Stimulus 2.0 won’t change outlook for business
The much-awaited second stimulus package has come. Never mind the headline figures. The cumulative extra fiscal stimulus delivered thus far is well within the limit of fiscal prudence. The not-so-good part is that the extra stimulus is unlikely to make much of a difference to the outlook for business.
A second stimulus was clearly on. The expectation earlier was that a stringent lockdown would help bring the virus under control and pave the way for an early return to normalcy. If normalcy returned soon, we could get by with a relatively small stimulus.
These expectations have since been belied. Fifty days from the commencement of the lockdown, it is clear that the climb-back to normal is going to be a long drawn-out affair — and in this, India is not unique. It follows that the economic costs will be higher than supposed earlier. It also follows that a top-up to the first stimulus was required.
The headline figure of ~20 trillion seems to include the fiscal and monetary stimulus imparted thus far as well as the stimulus to come.
In estimating the fiscal cost of the second stimulus, one cannot go by the nominal value of guarantees. It’s the conversion into cash outflows that matters.
Making reasonable assumptions about losses on guarantees (such as 20 per cent of the micro, small and medium enterprises, or MSME, loan guarantee turning into non-performing assets), the fiscal cost of the second stimulus amounts to about ~60,000 crore, or 0.3 per cent of gross domestic product (GDP). Of the initial stimulus of 0.8 per cent of GDP, the additional amount over what had been budgeted earlier was about 0.5 per cent of GDP. The two rounds of stimulus thus add up to a very modest 0.8 per cent of GDP. The rating agencies will not take fright.
One omission in the latest package is glaring.
The package in March included a combination of additional provision of foodgrain, cooking gas and cash transfer to the vulnerable for three months. This needs to be extended for another three months. (At the time of going to press, relief for migrant labour had been announced).
The second package focuses mostly on support to businesses, especially MSMES. The centrepiece is a ~3-trillion guarantee for loans to MSMES. Total outstanding credit to MSMES is around ~16 trillion. The loan guarantee would amount to growth of about 20 per cent in credit.
However, the outstanding credit is based on the earlier definitions for each constituent of MSMES. Using the new definitions, the guarantee may translate into incremental credit of no more than 10 per cent.
More credit is useful and may help MSMES that lack access to bank capital. But two other elements are more crucial at this point. One, an extension of interest and term loan repayment moratorium for another three months. This is needed to support cash flows and payment of wages at MSMES. Two, restructuring of loans that would otherwise turn into NPAS. It is for banks to decide in which cases an extension of moratorium suffices and which cases require restructuring. For extension of loan moratorium, provisions will have to be higher than the 10 per cent stipulated for the three-month moratorium.
In January 2019, the Reserve Bank of India (RBI) had announced a one-time restructuring of MSME loans up to ~25 crore, which has since been extended up to December 31, 2020. Banks were required to make a provision of 5 per cent on top of the provisions already made. The scheme needs to be extended for another year. The exposure limit for restructuring of MSME loans as well as provisioning needs to be enhanced. The government must compensate public sector banks for additional provisions by infusing the necessary capital into them.
If the finance minister ’s intention was to leave these two elements of support to the RBI, she might have indicated as much in her announcement and made a suitable provision for bank recapitalisation. Credit guarantee alone cannot help MSMES tide over the present challenges. The provision of ~10,000 crore for a fund of funds for MSMES means little when funds for MSMES have hardly taken off. It is also doubtful whether there will be enthusiasm among banks for infusing ~20,000 crore of subordinated debt into MSMES against a partial credit guarantee.
The latest package includes a liquidity scheme of ~30,000 crore, with a full guarantee from government, and a partial guarantee scheme of ~45,000 crore for non-banking financial companies (NBFCS), housing finance companies and microfinance institutions. The idea is to encourage financial institutions to invest in government-guaranteed bonds and commercial papers of NBFCS and others. This may help them deal with the immediate liquidity problem but it does not change the longer term outlook.
Neither the size nor the design of the second package will rouse animal spirits. The government may be counting on land, labour and other reforms to unleash a wave of new investment. For existing businesses, however, the outlook remains sombre.
In opting for a more stringent lockdown than elsewhere, Prime Minister Narendra Modi has chosen to disregard the counsel of much of the commentariat. His predilection for a modest fiscal stimulus goes counter to the prescriptions of many economists. In dealing with a crisis that has no precedent in independent India, it would appear that he has preferred to be guided by feedback from the ground, the inputs of a trusted group of bureaucrats and the political instincts that have served him so well thus far. The Gujarat model of governance seems well ensconced in Mr Modi’s second term as prime minister.