50 per USD.

Our view on the Nifty remains bearish as long as 12,250 is not broken on the upside. We could see a move lower towards 11,550 in the current swing.

With the RBI likely to stay on hold, abundant liquidity in the banking system and crude trading at comfortable levels, bond yields are likely to remain steady. Corporate bond spreads could come off further.

Reference:https://www.moneycontrol.com/news/business/markets/how-coronavirus-could-impact-indian-economy-financial-markets-4970051.html