17 March 2020
E
CO
S
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
th
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
th
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.
 Motilal Oswal Financial Services
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
th
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”
or
“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
2
 Motilal Oswal Financial Services
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
UK
OECD
US
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
2.2
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
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 Motilal Oswal Financial Services
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
th
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
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 Motilal Oswal Financial Services
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#
GJ
KA MP# MH#
RJ
TN
TR
UP
WB
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
th
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
th
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
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 Motilal Oswal Financial Services
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
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 Motilal Oswal Financial Services
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< - 10%
> - 10 % to 15%
Rating may undergo a change
We have forward looking estimates for the stock but we refrain from assigning recommendation
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provided to MOCMSPL by Monetary Authority of Singapore. Persons in Singapore should contact MOCMSPL in respect of any matter arising from, or in connection with this
report/publication/communication. This report is distributed solely to persons who qualify as “Institutional Investors”, of which some of whom may consist of "accredited" institutional investors
as defined in section 4A(1) of the Securities and Futures Act, Chapter 289 of Singapore (“the SFA”). Accordingly, if a Singapore person is not or ceases to be such an institutional investor, such
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
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