Motilal Oswal Financial Services

17 March 2020

COPE

The Economy Observer

Can Coronavirus help achieve long-pending structural changes?

RBI should resist cuts in policy interest rates



As the Coronavirus (COVID-19) rampages its way across the world, the US Federal Reserve, along with several other

major Central Banks such as the European Central Bank (ECB) and the Bank of England (BoE), have cut interest rates to

an all-time low, complementing it further with quantitative easing (QE). The President of the US has declared national

emergency and Italy – the world’s 8th largest economy – has expanded its quarantine to the entire country.

Accordingly, global financial markets are in turmoil and crude oil prices have crashed, raising the debate on whether the

RBI should cut rates. In a press conference on 16 Mar’20, the RBI Governor, Mr. Shaktikanta Das, announced another

USD/INR swap and additional LTROs worth INR1t. However, in line with our hopes, the RBI did not succumb to pressure

and resisted rate cuts. We believe that the monetary policy is highly inappropriate to address the supply-side

disruptions caused by COVID-19; instead, targeted short-term/temporary macro-prudential measures for affected

sectors/industries will certainly be more effective.

Additionally, we argue that COVID-19 presents an opportunity to implement some long-pending structural changes in

the country, which would go a long way in improving our economic strength. In this note, we discuss (a) How

historically an epidemic/pandemic helped bring about structural economic changes, and (b) What sort of structural

changes could be adopted in the Indian economy today?

Overall, the adverse economic effects of COVID-19 are unavoidable. Moreover, the regulators must also ensure that

whatever support is provided – to mitigate the impact – is not only temporary but also highly short-term in nature.

Interest rate cuts, therefore, must be resisted and any fiscal response should be extremely targeted and quickly

reversible.

COVID-19 has spread its reach to almost the entire world economy. The US Fed

reduced its policy interest rates by as much as 1.5pp this month and also announced

large bond-buying program as well. The ECB and the BoE followed suit along with

several other Central Banks in the world. Further, Mr. Donald Trump has declared

national emergency, many top educational institutes in the US have shifted to online

classes and Europe is now the epicenter of COVID-19. Accordingly, the US 10-year

bond yield is trading comfortably below 1% currently, global equity markets have

plunged and crude oil prices have crashed to about USD30/bbl. In this backdrop, a

debate has emerged on whether the RBI should also reduce interest rates or a

general fiscal stimulus should be announced?

Monetary policy is highly

inappropriate to address

the supply-side disruptions

caused by COVID-19;

however, targeted short-

term/temporary macro-

prudential measures for

affected sectors/industries

will be certainly more

effective.

Since the US Fed Chairman has already clarified that rate cuts will do nothing to

address the supply-side distortions led by Coronavirus, there is not much to add on

the (in)effectiveness of monetary easing in the face of current risks. We believe that

the RBI’s move to ensure ample liquidity on 16

Mar’20 was right. The RBI

announced another round of USD/INR swap and additional LTROs worth INR1t,

however, it resisted cutting rates. Further, we expect the Monetary Policy

Committee (MPC) to resist cutting rates next month as well, since rate cuts are

neither short-term nor targeted in nature. Further, there exists many other

fundamental reasons (discussed

here)

to resist sharp monetary easing in the Indian

economy. In a nutshell, we believe that monetary policy is highly inappropriate to

address the supply-side disruptions caused by COVID-19; however, targeted short-

term/temporary macro-prudential measures for affected sectors/industries will be

certainly more effective.

Nikhil Gupta – Research Analyst

(Nikhil.Gupta@MotilalOswal.com); +91 22 6129 1555

Yaswi Agarwal

– Research Analyst

(Yaswi.Agarwal@motilaloswal.com); +91 22 7193 4196

Investors are advised to refer through important disclosures made at the last page of the Research Report.

Motilal Oswal research is available on www.motilaloswal.com/Institutional-Equities, Bloomberg, Thomson Reuters, Factset and S&P Capital.

Additionally, we argue that COVID-19 presents an opportunity to implement some

long-pending structural changes in the country, which would go a long way in

improving our economic strength. In this note, we discuss (a) How historically an

epidemic/ pandemic helped bring about structural economic changes, and (b) What

sort of structural changes could be adopted in the Indian economy today?

How can an epidemic help bring about structural changes in an economy?

Let us consider two examples from history, which will help us to understand how

epidemics can help lead to structural changes in the economy.

“The Black Death” led to

the divergence between

Western and Eastern

Europe, which has

continued and probably

intensified, during the past

seven centuries as well.

In the mid-14

century, the bubonic plague called

“The Black Death”

swept entire

Europe. Wherever it hit, it killed almost half the population. In 1348, it struck

England and wiped out about half the population. The resulting massive labor

shortage shook the foundations of the feudal order and encouraged peasants to

demand that things change in their favor. After much to-and-fro, the Peasants’

Revolt broke out in 1381, after which feudal labor services dwindled away giving

way to an inclusive labor market in England. More interestingly, while the

devastating demographic effects of the plague were similar across Europe, its

economic impact was significantly different in Western Europe from Eastern Europe.

Feudalism gained traction in Eastern Europe as the lords were better organized and

revolts were crushed more brutally. Thus, began the divergence between Western

and Eastern Europe, which has continued, and probably intensified, during the past

seven centuries as well.

Almost five centuries later, a severe outbreak of cholera, called the

“Broad Street

cholera outbreak”

“Golden Square outbreak”,

hit the Soho district of the city of

Westminster, London, England in 1854 and occurred worldwide during 1846-60

(Source: Wikipedia). During similar outbreaks in 1832 and 1846, a total of 14,137

people died in England. Initially, it was concluded by the ‘Miasma theorists’ in 1851

that cholera was caused by particles in the air, which arose from decomposing

matter or other dirty organic sources; however, based on the pattern of illness

among residents, the physician John Snow believed that it was spread by an agent in

contaminated water. Through his research and elaborate investigations, Snow

established that poor filtering quality by two water companies, which drew water

from the River Thames, led to the outbreak. This discovery influenced public health

debates and led to the construction of improved sanitation facilities.

These two episodes show how massive structural changes can be brought about in

case of such epidemics. In fact, the authors Daron Acemoglu and James Robinson in

their excellent book titled

“Why nations fail”

counted

“The Black Death”

as one of

the small but critical junctures in history, which shaped the economic future of

many nations. Coronavirus was declared ‘pandemic’ by the World Health

Organization (WHO) last week and Indian authorities will do well to bring about

some massive changes.

What sort of structural changes are expected?

Two urgent changes include (a) more focus on health spending by the government,

and (b) further expansion of research and development (R&D) facilities.

The discovery of linking

cholera outbreak with

contaminated water

influenced public health

debates and led to the

construction of improved

sanitation facilities.

17 March 2020

Total spending by the

general government on the

health sector was only ~1%

of GDP in FY18 in India,

much lower than the global

average of 7.4% of GDP and

even lower than 1.3% in low

income and lower middle

income nations.

Total spending by the general government (center and states) on the health sector

was only ~1% of GDP in FY18 (year ending Mar’18) in India, much lower than the

global average of 7.4% of GDP and even lower than 1.3% in low income and lower

middle income nations

(Exhibit 1).

What’s worse is that India’s very-low government

spending on medical and public health and family welfare has been stagnant at 0.8-

1.0% of GDP during the past two decades. While the world is struggling to contain

Coronavirus, the total number of

swine flu cases

in Meerut district of Uttar Pradesh

has gone up to 71. So far, a total of more than 100 confirmed cases of COVID-19

have been reported in the country and over 4,000 contacts have been put under

surveillance.

Exhibit 1:

India’s government spending on health amongst the lowest

(% of GDP)

General government health expenditure

10.1

7.4

2.8

2.9

3.2

7.8

14.0

1.0

India

1.3

Lower

middle

1.3

Low

income

1.4

2.4

Indonesia Singapore

Middle

income

China

Upper

middle

World

OECD

India’s data for FY18 and CY2016 for all others

Source: World Bank Development Indicators (WDI), MOFSL

Compared to the global

average of 2.2% of GDP,

total R&D spending in the

world’s second most

populated nation was only

0.6% in 2015.

Further, it is imperative for any country to develop its ability in

research and

development (R&D).

India performs poorly in this segment as well. Compared to the

global average of 2.2% of GDP, total R&D spending in the world’s second most-

populated nation was only 0.6% in 2015 – only two-fifth of the average R&D spends

in middle-income nations

(Exhibit 2).

The number of researchers/m people in the

country was also amongst the lowest at 216 in India, as against the global average of

1,478 researchers/m people and the average of 775 researchers in middle-income

nations

(Exhibit 3).

Exhibit 3:

…with one of the lowest number of researchers

2.8

(Per m people)

Researchers in R&D

6,730

4,052 4,256 4,392

1,206 1,262 1,478

Exhibit 2:

R&D spending in India amongst the lowest…

(% of GDP)

R&D expenditure

2.1

1.5

0.6

1.6

1.7

2.2

2.5

0.2

179

216

775

R&D covers basic research, applied research and experimental

development.

Source: WDI, MOFSL

Researchers are professionals who conduct research and improve or

develop concepts, theories, models techniques instrumentation,

software of operational methods

17 March 2020

Crash in oil prices definitely helping Indian economy…

For an economy, which imports 80-85% of its oil demand, the crash in crude oil

prices should undoubtedly lead to a positive outcome (on net basis, even after

accounting for the second-order and third-order adverse impact). As highlighted in

our

note

published in Dec’18, lower crude oil prices have helped narrow the current

account deficit (CAD), assisted improvement in fiscal balances and/or benefitted

consumers by lowering inflation.

Exhibit 4

below summarizes the sensitivity analysis

of crude oil prices vis-à-vis various macroeconomic indicators.

Exhibit 4:

Impact of a fall in crude oil prices by $10/bbl on various macro parameters

Absolute amount



Impact



0.09% of GDP

0.06% of GDP



Comments

Assuming no change in retail

prices of LPG and kerosene

If the government retains the

windfall from the fall in oil prices

Fiscal deficit

Subsidies will fall by ~INR180b

A rise of INR1 in excise duty

will garner INR120-130b

Current

account

deficit (CAD)



Imports will fall by ~USD20b

Exports will fall by ~USD6b

Remittances will fall by $3-4b

Net impact of 0.4% of GDP

($10-11b)



Impact of lower import bill will be

partly offset by lower oil exports

and remittances



CPI inflation

A fall of USD10/bbl in crude oil

implies a fall of INR4-5/liter in

retail fuel, assuming full pass-

through. The direct weight is

4.3% in CPI

Crude oil & natural gas and

mineral oils account for

~10.4% of the Wholesale Price

Index (WPI) basket



Total impact of 50-

80bp (equally spread

between direct and

indirect impact)

A 10% hike in crude oil

price will lead to an

impact of about 150-

200bp on WPI



Assuming full pass-through (it

implies a trade-off between fiscal

windfall and consumers’ benefit)



WPI inflation



Assuming full pass-through

Source: MOFSL

…however, scope for even a small fiscal stimulus is limited

While the crash in crude oil prices will lead to a windfall, it is very clear that an

explicit fiscal stimulus is highly unlikely. In fact, many countries have announced

fiscal support and same is expected from Indian authorities. In contrast, the Indian

government decided to hike taxes on petrol and diesel by INR3/liter each on 14

Mar’20, making it clear that citizens are unlikely to gain much from the oil crash. We

have discussed our arguments regarding the inability to stimulate the economy

fiscally or the unnecessary nature of such an artificial boost in a

note

earlier.

More than half of the

central government

spending and as much as

30-50% for states is already

tied up in non-discretionary

expenditure.

Moreover, there is a dire need to increase health spending and improve the quality

of R&D facilities in India and it would not hurt to use the Coronavirus issue as a

trigger to make this happen. The problem, however, is that more than half of the

central government spending and as much as 30-50% for states is already tied up in

non-discretionary permanent expenditure

(Exhibit 5-6),

which leaves little space for

initiating these much-wanted and long-pending changes.

17 March 2020

Exhibit 5:

More than 50% of center’s spending tied in SIPS…

S&W

54.2

13.8

5.5

20.8

50.4

Interest

Pensions

Subsidies

SIPS

57.5 57.1 58.1 57.5 56.8 56.4 56.4

10.5

18.2 16.3 15.5 14.7 11.9 11.1

6.7 6.2 6.3

4.8 5.6 5.4

4.9

Exhibit 6:

… which account for ~44% for all states as well

SIP (% of total spending)

43.8

45.8

42.5

28.6

29.2

47.6 49.0 47.8

36.9

44.9

47.8

53.9

14.5 16.7

4.8

4.7

24.2 24.7 24.3 24.7 25.2

20.9 22.2 24.0

19.5

14.1 11.6 11.6 12.1

12.0

12.7 12.7 13.9 14.3 14.3

FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19

Data as % of total spending of the central government

SIPS = Salary, Interest payments, Pension and subsidies

All# AP#

KA MP# MH#

Data on subsidy not included for states

# Data for FY18; FY19 otherwise

Source: Reserve Bank of India (RBI), Budget documents, MOFSL

Rather than handing out guaranteed annual income to farmers and subsidies to all

sections of the society, it makes exponentially more sense to improve the quality of

social investments on structural basis.

Monetary easing inappropriate to address supply-side issues…

Since various major Central Banks of the world have announced sharp rate cuts and

quantitative easing in the wake of COVID-19, similar monetary easing was expected

from the RBI. However, in a press conference on 16

Mar’20, the RBI Governor, Mr.

Shaktikanta Das, disappointed the financial markets by choosing to resist rate cuts.

In fact, he announced two other measures to ensure ample liquidity in the system –

another round of USD/INR swap and additional LTROs worth INR1t. The USD/INR

swap is expected to provide liquidity to the forex markets in the short-term and the

LTROs should ensure sufficient domestic liquidity, in continuation to what was

announced in the last monetary policy in Feb’20. We are also in total sync with the

RBI’s move and expect the MPC to also resist rate cuts next month, since rate cuts

are neither short-term nor targeted in nature.

Further, we have already

discussed

our fundamental reasons against the massive

monetary easing in the country. A major differentiating factor between the

slowdown in India v/s the slowdown globally is that domestic savings (in particular,

household savings) have declined in India, while it has risen in most developed

economies. Even if one argues that lower physical savings (or real estate

investment) is the key reason for declining domestic savings in India, it is amply clear

that other structural reforms – including

lower residential real estate prices

– play a

much more important role in driving sustainably higher growth.

With the weakening INR,

lower policy interest rates

will further add to the

misery of foreign investors,

which is unwarranted.

We are in total sync with

the RBI’s move on 16

Mar’20 and expect the MPC

to also resist rate cuts next

month, since rate cuts are

neither short-term nor

targeted in nature.

Moreover, with the global risk-off situation, foreign portfolio investors (FPIs) have

withdrawn over USD7b in the first 10 trading sessions of Mar’20, resulting in >3%

weakening of the INR (toward 74 against the USD). With the weakening INR, lower

policy interest rates will further add to the misery of foreign investors, which is

unwarranted. Consequently, at this stage, the arguments for rate cuts have become

weak.

17 March 2020

Interestingly, a debate on the RBI participating in a globally coordinated action is

also misplaced considering the fact that the Indian economy needs foreign capital to

fund its current account deficit (CAD). Further, since India’s headline inflation is

expected to remain at 5-6% for

at least

the next 6 months (without incorporating

the adverse impact of COVID-19), rapid INR depreciation must also be avoided. In

any case, on the back of the global financial turmoil and the RBI’s LTROs, the 10-year

benchmark bond yield has declined toward 6.25% during the fortnight.

…but targeted short-term macro-prudential measures would be more effective

In a nutshell, we believe that the monetary policy is highly inappropriate to address

the supply-side disruptions caused by COVID-19; however, targeted short-

term/temporary macro-prudential measures for affected sectors/industries will

certainly be more effective.

Overall, it is totally incomprehensible as to how a rate cut or blanket monetary

easing would help contain the economic effects of COVID-19. Moreover, while small

targeted fiscal stimulus may be more effective, the adverse economic effects of

COVID-19 are unavoidable. If some sections are strained and production cuts are

hurting the employers or any industry, the targeted macro-prudential measures

would be the best suited.

The regulators must also

ensure that whatever

support is provided – to

mitigate the impact – is not

only temporary but also

highly short-term in nature.

The regulators must also ensure that whatever support is provided – to mitigate the

impact – is not only temporary but also highly short-term in nature. Interest rate

cuts, therefore, must be resisted and any fiscal response should be extremely

targeted and quickly reversible. It would, however, be rather useful if the economy

could use COVID-19 as an opportunity to achieve long-pending structural changes.

17 March 2020

Explanation of Investment Rating

Investment Rating

BUY

SELL

NEUTRAL

UNDER REVIEW

NOT RATED

Expected return (over 12-month)

>=15%

< - 10%

> - 10 % to 15%

Rating may undergo a change

We have forward looking estimates for the stock but we refrain from assigning recommendation

*In

case the recommendation given by the Research Analyst is inconsistent with the investment rating legend for a continuous period of 30 days, the Research Analyst shall within following 30

days take appropriate measures to make the recommendation consistent with the investment rating legend.

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17 March 2020

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Singapore Person must immediately discontinue any use of this Report and inform MOCMSPL.

Disclaimer:

The report and information contained herein is strictly confidential and meant solely for the selected recipient and may not be altered in any way, transmitted to, copied or

distributed, in part or in whole, to any other person or to the media or reproduced in any form, without prior written consent. This report and information herein is solely for informational purpose

and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments. Nothing in this report constitutes

investment, legal, accounting and tax advice or a representation that any investment or strategy is suitable or appropriate to your specific circumstances. The securities discussed and opinions

expressed in this report may not be suitable for all investors, who must make their own investment decisions, based on their own investment objectives, financial positions and needs of specific

recipient. This may not be taken in substitution for the exercise of independent judgment by any recipient. Each recipient of this document should make such investigations as it deems

necessary to arrive at an independent evaluation of an investment in the securities of companies referred to in this document (including the merits and risks involved), and should consult its

own advisors to determine the merits and risks of such an investment. The investment discussed or views expressed may not be suitable for all investors. Certain transactions -including those

involving futures, options, another derivative products as well as non-investment grade securities - involve substantial risk and are not suitable for all investors. No representation or warranty,

express or implied, is made as to the accuracy, completeness or fairness of the information and opinions contained in this document. The Disclosures of Interest Statement incorporated in this

document is provided solely to enhance the transparency and should not be treated as endorsement of the views expressed in the report. This information is subject to change without any prior

notice. The Company reserves the right to make modifications and alternations to this statement as may be required from time to time without any prior approval. MOFSL, its associates, their

directors and the employees may from time to time, effect or have effected an own account transaction in, or deal as principal or agent in or for the securities mentioned in this document. They

may perform or seek to perform investment banking or other services for, or solicit investment banking or other business from, any company referred to in this report. Each of these entities

functions as a separate, distinct and independent of each other. The recipient should take this into account before interpreting the document. This report has been prepared on the basis of

information that is already available in publicly accessible media or developed through analysis of MOFSL. The views expressed are those of the analyst, and the Company may or may not

subscribe to all the views expressed therein. This document is being supplied to you solely for your information and may not be reproduced, redistributed or passed on, directly or indirectly, to

any other person or published, copied, in whole or in part, for any purpose. This report is not directed or intended for distribution to, or use by, any person or entity who is a citizen or resident of

or located in any locality, state, country or other jurisdiction, where such distribution, publication, availability or use would be contrary to law, regulation or which would subject MOFSL to any

registration or licensing requirement within such jurisdiction. The securities described herein may or may not be eligible for sale in all jurisdictions or to certain category of investors. Persons in

whose possession this document may come are required to inform themselves of and to observe such restriction. Neither the Firm, not its directors, employees, agents or representatives shall

be liable for any damages whether direct or indirect, incidental, special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

The person accessing this information specifically agrees to exempt MOFSL or any of its affiliates or employees from, any and all responsibility/liability arising from such misuse and agrees not

to hold MOFSL or any of its affiliates or employees responsible for any such misuse and further agrees to hold MOFSL or any of its affiliates or employees free and harmless from all losses,

costs, damages, expenses that may be suffered by the person accessing this information due to any errors and delays.

Registered Office Address: Motilal Oswal Tower, Rahimtullah Sayani Road, Opposite Parel ST Depot, Prabhadevi, Mumbai-400025; Tel No.: 022 71934200/ 022-71934263; Website

www.motilaloswal.com.

CIN No.: L67190MH2005PLC153397.Correspondence Office Address: Palm Spring Centre, 2nd Floor, Palm Court Complex, New Link Road, Malad(West), Mumbai- 400 064. Tel No: 022

7188 1000.

Registration Nos.: Motilal Oswal Financial Services Limited (MOFSL)*: INZ000158836(BSE/NSE/MCX/NCDEX); CDSL and NSDL: IN-DP-16-2015; Research Analyst: INH000000412. AMFI:

ARN - 146822; Investment Adviser: INA000007100; Insurance Corporate Agent: CA0579 ;PMS:INP000006712. Motilal Oswal Asset Management Company Ltd. (MOAMC): PMS (Registration

No.: INP000000670); PMS and Mutual Funds are offered through MOAMC which is group company of MOFSL. Motilal Oswal Wealth Management Ltd. (MOWML): PMS (Registration No.:

INP000004409) is offered through MOWML, which is a group company of MOFSL. Motilal Oswal Financial Services Limited is a distributor of Mutual Funds, PMS, Fixed Deposit, Bond,

NCDs,Insurance Products and IPOs.Real Estate is offered through Motilal Oswal Real Estate Investment Advisors II Pvt. Ltd. which is a group company of MOFSL. Private Equity is offered

through Motilal Oswal Private Equity Investment Advisors Pvt. Ltd which is a group company of MOFSL. Research & Advisory services is backed by proper research. Please read the Risk

Disclosure Document prescribed by the Stock Exchanges carefully before investing. There is no assurance or guarantee of the returns. Investment in securities market is subject to market risk,

read all the related documents carefully before investing. Details of Compliance Officer: Name: Neeraj Agarwal, Email ID: na@motilaloswal.com, Contact No.:022-71881085.

* MOFSL has been amalgamated with Motilal Oswal Financial Services Limited (MOFSL) w.e.f August 21, 2018 pursuant to order dated July 30, 2018 issued by Hon'ble National Company

Law Tribunal, Mumbai Bench.

17 March 2020