Dark Clouds on the Horizon?

COVID-19 casting a shadow on India’s growth

The year 2020 will go down in history as the year of the COVID-19 pandemic that brought the world economy to a virtual standstill. With about 200 countries and territories being affected by the deadly virus, the COVID-19 crisis is unfolding in India with the curve steepening considerably. On the economic front, the pandemic has stymied growth worldwide – international travel has been banned, many places have been brought under lockdown, and factories and businesses have been shut for now. India, though less integrated with the world, has not been fully insulated from the economic implications. The country was already going through a temporary phase of slowdown and the virus outbreak has only exacerbated the situation. While the government’s decision to go for a countrywide lockdown is being hailed as a swift and necessary response for a country home to 1.3 billion people, the government needs to brace itself for the economic fallout of the pandemic. With the prospects for the country coming out of the slowdown looking gloomy, the target of a $5 trillion economy by 2025 now seems a far-fetched dream.

Current scenario: Country coming to a stands till

The national lockdown from March 25, 2020 onwards is the world’s largest COVID-19 lockdown. The country’s first case was reported on January 30, 2020 in Kerala. The number of infected cases has now risen to over 28,000. The central and state governments’ directives for lockdowns and curfews have brought construction activities to a halt in an already slowing economy. Many metro rail, highway and residential real estate projects are staring at site closures.

Border sealing, suspension of public transport and scaling down of operations by corporates has impacted manpower mobility. The labour force has reduced by almost 50 per cent across the country, further adding to the construction industry’s woes. The scenario implies that the slowdown in construction work will push costs upward given the interest and debt servicing needed for the extra period. However, lower input costs with a slump in commodity prices such as crude oil may be the only silver lining for players.

Measures taken: Are they enough?

The Reserve Bank of India (RBI) has taken a host of measures for individuals and companies by providing them temporary relief from loan servicing and making loans cheaper. In a major announcement, all lending institutions have been permitted to allow a moratorium of three months on payment of instalments with respect to all term loans and payment of interest with respect to working capital facilities (sanctioned in the form of cash credit/overdraft) outstanding as on March 1, 2020. Also, the moratorium on term loans and the deferring of interest payments on working capital will not result in an asset classification downgrade. The move is expected to come as a relief to a large chunk of self-employed people as well as small businesses, whose incomes may have dropped during the lockdown period.

In order to mitigate the impact of the coronavirus, revive growth and preserve financial stability, the apex bank has slashed the repo rate by 75 basis points to 4.4 per cent and the reverse repo rate by 90 basis points to 4 per cent and further by 25 basis points to 3.75 per cent. The cash reserve ratio (CRR) of all banks has been reduced by 100 basis points to 3 per cent with effect from March 28, 2020 for a period of one year. The requirement of a minimum daily CRR balance has also been reduced to 80 per cent from 90 per cent to ease pressure on banks. Banks have been permitted to borrow against 3 per cent of their statutory liquidity ratio (mandatory holding of government bonds), up from the previous 2 per cent. These measures will inject liquidity of Rs 3.74 trillion into the financial system. However, the benefit of the reduction in interest rates will be felt only after the lockdown is lifted and business activities begin again.

RBI also launched its first targeted long-term repo operation (LTRO) of Rs 1 trillion, with a maturity of three years at a floating rate linked to the repo rate. The liquidity provided to banks via this window has to be deployed in investment-grade corporate bonds, commercial paper or non-convertible debentures in equal proportions in both the primary and secondary markets.

With regard to the ongoing insolvency proceedings, the 330-day time frame for resolution of cases under the Insolvency and Bankruptcy Code will exclude the lockdown period. Besides, the apex bank has extended the 210-day resolution period for stressed asset management by 90 days as banks are finding it difficult to meet deadlines due to the national lockdown.

Likely impact

The three-month moratorium will have a near-term impact on collections and disbursements of non-banking financial companies (NBFCs). As per industry analysts, growing solvency stress among NBFCs will increase the risk to banks’ asset quality because banks have large exposures to the sector. Thus, NBFCs may resort to LTRO which is a cheaper loan for the infrastructure sector. While the moratorium is seen as a short-term respite for retailers and corporates, it is, in a sense, a postponement of bad loans. The spike in non-performing assets (NPAs) will be reflected in the next few quarters after the removal of the moratorium as debt servicing capabilities of borrowers are impacted.

Restricted movement of private and commercial vehicles will impact toll revenues and thus the cash flow of road developers. The commercial vehicle loan market too will face challenges as curtailed traffic will lead to weak earnings for fleet operators. Infrastructure developers are now faced with twin challenges of delayed project completion (in turn, leading to cost overruns) and uncertain infrastructure capex growth. This may result in corporate delinquencies in some cases, further ballooning banks’ NPAs. Industry analysts opine that the elongation of the working capital cycle will also impact payment to suppliers. Thus, the COVID-19 disruption is likely to lead to restructuring of debt obligations and financial agreements will have to be revisited.

Private equity (PE) investors, which had been actively investing in the country’s infrastructure sector in the past two years, seem to have shifted gears, slowing their investments in 2020. As per EY, investments in companies in the technology, consumer goods and pharmaceutical sectors may go up, while activity in financial services, infrastructure and real estate will take time to gain traction. With preference for safer investment avenues, foreign portfolio investors have also pulled out a huge amount from emerging markets with India being no exception.

Investments via infrastructure investment trusts (InvITs) are also expected to take a back seat. Most of the InvITs in the country house road and power assets. The temporary suspension of tolling activities will impact the return on road assets. Even once travel restrictions are removed, a situation of normalcy is unlikely to result immediately. Moreover, the Ministry of Power has placed a moratorium on payments from distribution companies to generation and transmission companies up to end June 2020. All these factors are likely to impact the yield generated by InvITs. Coupled with the uncertainties surrounding the force majeure clause, institutional investors will be in no hurry to park funds in infrastructure assets. This may push out the timelines for issuing and listing of InvITs.

The COVID-19 pandemic and the lockdown are leading to delayed resolution of insolvency cases, thus eroding the market value of distressed assets. The hiatus in insolvency proceedings is compelling fund managers to explore invocation of the force majeure clause to circumvent deals that they had committed to before. Many potential buyers are either in a wait-and-watch mode or are seeking timeline extensions, which is denting asset valuations and putting a question mark on the viability of businesses.

Outlook

The International Monetary Fund has slashed India’s growth forecast to 1.9 per cent for 2020-21 on the back of deteriorating credit conditions and weakening consumption demand. Global headwinds and supply chain disruptions will weigh heavily on exports and private investment. The government needs to loosen its belt on the fiscal deficit target for 2020-21 to first augment public healthcare infrastructure and medical facility requirements, second to ensure livelihoods, and then to undertake recovery meaures. The government not only has the onus of providing the necessary financial aid for COVID-19 relief measures, but also needs to support and increase expenditure on the severely hit infrastructure sectors once the lockdown lifts.

The COVID-19 impact on the infrastructure sector is touted to be even worse than the 2008 financial crisis. In 2008, private capex took a hit, but the ongoing pandemic has put government capex under a lot of pressure, and this is not a good indicator for the economy. With foreign investors fleeing from the country, domestic investors and lenders have a bigger role to play. Amidst caution, fresh loan disbursements may be slow to come to businesses. Thus, stuck in a vicious cycle, whether the recovery of the Indian economy will follow a U shape, V shape or a “Nike swoosh” hinges a lot on the effectiveness of the containment of the virus, the timing and success of policy responses to the COVID-19 crisis, and the behaviour of the private sector and financial markets.

Ishita Gupta

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