Recently, the rating agency Fitch said the coronavirus pandemic has significantly weakened India’s growth outlook for this year and exposed the challenges associated with a high public-debt burden. Matching Moody’s view, it has downgraded India’s outlook from stable to negative.
The decline in India’s growth over the last three years can be traced back to over a decade ago, after the financial crisis, when India’s banks were sitting on non-performing loans and the banks and corporates heavily indebted – this was dubbed the twin balance sheet problem. Distracted by feel good events like the fall of oil price, the twin balance sheet problem became somewhat forgotten.
Over time, however, the problem has worsened. Growth has been consumption-led and lacked investment. There, as consumption has fallen, growth has also declined. This scenario has been exacerbated by the current pandemic. This, coupled with issues around access to land, raw materials, energy, and transport infrastructure, has stifled investment.
Many observers say the Indian economy will contract in the current fiscal year, though expectations are for a bounce back in fiscal years 21 and 22. This, however, does not tell the full story. Some sectors have been affected more than others – telecommunications, IT services and pharma experienced far less disruption than airlines, travel, and the automotive industry.
Unfortunately, a number of businesses will no longer be viable at their current scales in the new normal. Therefore, cash rich businesses may see new acquisition opportunities, and those which are struggling might see merger opportunities that can reduce costs through shared services, facilities, and staff.
Challenges and Opportunities for Growth in India
Labor issues and the health of the financial system are problems that have stifled India’s growth. These have been amplified by the lockdown in India, which has resulted in over 30 million urban workers migrating home to rural areas. This mass movement, however, is potentially a short-term issue. The long-term issue is the health of the financial system, specifically liquidity problems. Credit, the lifeline of any economy, must begin flowing.
While the Government of India (GOI) has done the necessary in response to COVID-19 – for example, small loans, provision of grains, and eased regulations – it has not done everything possible, and there should be further reforms to come. There could be better implementation of provisions such as the large loan guarantee program; The Reserve Bank of India (RBI) could further cut rates, and there could be more cash transfers to individuals.
PM Modi has correctly identified some of these problem areas, namely the four Ls: land, labor, liquidity, and law. Reforms in these areas are not just critical, but necessary for India to return to its growth levels of the first two decades of this century.
However not every outlook is negative – there are some positive signs: IT exports, for example, continue to grow and inflation has remained low. The rupee is also relatively strong. Yet, sectors that have a high discretionary spend by customers, such as auto, travel and tourism, financial services, and real estate, are likely to struggle throughout the current financial year because consumers and companies are trying to save cash where possible.
Those sectors which can operate online, such as education, IT, and retail, are likely to be the quickest to recover. In fact, online learning is seeing a huge increase in demand, and companies and consumers are seeing the benefits of digitization in a number of other areas.
Three Example Sectors
RED – Automotive
This sector was already struggling in India before the lockdown. Demand is extremely low, due to the high discretionary spend, and domestic demands and exports are both shrinking. There are also disruptions in the supply chain, causing problems because of high dependence on imports from China. New product launches are to be deferred as a result.
AMBER – Infrastructure
Due to the slowdown in Government spending, uncertainty in the supply of raw materials, and unavailability of workers is causing delays in capital projects.
GREEN – Agriculture
Favorable weather conditions have led to a bumper harvest. Moreover, there has been an increase in the rural labor supply because of the current reverse migration to rural areas. Alongside this, the Government’s USD 21 billion stimulus packages aimed at strengthening infrastructure, logistics, and capacity building for the agriculture sector have been positive for agriculture specifically.
Those with robust balance sheets that can weather the crisis and conserve cash are likely to be those that come out on top in the post-COVID world. Companies that work across sectors, and those in healthcare and technology are the most likely.
The Micro, Small, and Medium Enterprises (MSME) sector has been hit the hardest, in large part due to their limited resources and capital. Accordingly, the Indian Government has been trying to support MSMEs, in terms of employment and growth, considering their importance to the economy.
M&A activity is expected to continue, albeit with significant impacts. Namely, there will be cash challenges and uncertainty, while sectors and players will become relevant at different times. There is sure to be some activity, however, as those firms that can adapt best will find opportunities in the market.
While India is focusing on the current needs its population, there is more to do to address the existing, and now compounded, growth challenges. The country based much of its recent growth on consumption which has dried up in recent months, and all but stopped during the strict lockdown. As companies and individuals attempt to conserve cash, India must address its liquidity issues first and foremost.
Financial investors are likely to be more active than strategic investors in India. Strategic investor activity will depend on the sectors in which they are operating and their own circumstances. For example, health-tech and telemedicine could potentially see a fair amount of M&A activity, as well as E-commerce and consumer technology. On the other hand, aviation, hospitality, and financial services are likely to see less.
Recent Government divestments may be a continued trend given the financial constraints of the economic crisis. FDI has contracted in India, though this is a global theme of governments protecting national interests and domestic companies first and foremost. On the other hand, geopolitical tensions with China could also be impactful. Any disagreement or trade ban with a major economy will have an impact on any economy. Moreover, India has a great degree of trade and FDI from China.
Some sectors are likely to be more impacted, such as antibiotics and electric products, that are heavily dependent on trade. As a result, sectors already damaged due to the pandemic could find themselves worse off, and prices could increase for consumers as a result.
Understanding where liability lies is crucial for buyers. Disruption to diligence work constrained by the lockdown, such as accessing sites and physical meetings, has contributed to the slowdown. Therefore, buyers and sellers will need to adapt to provide sufficient diligence so that buyers are comfortable.
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