At the start, I would like to appreciate the efforts of our analyst team in India during this volatile period. The team has been working hard, we have spoken to most of the companies held in our portfolio as well as those which are potential investments. We have been focusing a lot on understanding each business’ sustainability from a cost and balance sheet point of view. This is an ongoing effort, but we are on top of things mostly.
Covid-19 impact - the situation is still developing in India. Till 2nd April, the country had 2000+ case with roughly 50k people tested. While the infection rate remains low as of now, it is incrementally on a rise. India is slowly scaling up medical testing - it has now licensed select private labs to conduct these tests. The total tests per day is now getting scaled to roughly 5000 and I think it is going to increase further and hence we will see better picture in next two weeks. India went on a 3-week lockdown from 25th March, which is very important for the containment of covid-19, but it will also impact the economy dearly. On execution, the country is practically closed but there have been issues with the movement in parts of the large migrant worker population (100mn+ cohort) as they try to head back to their homes in absence of work or social security. This is similar to what we saw during demonetisation in 2016 where the lower strata of the population were impacted the most. I think implementation and planning could have been better, but these challenges are always there in a large country like India which is also resource constrained. Overall, I think market remained worried about the large spread of the pandemic which can have a big negative impact in the medium term, especially given the weak healthcare infrastructure. India currently has less than 1 hospital bed/1000 people (c1mn beds) out of which only 5-7% may be for critical illness. My base case is still a contained pandemic as numbers remain low in India, but I do worry about the tail risk of a large pandemic as the impact may be more negative for India vs other countries.
Policy response - as expected, the government and the Reserve Bank of India (RBI) has come out with a measured fiscal and monetary response to the situation. On the fiscal front, they have announced cash and kind support for lower income group households worth 0.7% of GDP (actually less as it includes some existing schemes). On monetary front, the RBI has announced 75bps policy rate cut, 90bps reverse repo cut, 100bps CRR cut and INR1tn of liquidity for banks to participate in debt capital markets. Along with this, the RBI has announced moratorium on repayment of term loans and deferment of interest on all loans for three months. This was a measured move and probably less than what is required but I continue to believe that the government remain constrained on the fiscal side and hence don’t expect a big stimulus unless things go out of hand. India already runs a combined fiscal deficit of c7% and while they have benefit of lower oil prices (c2% of GDP) there would also be worry around lower exports and tax revenues. Hence, I don’t think they would go beyond 4-5% of GDP of stimulus and that too in a calibrated approach. I believe the govt also wants to protect the currency in a capital outflow environment, which adds to the constraint. In my base case of contained outbreak, the GDP impact could be 3-4%, which is manageable in short term, but in case of a larger outbreak the risk to economy and currency is high.
Markets and flows - Indian markets continue to lag regional markets and I think the market is pricing in some probability of my tail risk on the outbreak and economy/currency. Indian markets were down 25% in March (in US$ terms) which is the worst monthly performance in last 10 years. YTD, Indian market is down c30% vs Asia and US at c20% and China down only c10%. In terms of flows, YTD net outflows from India were US$ 6bn and in March they were US$8bn, which is the largest monthly net outflow ever. The skewness on sector returns continues with defensives such as staples, healthcare and IT services outperforming cyclicals such as financials and industrials. These market and sector returns and flows data clearly show a risk-off environment vs India and the realisation of a tail risk. At 15x trailing PE on cyclically low earnings, the market remains cheap and I think the opportunity for an upside from these levels is attractive. The key is to manage any further leg down tail risk with proper stock selection and positioning.
Fund positioning - the fund continues to remain slightly aggressive in its positioning with an overweight in financials and underweight in consumer staples. As I am going through the transition, I continue to focus and concentrate on quality businesses within these sectors and exiting lower quality businesses. This is core to my investment philosophy, and I believe it will help in this environment. Within financials, we now only own some of the best quality institutions in India. On defensives, the fund is focusing more on mid cap staples, IT services and healthcare names which I think provides better value and higher risk-adjusted returns vs some very high valuation large cap consumer names. Also, we are keeping a reasonable cash position to take advantage of potential opportunities. Overall, I think the fund is in a good shape to manage through this crisis and take advantage of the recovery and cheap market valuations on the upturn.
