‘Self-Reliant India’ package: Economy needs more demand-side measure

Published: May 20, 2020 5:15:22 AM

Expect RBI to cut the reverse repo rate by 75bps by October, and purchase $75bn of G-Secs via OMOs or bidding at primary auctions

We estimate that each month of lockdown shaves off 100-200bps from headline growth. We estimate that each month of lockdown shaves off 100-200bps from headline growth.

By Aastha Gudwani & Indranil Sen Gupta

As India braced for lockdown 4.0, with total Covid cases crossing 100,000 (run rate now at ~5,000 cases a day), details of the ‘Self-Reliant India’ package that PM Modi announced in the run-up to lockdown 4.0 were keenly awaited. In five parts, the finance minister, laid out the details of the Rs 20 lakh crore (10% of GDP) economic package (fiscal + monetary), focusing on a broad range of sectors, ranging from agriculture to defence, MSME to NBFC, rural employment, migrant workers, urban poor, rental housing, space atomic energy, etc. We laud these measures and expect them to push India’s potential growth up in the medium term. However, given that the current outlay for these measures amounts to Rs 4 lakh crore (1.1% of GDP, BofAe, see graphic), we see growth falling to -0.1% in FY21. We expect the Reserve Bank of India to follow up the announced measures with further monetary easing.

Details of the package
Reforms in agriculture, mining, power and industry, higher foreign direct investment (FDI) in defence, and opening up of strategic sectors to private enterprises should help push up growth over time. Most of the measures announced are in the right direction, but the focus is largely on supply-side reforms. Demand-stimulating measures that are currently needed to ward off the Covid-19 shock were rather limited. Thus, in the near term, GDP will likely contract by 12% in the June quarter, and by 0.1% in FY21 (see graphic). This assumes the national lockdown is extended to June (with some relaxations), with the restart taking up to mid-August. We estimate that each month of lockdown shaves off 100-200bps from headline growth. Moreover, given migrant labour dislocation, we expect the restart to be quite patchy, shaving off about 120bps. In response, we expect the RBI MPC to cut the reverse repo rate by 75bps to 3% by October (lower than the previous cyclical low of 3.25%) atop the 115bps cuts announced since March.

The stimulus package was announced in tranches, and included measures such as creation of an agriculture infrastructure fund (0.5% of GDP), liberalisation of agriculture produce marketing, raising allocation to MGNREGS by 0.2% of GDP, and extension of Kisan credit cards (by 1% of GDP). The ministry of finance (MoF) has also liberalised investments in mining and defence (by raising the FDI cap to 74% from 49%). It will also strategise to push up investment in champion sectors, and open up strategic sectors to private players. A large part of the measures announced revolves around access to credit, adequate liquidity, government guarantees, etc. Notably, of the total Rs 20 lakh crore, RBI’s measures are expected to provide Rs 8 lakh crore (3.8% of GDP). We estimate the cash outgo associated with these measures by the Centre at Rs 2.4 lakh crore (1.1% of GDP). We believe the additional borrowing announced previously should help fund this.

Thus, we maintain our FY21 growth forecast of -0.1% of GDP. We do see a downside risk to this estimate, should the lockdown be extended further. Also, we have cut our 2020 global GDP forecast to -3.1% from -2.7% earlier.

What more to expect?
Given a large part of the measures were focused on revival, we think some demand-side measures are still needed. We expect the following to be announced:
Subvention: We expect MoF to offer interest rate subsidy for SMEs and real estate
Issuance of PSU bonds of 0.5% of GDP to fund capex.
Recapitalisation of PSBs via non-fiscal levers like re-cap of bonds, and use of RBI revaluation reserves
We also expect RBI to follow up with measures such as:
75bps RBI reverse repo rate cut to 3% by October, with inflation set to slip to 2.5% in 2HFY21 (see graphic).
Purchase of G-secs of $75bn via OMOs or bidding at primary auctions, to fund the Centre’s additional borrowing of 2% of GDP and the consolidated fiscal deficit of 10% of GDP
Giving banks the assurance of held to maturity facility to incentivise them to invest their surplus in G-secs at low yields to offset future mark-to-market hit. Banks could invest, say, Rs 2 lakh crore/0.9% of GDP of their Rs 8 lakh crore money-market surplus to fund higher issuance. As the blended cost of funds is about 5%, a bank may prefer to buy, say, a 10y with a coupon of 6%, instead of parking its surplus at 3.75% RBI reverse repo. At the same time, it loses Rs 7.1 if the 10y yield goes up by 100bps to 7%.
We continue to expect RBI to sell $50bn of FX to support the rupee.

Edited excerpts from BofA Global Research’s Self-reliant India stimulus–10% of GDP, 1.1% fiscal
impact (May 18, 2020)

Gudwani is India Economist & Sen Gupta is Chief India Economist, BofA Merill Lynch. Views are personal

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