Economy doctors’ COVID-19 prescription

Economists Montek Singh Ahluwalia, C Rangarajan, and Pronab Sen had played a pivotal role in fixing the 2008-09 crisis. They say the current crisis is different from the one a decade ago and requires a different set of prescriptions. INDIVJAL DHASMANA fin

BUSINESS ALSO NEEDS TO BE SUPPORTED BY EXPANDING CREDIT AND REGULATORY FORBEARANCE... THE FOCUS OF FISCAL, MONETARY AND CREDIT POLICY MUST BE TO LIMIT DAMAGE THE POLICY RATE NEEDS TO BE BROUGHT DOWN. BUT PLEASE REMEMBER THAT IT IS A DOUBLE-EDGED SWORD... LIQUIDITY MANAGEMENT SHOULD BE CLEARLY THE RESERVE BANK’S FIRST STEP. THERE SHOULD NOT BE A SHORTAGE OF CASH

We are facing a health emergency that also has serious economic effects. It is unprecedented and so there is no rule book.

The first priority has to be health and since there isn’t yet a vaccine or curative therapy, the only way of avoiding massive infections is lockdowns and social distancing. This will be disruptive. We do not really know how long this disruption will last. But it is bound to spill over beyond the end of March.

The economy was limping even before the crisis and it will now do much worse. The usual source of information about the global economy is the International Monetary Fund. It has not updated its somewhat upbeat forecast made in January before the pandemic but independent analysts now project negative growth for the world for two quarters at least.

The highly adverse negative global environment will depress our performance. To this we have to add the domestic disruption from lockdowns and loss of income and uncertainty about the future … we can try to start recovering in the third quarter of 2020-21.

Health will involve more expenditure and the Central government has to help the states. We need to take steps to expand social security to help informalsector workers who will lose jobs and income. Business also needs to be supported through credit expansion and regulatory forbearance. Otherwise, there will be a string of bankruptcies, which would be a system failure.

The fiscal deficit will exceed the Budget target not just because of additional health expenditure but because revenues will fall short, with GDP growth being very low. We can worry about bringing the deficit under control through a credible medium-term strategy once the downturn is arrested. For the present, the focus of fiscal, monetary and credit policy must be to limit damage.

Hopefully the group under the finance minister, working along with the RBI, will come up with concrete proposals very soon. T he 2008-09 crisis was a typical economic crisis. It started with the collapse of financial institutions, then it affected the overall economic situation and it engulfed the world, including India. Currently, external demand is falling, domestic demand is going down, and there are disruptions to the supply chain. It is here that the RBI and the government should take the measures.

A) Reserve Bank of India

i) Banks will face a situation in which repayments of loans will be delayed and so a certain amount of regulatory forbearance becomes necessary. This can be in terms of relaxing the rules of what constitute non-performing assets (NPAS). Incomerecognition norms need to be relaxed. This must apply to bank loans to all sectors and all sizes, not only micro, small and medium enterprises (MSMES) but also large companies.

ii) The RBI must supply more liquidity to the banking system. It has already taken some steps. Besides open-market operations, it has started long-term repos. In 2008, the US Fed bought corporate bonds. That is not permitted in India. But banks are holding government securities. So it is possible for them through open-market operations and other standard techniques to provide additional liquidity to the banking system.

iii) The policy rate needs to be brought down. But it is a double-edged sword. Some people are dependent on interest income on deposits.

B) Government i) It must incur all expenditure necessary to combat the virus — expenditures for testing not only in government hospitals but also private ones. There should be additional isolation wards in hospitals, arrangements for more masks, sanitizers, etc. It should also incur the cost of importing equipment for testing.

ii) There are industries that are particularly affected — travel, transport, hospitality, etc. Some help needs to be provided to them. The government must defer dues such as excise duty and licence fees.

iii) Advice should go from the government that businesses should not retrench workers, which it has done. But certainly some people will be thrown out of employment. There should be cash transfer. Some state governments are doing it. The government should do what it does at the time of drought and flood. In collaboration with non-government organisations, it should provide basic amenities like food and clothing and certain other things. T he 2008-09 crisis originated essentially in the financial sector but it affected global trade — the second part is very similar to what is happening currently. However, within the country we were relatively insulated then. So, most of the losses we took in terms of GDP growth came from exports that time. Generally, it is believed that exports constitute 20 per cent of GDP. But this is not correct. Exports are in the manufacturing sector so you should look at value added; this comes to about 5 per cent of GDP. What we are looking at now is that because you have restrictions on everything other than essentials, you are looking at industry, which is closed and constitutes 15-20 per cent of GDP. So, the effect of the crisis on GDP is much larger now than in 2008-09. And then second-round effect is going to be there in the way which was also there in the earlier crisis.

The kind of V-shaped recovery we had in the aftermath of the earlier crisis was because of the demand the government pumped in through fiscal measures. Now, the hit you are essentially witnessing is the supply-side problem because you are forcing industry to simply shut shop. So a demand boost would not really solve the problem. In fact, nothing is going to happen until the contagion is checked. The only thing we can now do is to focus on the income hit that has taken place.

The requirement of cash will not go down. You and I can buy essentials through the credit or debit card, but not all. So liquidity management should be clearly the RBI’S first step.

The second issue is force majeure. You have essentially asked industries to shut shop. Their revenue flow has come to a stop. Unless industries have large retained earnings on their balance sheets, they will simply not be able to service their debts. It is extremely important for the RBI to go for forbearance of asset recognition, and hold it off till it starts counting again. The RBI should keep it open-ended and not classify any assets as NPAS. It should re-set the zero date from which the clock will again start ticking. It will lead to lots of pressure on banks because they will have to pay interest on deposits but will not be able to earn interest on a very large chunk of their assets. Eventually, the government, through fiscal measures, will have to pump money into the banking system.