Wish-List for a Fiscal Response to Covid-19

24 MARCH 2020

Citi analysts have revised India’s FY21 real GDP growth estimate to 5.5% YoY, down 40bps, with risks tilted towards the downside. Expanding impact of Covid-19 has shifted the risks from supply bottlenecks to a dwindling (domestic & global) demand issue. Citi analysts believe that travel restrictions, domestic disruptions (closure of cinema halls etc.) and health related risk aversion may affect service sector activity as well and keep core prices low. Citi analysts expect headline inflation to fall below 6% YoY by next month and drift below 5% in June.

Around ~40 central banks across the globe cut lending rates last week, while the RBI took several measures to provide adequate liquidity to the foreign exchange market. Amid a string of supportive stimulus from governments around the world, fiscal policy response in India has been relatively muted thus far. Threats of a global recession, stressed financial markets and weak domestic demand growth may call for a sizable, targeted and timely stimulus in Citi analyst’s view.

They now believe that the FRMB restrictions may have to be temporarily set aside, similar to the post-GFC period when fiscal deficit rose from 2.6% of GDP to 6.1% in just one year following a slew of stimulus measures.

Wish-List for Fiscal Stimulus:

  • Enhanced budgetary allocation for spending on healthcare.
  • Direct cash transfer to daily wage earners in industries like construction, travel etc. affected by the lockdowns.
  • Temporary postponement of taxes and cheap loans for travel and tourism sector (9.2% of India’s GDP) that has experienced the maximum brunt of the slowdown.
  • Cheap credit lines to MSMEs which have suffered from a rapidly deteriorating near-term business outlook.
  • Temporary GST cut to help consumers hit by extremely low sentiment and negative wealth effect.
  • Temporary suspension of LTCG tax to encourage flows back into the equity markets.
  • Frontloading of public spending, directing state/local bodies to purchase public transport vehicles and a scrappage policy for commercial vehicles may be among measures to be considered.

*Non-bank credit covers CPs and Corp. bonds. Source: RBI, SEBI, CEIC, Citi Research, Bloomberg

With Citi analyst’s average Brent price forecast revised down to USD 26/bbl for FY21, the total windfall for India could be ~INR 2.8tn (1.3% of GDP). Following the recent INR 3/liter increase, the total excise duty on petrol has reached a new high of INR 23/liter. Citi analysts believe that it is critical to pass on some of the benefit of lower crude prices to consumers hit by negative income shock and depressed sentiment.

While the RBI has taken significant steps like additional rounds of LTRO, FX swaps and sovereign bond purchases to support the INR and provide liquidity, spreads have widened considerably in the corporate bond and commercial paper markets. Citi analysts expect 25-50bps rate cut in April or earlier in case of material worsening of the situation. They expect the RBI to try and keep the 10yr G-sec yield below 6% through direct actions.

Fixed Income investors may continue to prefer high credit quality, short duration funds and remain diversified in their portfolios. Fixed Income investors with higher risk appetite may also look at allocating to dynamic bond funds having high credit quality portfolios.

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