Updated: March 28, 2020 10:49:41 am
Given the rapidly changing situation globally and in India, any forecasts will necessarily have a large margin of error. But at the same time, not having even a broad sense of where we are headed can create bigger problems. With that disclaimer, we estimate that the lockdown, which impairs 37 per cent of India’s total output, could shave 4 per cent from the annual GDP over 21 days.
There are several factors that are likely to make the impact on annual output worse. The national lockdown may be extended beyond April 14, and its relaxation thereafter is likely to be staggered. Further, the loss of income during this period could impair economic momentum for several quarters after that. There are challenges in the financial system too, where foreign lenders had contributed to more than a third of incremental credit in the last 12 months, but now that market is effectively shut. Slowing global growth will have its own impact on Indian exporters, as will the disruption in global supply chain caused by factories shut by quarantine rules.
On the positive side, governments across the world, including India’s, are announcing large spending programmes to protect people’s livelihoods; even if with a lag, some of the global stimulus could help India’s export demand too. Similarly, the significant monetary easing by developed market central banks is likely to make funding easier once the current market turbulence abates. The lower price of oil also helps the Indian economy.
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Unlike prior instances of economic disruption, which had a strong rebound in economic activity once restrictions were removed, much of the income lost in the current slowdown is likely to be permanent. While there may be some rebound, the drop in consumption due to lost incomes can kick-start a vicious cycle of slowing economic growth.
We may look to revive economic growth after we have the virus under control, but we must look to minimise damage now. Given that income generation has stalled, economic activity can only be sustained by digging into past savings or borrowing from the future. These can happen at the levels of individuals, firms or governments. Salaried folks are able to maintain their consumption because the firms that they work for either have cash reserves, or are able to borrow money to keep paying salaries. The self-employed are dipping into their rainy-day funds, as are the governments of Singapore and Norway: Their savings over the past decades are now being put to good use. Countries like Saudi Arabia, impacted by both the lockdowns as well as lower oil prices, are going to borrow to maintain their spending, which can then sustain their citizens.
Poor individuals do not have any buffers to dig into, and also cannot borrow easily. This is particularly true of migrant workers in urban areas: Many do not have the social networks that can help them survive the lockdown using informal credit. In rural areas they have that cushion – that India has a weak state but a strong society plays a role there; migrant workers lack this support.
The first stimulus announced by the central government, therefore, targets the poor – trying to help them stay fed and meet basic needs without having to invoke a “lives versus livelihoods” optimisation when it comes to following social distancing norms. There is an attempt to protect low-paid employees of small businesses whose jobs may have been at risk by paying their provident fund contributions. Prudently, the package also works on better utilisation of assets built up in the past – not just the excess inventory lying with the Food Corporation of India, but also allowing formal sector workers to tap into their Employees’ Provident Fund Organisation (EPFO) funds.
Subsequent stimulus announcements could help improve the survivability of small businesses, support specific industries (like airlines, travel and tourism) and keep the financial system running. Small firms are only slightly better off than unsalaried individuals, with low savings cushions and weak cash flows: The drop in incomes may affect the solvency of some, but the lack of liquidity is likely to hurt most of them. When inflows stop, fixed costs become a challenge: Other than salaries, these mostly mean rents, interest costs and utility bills. While rents are bilateral, and may be adjusted between landlords and tenants without the state having to intervene, the incessant interest rate accumulation can cause significant damage to individuals and firms. It was not surprising therefore to see the RBI announce forbearance on deferment of loan repayments for three months. But this then pushes the pain to the financial system. The regulator has also eased some norms to help with their liquidity and viability.
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The financial system has other problems too. The bond market currently shows signs of dislocation, as it is unclear which firms will survive the downturn. That this is happening globally is no solace. As foreign funding, which filled in the gap as the non-banking financial firms slowed their loan growth, has slowed too, this market needs support. Without a backstop from the government, the central bank may not be able to provide the necessary liquidity.
These steps are necessary to minimise the damage during the lockdown. A second part of government spending must kick in once normal activities resume, and losses from the lockdown have been assessed. This would be to stimulate economic growth.
Is there enough fiscal space? Just the drop in growth, shortfall in taxes, and the low likelihood of meeting disinvestment or spectrum sale targets means the central deficit could be well above the budgeted target. The central bank may need to buy bonds: something that is happening across the world. But if central banks start printing money to buy government bonds, how does one figure out the limits of fiscal spending? We believe this constraint would be an external one. If printing money to consume goes beyond a threshold, it would disturb India’s external balances and thence cause the currency to weaken. Our preliminary estimates suggest there is adequate room currently for a significantly stronger stimulus than provided thus far.
An equally important issue is inter-generational income transfer. A fourth of central government spending today is interest costs, a stark reminder that the money spent as stimulus today is money we borrow from our kids. This consideration must be balanced with the economic growth we must target to give them a brighter future. It is necessary to keep the stimulus temporary (unlike the wage increases to government employees given during 2008-09 that caused permanent damage to fiscal balances), and prioritise building assets rather than consuming.
Some observers are also concerned about what high deficits would do to India’s credit ratings. It remains to be seen how agencies respond to globally large fiscal deficits monetised by central banks; India may not be an outlier here. Further, these agencies focus on sustainability of debt, and growth, which is an integral part of that analysis, and therefore must be the policy priority.
This article first appeared in the print edition on March 28, 2020 under the title “How to minimise the damage”. The writer is co-head of Asia-Pacific Equity Strategy and India Strategist for Credit Suisse.
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