Bracing for a third Covid wave

Taking stock

After a period of receding case count, India’s daily caseload has risen rapidly since last month, rising to over 90,000/day as on Jan 6, 2022, from 6000-7000 in last week of December, more than a ten-fold increase. This rise is partly fuelled by the highly transmissible Omicron variant, as the country finds itself in the throes of a potential third Covid wave. The daily positivity rate ticked up to >6.0%, with the more affected states facing a double-digit pace.

Case growth is concentrated in the densely populated metro cities for now, including Mumbai, Delhi, and the states of Kerala and West Bengal. International experience suggests that hospitalisation rates and fatality, on account of the Omicron variant, remain largely under control despite the faster spread. At the same time, the variant appears to escape immunity through vaccination as well as previous infections. As India braces for a third Covid wave, over 60% of the eligible population is fully vaccinated and jabs for 15-18 years olds are underway. Booster shots are being dispensed to the elderly with co-morbidities and might be gradually expanded to the adult population in the coming months.

We recall that the second wave had seen daily cases rise from ~10k in early Feb21 to peak at 400k in May21, before returning below 10k in Nov21. Notably, the strain causing the second wave was more virulent, resulting in a spike in hospitalisation and deaths, whilst vaccination coverage was low (<5% of the eligible population had received both doses by May21).

Back to the present, while vaccinations have not lowered the scope of getting infected, the pressure on medical facilities remains low for now. In Mumbai, the number of days for doubling in cases has been falling, suggesting faster transmission, even as 90% of the active cases are asymptomatic, 9% symptomatic and 1% critical[1]. As for the hospitalisation rates, 20% of the total beds are occupied, with the occupancy of ICU beds also at a fifth in the city. While the data points to sufficient cushion, if a faster doubling of the caseload can potentially use by existing capacity. Moreover, regional variations in access to healthcare personnel, medical facilities, oxygen ventilators and critical care underscore the need for proactive action before caseloads intensify beyond the metros.


Response

The initial response to the surfacing of the Omicron variant was to tighten restrictions on international travellers/ arrivals. As the domestic caseload ticked up, curbs towards late-year were primarily targeted at end-year festivities and holidaymakers. Since then, restrictions have broadened out, with multiple states imposing a mix of weekend/night curfews, return to work-from-home for employees, partial closure of schools and lower occupancy of restaurants/ theatres etc. Ongoing political rallies ahead of state elections this quarter are feared to hasten the spread. Current high mobility levels suggest that a further rise in new cases is on the anvil, which might necessitate further curbs, albeit the risk of a nationwide lockdown is very low.

 

Economic impact

Our high-frequency gauge, DBS WAG (Weekly Activity Gauge) which captures mobility, power consumption and employment data, had surpassed pre-pandemic levels and was at a record high into late-December, fuelled by new year celebrations as well as the festive period in 4Q21.

As of early Jan, the retail and recreation mobility gauge has moderated a notch, whilst that to workplaces had already started to come off highs since after Christmas, presumably influenced by end-year holidays. As states reimpose restrictions, discretionary mobility is likely to slow, as in previous episodes.  However, the pullback might be shallower than the second wave, which was less than the first. Traffic congestion levelled off in cities like Mumbai and Delhi in early 2022.

It is early for monthly data prints to capture the trend, but indicators had begun to plateau towards late December. Passage of festivities has been softening production indicators, including core output and IIP. Composite and services PMI posted a sequential decline in December but remained in expansionary terrain. Goods and Services Tax (GST) collections remained firm above INR1trn for the sixth consecutive month, with e-way bill generation ending 2021 on a strong note. Sector-specific shortages continue to hamper the likes of auto/two-wheelers, resulting in higher inventories. Monthly lending data is beginning to show credit pick-up across sectors.

 

For FY22, we maintain our annual GDP growth forecast at 9.5%, but see risk of a modest downdrift. Having built in some downside with the fluid pandemic situation, we maintain our FY23  real GDP growth forecast at 7% (India Outlook 2022: Shifting to a higher gear). This compares with the International Monetary Fund’s FY23 projection of 8.5% and Bloomberg consensus at 7.6%. Our forecast is premised on the assumption that a potential worsening in the Covid situation is yet again met with localised curbs rather than a lockdown and that barring few contact-intensive industries – other sources of support – consumption, infra push, stronger exports, manufacturing and public spending will remain in place.  

 

Policy impact

The RBI policy commentary in Dec21 pointed to the preference for a gradual road towards policy normalisation. Guidance reinforced that the MPC’s priority is to secure growth impulses and preserve policy room to meet this objective, diverging from the global policy shifts, particularly the US Fed. Even as inflation risks were highlighted on imported pressures and volatility in food, ‘flexibility’ in the price stability mandate will see the recovery path dictate policy direction.

This hesitation, however, meets potential supply disruptions, fanning price pressures which might keep inflation on the upper end of the target range in FY23. Existing liquidity has already been repriced higher courtesy of the string of VRRR auctions, which had driven up money market/short-term rates. A follow-up increase in the reverse repo rate might be taken in February or outside of the formal reviews. With money market rates also adjusting up, any hike in the RRR is likely to be non-disruptive. In effect, this leaves sufficient flexibility for the RBI to defer adjustments in the RRR if the Covid situation deteriorates and is perceived as a fresh risk to growth. Consequently, a change in the policy stance from accommodative to neutral might also be delayed to the mid-2022 rate review. Sticky inflation and global rate adjustments prompt us to retain our call for the repo rate to be adjusted by a cumulative 50bps in 2H.

On the fiscal front, a higher caseload might prod the authorities to slow the pace of fiscal consolidation in the FY23 Budget. The need to accommodate higher spending on welfare programs might limit the budgeted reduction in the deficit to 50-60bps compared to 80bps from -6.8% of GDP in FY23. We’ll discuss the fiscal math in detail in our upcoming pre-Budget note, ahead of the FY23 Union Budget which will be tabled on 1 February.

 

Implications for markets

Notwithstanding the Omicron threat, global central banks particularly the US Fed have their eyes trained on high inflation and an improving labour market, thereby sticking with plans to withdraw from the Covid-driven ultra-accommodative policy bias. US Treasury benchmark yields rose by the strongest (daily) pace since 2009 earlier this week.

An unfavourable global environment coupled with caution over a heavy fiscal borrowing pipeline, liquidity withdrawal, rise in oil prices and lack of direct support from the central bank has driven 10Y INR yields to near 20-month highs, past 6.5%. The RBI sold INR109bn worth of government bonds in Nov-Dec21. Apart from the centre’s borrowings, states are also set to borrow a high INR3.24trn in 4QFY22 (1Q22). While we foresee limited room on the downside, some form of support via secondary market bond purchases might be forthcoming given the sharp one-sided rally in yields, which will help to cap a further near-term increase.  We are also monitoring progress on a potential INR bonds inclusion into global benchmark indices (India: Setting the stage for bond index inclusion). Our Rates Strategists latest regional report is here - Asia Rates 2022: Growth Priorities vs Fed Concerns.

For the currency, the dollar is expected to strengthen further, as the US Fed readies to raise rates. This coupled with a notable widening in India’s trade account gap sets the stage for a softer rupee trajectory in 2022. To recall, the current account balance returned to red in 2QFY22 (3Q21) to a deficit of -1.3% of GDP (US$9.6bn) vs 0.9% of GDP (US$6.5bn) in the quarter before. The key reason behind this deterioration was the widest quarterly trade deficit in over two years at -US$44.4bn vs -US$30.7bn in 1QFY, as normalisation in domestic activity and higher commodities drove imports higher, outpacing firm export earnings. With the Oct-Dec21 trade balance worsening further, 3QDFY22 (4Q21) current account deficit might be in the tune of ~3.5-3.8% of GDP. Combining the likelihood of a wider trade deficit, a higher commodity bill as well as smaller knock-on impact on economic activity from early stirrings of the Omicron variant suggest that the FY22 CAD will average -1.8% of GDP (vs our earlier forecast of -1.5%), with bias for further widening, followed by -1.9% gap in FY23.

In view of the US Fed/ G10 normalisation moves, India’s external buffers are comfortable, even as incremental FX reserve accretion has slowed down. The RBI’s FX intervention strategy is likely to be more two-sided in 2022, preventing excessive depreciation pressure on the rupee due to a firm US dollar, higher rates, and elevated commodity prices, whilst keeping in tune with the regional price action to preserve trade competitiveness and contain imported price pressures.

[1] BMC statistics, Mumbai (link)

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