Markets looking forward to bailout

But the currency could take a hit if rating agencies respond unfavourably

The latest Purchasing Managers’ Index (PMI) numbers led to panic in the retail investment community. It is worthwhile explaining PMI. The PMIs are surveys. Senior business executives in various sectors are asked if there’s an improvement, a deterioration, or no change in business conditions, compared to a month ago. 

Responses are normalised on a scale of 0-100 where any number above 50 represents expansion, 50 is equilibrium, and anything below 50 is contraction. These responses are sub-divided into Services and Manu­facturing to create two sector indices.  

So, the PMI is a month-over-month sentiment indicator. Any number over 50 indicates senior managers think there’s expansion. His­torically PMI has a strong positive correlation to real economic conditions. 

But each manager is seeing only a little slice of the economy as it affects his company. There is no weighting given to the managers of big companies versus small companies. Similarly, there’s no excess weighting given to Services versus Manufac­turing, although the former contributes far more to gross domestic product (GDP). 

So, you could have, say, three managers who control a total of 20 per cent market share claiming expansion, while one who controls 40 per cent market share claims contraction. In such a case, the PMI would be misleading. But if the respondent list is well-curated, such anomalies should even out. 

Given that PMI is a sentiment indicator, an April reading of 5.4 (Services) and a reading of 27.4 (Manufacturing) are both unsurprising. It just means almost all respondents saw a contraction in April, compared to March. Since April was a complete shutdown this was expected, since the first 20 days of March were close to normal. The shutdown in the last ten days of March did have a negative impact also since March PMIs indicated contraction compared to February. 

So, the PMIs say nothing we did not already know. Looking at April high-speed indicators, ICRA estima­tes power consumption fell by about 22 per cent. Importantly, this would have been high-tariff industrial consumers who were in shutdown. This means earnings for power companies dropped by much more since industrial power tariffs are several times higher than household tariffs. 

There are also estimates that sales of diesel fell by 25 per cent, which sounds plausible. We don’t have volume data for April 2020 petro-imports but the price of the crude basket fell to $19.9 per barrel versus $34 in March. Railway freight movements also dropped by 35 per cent in April 2020 versus April 2019, with earnings down 37 per cent (excluding NTPC and Concor). 

The transport crunch should ease now. But discoms (mostly state-run) would have sustained huge losses and that cash crunch will sustain into mid-May at least. Hence discoms may not be able to clear dues with power generators. Down the line, generators may not be able to pay coal suppliers (that is, Coal India) and solar equipment manufacturers, etc., would also see dues mounting up. The power sector has already contributed large non-performing assets (NPAs) and we may see a rising trend here again. 

It’s not just power, of course. The financial sector is going to be an area of major concern since NPAs will rise in all directions. The stresses of the lockdown have already led to downgrades of several public-sector banks. Fintech companies and non-banking financial companies (NBFCs) are also under the gun. There’s a real chance of retail defaults jumping multi-fold in the aftermath of the crash. The moratorium kicks the problem just a little further down the road. 

It’s hard to see a revival in demand if banks cannot extend credit either to corporates or retail customers. Under similar circumstances, the US Federal Reserve, the US Treasury Department, the European Central Bank and the Bank of Japan all took desperate bailout measures in 2008 and 2013. The Quantitative Easing (QE) programmes from central banks allowed commercial banks to lend because the central bank was willing to pick up potentially risky paper from them. The US Treasury De­partment also bought toxic assets at discounts during the subprime crisis. 

The RBI could try something similar. It has already opened a special window for debt mutual funds. The danger is, there could be a sharp drop in the value of the rupee if the rating agencies respond unfavourably to any QE. But some such scheme — call it what you will — may be the best option. A lot of sentiment is riding on expectations of a bailout.