The lockdown has shut down non-essential businesses for weeks and most likely result in GDP contraction in 1QFY21. Unemployment levels have soared as small businesses struggle to survive the lockdown. Unless the government intervenes to support the economy, FY21 growth could sink below 3% YoY. The consensus estimate for Nifty EPS has been downgraded by just ~6% in the last one month and current estimates still imply double digit growth in earnings. This scenario is unlikely to materialize and FY21 estimates will see sharp cuts as clarity emerges on the extent of damage to the economy.
The government has announced some measures like distribution of cereals and cash transfers to the poor as immediate relief measures. However, more steps like higher spending for healthcare, cash transfers, loan guarantees for small businesses etc. may be needed to revive the economy. The RBI has also announced a series of measures twice that include policy rate cuts, liquidity infusion, moratorium on loan payments and support to smaller NBFCs and MFIs to tide over the crisis. While these measures are helpful, continued availability of liquidity may require active intervention of RBI. The government borrowings for FY21 are likely to exceed the budgeted amount by a wide margin as tax collections are likely to fall short of estimates even as the government would have to step up its expenditure to revive the economy. The sovereign bond yields have been hardening over the last few weeks despite a sharp policy rate cut of 75bps, on concerns of fiscal slippage. The RBI will have to step in to ensure that borrowing costs for government do not spike due to higher borrowings.
The worries on economy and corporate earnings have dragged the equity markets. The benchmark Nifty Index fell by ~38% from peak in a span of one month and several stocks corrected by more than 50%. As a result, valuations multiples have contracted and the Nifty index is now trading at ~17 times on trailing PE basis compared to ~25x in February. That said, both Indian and global equity markets have rallied since last week of March even as cure or vaccination for coronavirus eludes us and the epidemic continues to spread.
Although the equity markets have recovered from the lows of March, outlook on the economy remains uncertain. The lockdown would strain balance sheets of corporates as companies try to manage fixed costs with near zero sales. In such an environment, resilient companies with strong cash flows and bullet-proof balance sheets will command a premium. We recommend Bharti, Kotak Bank, ICICI Lombard, L&T, Maruti, SBI Life and Torrent Pharma among large-caps and Ashok Leyland, Deepak Nitrite, Kansai Nerolac and Navin Fluorine among mid-caps.
This article by Mr R. Venkataraman was published in Economic Times, April 27, 2020