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Tuesday, January 18, 2022

The right mix for a recovery

To suppress the vicious circle of dipping demand and supply due to pandemic, fiscal interventions have to be stronger. A monetary-fiscal-exchange rate trilogy needs to be used as a toolkit of public policy.

Written by Simrit Kaur , Kamaldeep Kaur Sarna | New Delhi |
May 7, 2020 6:42:08 pm
Mumbai Police Commissioner Param Bir Singh visited Sir JJ Marg police station, which has the maximum number of Covid-19 cases in the city. Twenty seven policemen from the city have tested positive for coronavirus on Thursday.

History reveals that once in nearly every 100 years, the world has been devastated by a virulent disease. In 1720, it was the Great plague of Marseille, which claimed over a lakh lives; in 1820, it was the cholera outbreak, and the death toll was again was about a lakh; 98 years later, the Spanish flu of 1918 claimed several million lives. Now, COVID-19.

Undoubtedly, saving ourselves, our loved ones, and our societies — local and global — is the priority. Governments are adopting policies which have increased their expenditures, with a substantial dip in revenue collections. For governments and economies, these are challenging times. Estimates by the Asian Development Bank indicate that the global cost could range from $2 trillion to $4.1 trillion, which is between 2.3 per cent to 4.8 per cent of the global GDP.

The greatest challenge lies in dealing with the short-run trade-off between reducing the magnitude of the recession and flattening the pandemic’s curve. Economics and the economics of health do provide policy choices. Drastic policy interventions are the need of the hour. In the simple Keynesian framework of aggregate demand and supply, negative supply shocks induce depressed demand, which makes a firm cut back on investments, thereby depressing productivity growth. In other words, the supply-demand doom loop takes place, be it in the form of a huge decline in travel services, tourism, hospitality, oil and gas prices, automobiles, consumer goods or rising disruptions in the supply chain, unemployment, inequality, and borrowings.

Conventional policy options, such as fiscal stimuli and monetary easing remain important. The efficacy of trade policy, for obvious reasons, remains questionable under the present circumstances. Lessons from the global financial crisis of 2008 reveal that countries which embarked on greater fiscal expansion, in the form of bigger stimulus packages as a proportion of GDP, showed relatively better GDP and employment recovery after the crisis. Additionally, the time of response also mattered along with the composition of the countercyclical fiscal measures.

Unprecedented fiscal stimulus packages among G20 countries were adopted, which amounted to nearly $2 trillion (roughly 1.4 per cent of the world GDP). Of course, post the crisis, governments embarked on fiscal austerity measures due to sky-rocketing public debts and mounting fiscal deficits. For India, higher fiscal deficits were announced to counter sluggish growth in the previous year.

The COVID pandemic has necessitated further loosening of fiscal measures. As a result, the Indian government will not only miss the fiscal deficit target of 3.5 per cent, it may have to settle for something between 2 to 3 per cent points higher. The present stimulus of close to 1 per cent of GDP is inadequate, not just in absolute terms, but also relative to the global response. For instance, Japan has announced its Emergency Economic Package of around 20 per cent of GDP and the US has announced $2.3 trillion (nearly 11 per cent of GDP). Among BRIC nations, Brazil has announced a stimulus package of around 6.5 per cent of GDP, the Russian Federation about 3 per cent, and China of nearly 2.5 per cent (IMF, 2020). The case for large fiscal deficits at this point is overwhelming.

The Indian government cannot afford to shy from this measure. Paul Krugman argues in favour of sustained large, deficit-financed public investment on a continuing basis, more so because it seems that bad times will be a very frequent occurrence. While MSMEs may continue to pay their workers even for periods of no production, this cannot last long. Soon, governments will have to take up the additional responsibility of assisting these enterprises as well.

The gradual opening up of sectors with higher backward and forward linkages should be prioritised. Channelizing CSR resources towards sectors most adversely affected will have to be worked out. Extraordinary times necessitate extraordinary efforts. Policy-makers must brainstorm and provide suggestions, including “out of the box” ones. There must also be a focus on the efficacy of expenditure. Leakages, losses, and delays across policy interventions must be viewed with zero tolerance.

Adopting an expansionary monetary policy remains important as well. This is not simply to address the crowding-out effect of expansionary fiscal policy, but also for its multiplier effects. The induced increase in investment spending due to money easing expands demand, thereby creating the potential to reverse the supply-demand doom loop. However, recent evidence has shown that the efficacy of monetary policy in India has not been substantial. Though liquidity is still a concern, much-required actions have already been implemented in India.

The RBI reduced the repo rate and reverse repo rate by 75 and 90 basis points to 4.4 and 4.0 per cent respectively. Recently, the reverse repo rate was further reduced from 4.0 per cent to 3.75 per cent. Various other pump-priming measures were also announced to the extent of Rs 3.7 trillion (1.8 per cent of GDP) in the form of Long Term Repo Operations (LTRO), a Cash Reserve Ratio (CRR) cut of 100 basis points and an increase in Marginal Standing Facility to 3 per cent of the Statutory Liquidity Reserve (SLR). The central bank should keep on taking adequate steps such as the expansion of asset purchases, expanded term lending, temporary targeted measures for the hardest-hit sectors to instil confidence by easing financial conditions. This will also ensure the flow of credit and liquidity in domestic and international markets.

According to the Institute of International Finance, in March alone, record-breaking portfolio outflows of $83 billion have taken place from emerging markets. This is higher than during any recent crisis, including the financial crisis of 2008. Central banks of emerging economies, including India, need to address the capital flow reversals and commodity shocks promptly. Capital and liquidity buffers can be utilised in the meanwhile as a regulatory response. Needless to say, coordinated monetary policy actions among nations will provide stability to financial markets and the global economy.

The ongoing pandemic has already caused massive disruptions in supply. With worse to come, the negative impacts on aggregate demand, employment and productivity shall be immense. Effective coordination between monetary and fiscal easing, though already in place has to be strengthened. To suppress the depressive loops, fiscal interventions not only have to be stronger but must take the lead in the mix of monetary-fiscal-exchange rate trilogy as tools of public policy.

Kaur is principal, Shri Ram College of Commerce and professor of economics and public policy, University of Delhi and Sarna is assistant professor, department of commerce, SRCC

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