In the years after the Second World War, financial crises were frequent. But the current contagion has thrown many countries off guard. There is little or no experience to guide countries on how to tackle such an epidemic. The only alternative, widely adopted now, has been to suspend business as usual and coerce citizenry to recede into the safety of their homes. Unfortunately and expectedly, the suspension of economic activity has scathed sections of the economy and the call to resuscitate the economy must be cognisant of these costs.
It needs no expert to spell out that the shutdown of operations will have serious economic ramifications. However, what remains unknown is the length and the extent of the slowdown. Considering that companies make their production and sales decisions in anticipation, order books of companies may in fact be more severely hit in second quarter of the financial year 2020-21. This has a serious implication for businesses. Large corporations with financial flexibility stemming from internal resources, reserves and access to capital markets may tide over the present liquidity strain as well as shift lines of production with relative ease. Some companies may in fact turn to corporate debt market. However, for companies that cannot access such markets, and the lack of investors can create financial stress. On the other hand, small firms that have wailed for assistance since the implementation of GST will have to go through another round of re-organisation.
A moratorium on repayments announced by the finance minister may be a mild relief considering that supply chains interlink cash flows across businesses. Operational creditors strapped for cash may be compelled to trigger insolvency. The OECD in its latest report suggests that the contagion in corporate credit markets has begun to impact the solvency of businesses across the affected countries. This risk may not be far for India, as result it may further strain the banking system. While India has raised the threshold of default under IBC, it may be useful to suspend its application for a brief period, particularly since establishing a price for stressed assets is difficult. Germany, Turkey and Netherlands for example have imposed a stay on obligation to file for insolvency, while Italy has provided SMEs moratorium. Simultaneously, to keep businesses from going under, liquidity must be provided to small businesses under financial stress. In India, MSMEs have a longer debt turnover as compared to their credit turnover, making them more susceptible to financial stress. Unless such relief is made available, small businesses may be squeezed out resulting in greater dominance by few large players — this is already being observed in many sectors such as IT and Pharma in India.
The crevice in the labour force is also now more apparent. While there are sectors where services can be rendered remotely, allowing continuity of work, a large population remains stranded. Over the last few years many economists have pointed to the growing prevalence of contractualisation of labour force in the Indian economy. In 2015-16, the share of contract workers in labour force is estimated to be more than a third in the organised sector. The strain on sectors, particularly those unorganised, may prove catastrophic for contractual workers.
While economy grapples with the lockdown, stock markets continue as usual amid a major sell off thus triggering circuit breakers twice in India and thrice in US over a short span of two weeks. This begs the question of price discovery by stock markets amid exceptional circumstances. In response to this, countries such as France, Italy and Belgium have implemented a ban on short-selling in locally listed stocks. However, SEBI followed suit to the extent of imposing restricting on the position limits in derivatives. An important participant in the Indian capital market has been the foreign investors. India relies on investment inflows for its balance of payments and much of its currency movements are affected by portfolio flows. Assets under the custody of FPI declined by 14 per cent between February and March 2020. This was accompanied by a significant reduction in inflows from Mauritius. The decline in FPI inflows this financial year however has not been exceptional. Further, oil prices are now at their lowest since 1999. Around 14 per cent of India’s exports are petroleum and 25 per cent of imports comprise of oil. The decline in oil prices and demand can leave the trade balance unaffected. Yet, seemingly in anticipation of further pressure on the currency, in March, investors from Mauritius, currently on the FATF grey list, were allowed to invest in the country through category I. A country is put on the grey list for having strategic deficiencies in countering money laundering and terrorist finance. This along with the recent ban on FDI from China through the automatic route can create an opportunity for regulatory arbitrage. It is therefore important to revisit such laws when the economy returns to normalcy.
Finally, the pandemic has re-established the primacy of government, where citizens ordinarily advocating free market are now urging the governments to open up its coffers. To all those asking for relief, the moot point remains what is the size of the government they prefer. There is no doubt that the lockdown was necessary, particularly so, given the unequal access to healthcare. Its cost can only be compared with the counterfactual — its delay. Thus we must desist from gazing at the crystal ball, predicting growth outcomes, and instead, estimate the cost wisely. It is also an opportunity to identify and address inequalities that the government must address by extending its resources to the economically weaker sections of society than offer sops to those who can withstand. The government is now confronted with a choice — given co-ordinated expansionary fiscal policy pursued across the globe — monetary policy must support India’s fiscal obligations.
The writer is assistant professor, NIPFP