Implications of Pandemic & Consequent Economic Crisis: What to Do About It

Questions from Asit Ranjan Mishra, Senior Editor, Mint

Q1-How do you assess the economic fallout of Covid-19 outbreak on Indian economy?

A1: There is an unprecedented shock to every economy in the World, including the Indian economy. There are three aspects. One the Lock-down, which is unprecedented even when compared to that in the key economies involved World War 2. It practically immobilizes the work force and thus reduces production to zero in 80-90% of economy. The #Lock-down in China, the first globally, were also an unprecedented disruption of production-inputs, the supply of intermediate goods, given China's role in so many critical Global supply chains and its monopolization of so many products. The contagion fear before the lock down, which will remain after the lock down, constitutes a huge demand shock for contact services which involve dense collections of people like air, rail & bus transport, Tourism, Restaurants & Hotels, Entertainment, Malls & retail markets.

Q2- From the standpoint of a shock to the economy as well as the financial market, how similar or different do you think the Corona virus outbreak is vis-a-vis the global financial crisis of 2008.

A2: The Pandemic is a Real Supply cum Demand shock to the economy, which will affect the financial system. The Global financial Crisis was a financial system collapse, which propagated into the Real economy. In that sense they are opposites. However, once the effects reach from one to the other, lots of similarities emerge with respect to the financial elements of the current crises and how to deal with them. The real elements are different and so will the fiscal measures to deal with it have to be different.

    As in the previous Financial Crisis, the Monetary Authority has now to ensure, that the Financial System keeps functioning smoothly and liquidity issues don’t undermine Solvent Financial institutions and result in Contagion from insolvent companies and financial organizations. RBI must ensure that key Institutions (like Banks) have enough liquidity, critical financial markets, like those for Foreign exchange, have adequate liquidity and Critical Instruments like Government Security do not show any upward spikes in rates. The last also requires close Monetary-Fiscal Co-ordination. RBI has also to ensure undue rise in risk premiums on undeveloped markets like those for CPs, by ensuring enough general liquidity and negative real Repo rates. RBI as an institution has sufficient experience from the Global Financial crisis to deal with these issues.

Q3-Forecasters and rating agencies like Moody’s have revised downward their growth estimate for India to 2.5% for 2020 calendar year? Do you find such estimates plausible?

A3: We are in the process of estimating the likely GDP growth in 2020-21.  Analytically, it's useful to divide the economy into three parts and three phases. These are the (a) Essential Commodities and Services, (b) The Contact Services in which fears of epidemic will continue to reduce Demand, and the (c) Rest of the economy. The phases are (1) The lockdown phase and near Lockdown conditions, (2) The phase of gradual recovery (3) Restoration of economy to "normal" growth.

     Right now, the available forecasts seem to be heavily dependent on assumptions about when the Pandemic will peak. Uncertainty will remain high, till the SARS Corona Virus 2 Pandemic has peaked in India, USA, EU and China.

Q4-How do you see the economic relief package announced by the government and the financial package by the RBI? Will they be enough under the current circumstances?

A4: Both packages are rightly designed to deal with Phase 1(as defined above), the impact of the Lockdown, which covers 80-90% of the economy, and the succeeding 4-6 weeks. The best part is the assurance that the Govt now has its ear to the ground and using information to design and modify packages. The challenge is therefore shifting to effective implementation. As States are responsible for both Health and Welfare and effectiveness of Health and Social welfare measures depends on the States, who are present at ground level.

Q5-Do you think India should announce a large stimulus package including a bailout for Indian companies affected badly?

A5: Fiscal stimulus is completely the wrong thing to do in a lock-down, when there is no supply of or demand for any commodity or service, besides essential commodities. During this period, Fiscal measures must focus on ensuring survival of citizens, by ensuring access to free food and health Services, for those who do not have cash. 

    Once the lockdown is over and we enter phase 2 (as defined above). Fiscal measures must be targeted at industries and sectors which are most severely affected by the Epidemic (Contact Services mentioned above). Next in line must be industries and sectors which were already badly hit by the growth recession and whose situation has worsened because of the Pandemic. In this context, elimination of Cesses & Surcharges in both GST and Personal Income Taxation, will play an important role.

Q6-Do we have to revisit and reset the self-imposed redlines in fiscal policy such as fiscal deficit and debt to GDP ratio limits to revive the Indian economy?

A6: The Mantra of "Fiscal space" is completely irrelevant during the Crisis. The FRBM should be suspended or reformed to take explicit account of such crises. Ignoring Fiscal deficits during the crisis to institute temporary expenditure does NOT mean that irresponsible introduction of, and commitment to, schemes which will sink the deficit in the medium-long term.

Q7-Should a stimulus be more effective through direct and indirect tax cuts or direct cash transfers?

A7: Once the economy comes out of the crises mode and enters Phase 3, the primary policy issue will be how to speed its recovery back to its growth potential. In this context tax reforms (Direct Tax Code, GST) are far more important than expenditure reforms. Tax reduction must be considered as part of these tax reforms, to provide short term stimulus, while ensuring long term fiscal sustainability through improved voluntary compliance and higher buoyancy. Direct cash transfers will of course be necessary for those affected by crisis, but overall increases will be sustainable if and only if combined with reduction of leakages(inefficiency and corruption) in major subsidies like fertilizer and food corporation.

Q8-Is it the right time to revisit the idea of Universal Basic Income and guaranteeing social security to all the vulnerable people?

A8: The Universal Basic Income (UBI) concept, though it may be relevant for Developed countries, is irrelevant for India. A "Targeted" UBI is a contradiction of the term "Universal". We in India had developed the concept of Direct Cash Transfers(DCT) to the bottom 40% of the Population in the mid-2000s, pursuant to which we recommended the creation of a Universal ID (UID) to help target such transfers. With are Bureaucratic Socialist system heritage of evasion & corruption and abysmal conviction rates for illegal activity, a sustainable system requires close attention to incentives. We need a system of Net Income Transfers, which meshes DCT into the existing personal income tax system through an integrated, “Negative Income tax  (NIT)”.  The time to consider it will however be in 2021-22, after the economy is on road to recovery

Q9-Do you think Covid-19 will accelerate the process of deglobalization already visible through intensifying trade wars?

A9: De Globalization started after the Global Financial Crisis and is clearly visible in the declining World Trade to GDP ratio as well as in reduced Capital flows, particularly to Emerging Market economies. These trends will intensify and expand to include greater restrictions on low tech migrant workers.

Q10-How do you think economies may change the way they work, say two to three years from now? What policies will guide cooperation and competition among them?

A10: The Partial Economic Decoupling and Hight Tech decoupling set in motion by the Tariff War will accelerate. The decoupling will be between free, open democracies which follow rule of law domestically and accepted rules of country behavior internationally and those who merely pay lip service to these principles of acceptable behavior.

Q11-Do you apprehend more pressure now on global supply chains to withdraw from China?

A11: Yes there will be an accelerated diversification of Global Supply Chains from China, particularly in industries which China had monopolized through Subsidies, NTBs and mercantilist practices.

Q12- What of 2021 and beyond? Will the Indian economy be stuck in low level equilibrium of 5-5.5% for the next few years?

A12: That would be a disaster of unmeasurable proportions for the Indian economy and the Welfare of its people. Union and State Govts (e.g. GST council) use the current hiatus in economic activity to prepare a comprehensive calendar of Reforms to be implemented during H2 of FY21 and H1 of FY22. Besides comprehensive reform of GST and Indirect Code, it must include reform of External sector & Exim policy, Agriculture, Skilling (incl Apprenticeship), Regulatory reforms for promoting Educate in India. Land and Labor flexibility for Coastal/Special Export Zones & Import Substitution Zones, Electricity Distribution & pricing for Industry, and Manufacturing subsidies for Industries monopolized by Dictatorships who don't follow Global Rule of Law.

      A tragic once in a century crisis like this, also provides an unprecedented opportunity to transform the Indian Economy. We would be compounding the tragedy if we waste this opportunity. 

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Note: A version of this note appeared in Mint, Monday, 30^th March 2020 t.co/TwKlSlWFro ).

Macroeconomics of Crisis

Introduction

    Theoretically inclined Macro-economists think of an economy in terms of Growth Trends and Cycles, with latter showing peaks and troughs (recessions) of differing severity. The Global financial Crisis (GFC), which some refer to as the US financial Crisis reminded us of the possibility of a third possibility, Depressions, not seen since the Great Depression of the 1920s.  The Global Pandemic set off by the SARS Coronavirus 2, has brought in a new economic state, a government mandated Lockdown of whole or part of the economy, which requires a rethinking of the different levels of economic distress and how to deal with them.

    In the context of India, an emerging market economy, we think of all these in somewhat different way from developed, rich, mature developed economies (DCs). In normal times, the key issue for Indian economy is to maintain growth rate at is potential.  India’s equivalent of the DC Recession is a “Growth Recession, which have historically been driven by droughts, but were increasingly driven by oil shocks and demand shocks. The Indian equivalent of the Depression (or near-depression) is an Economic Crises, like the BOP crisis of 1990-1991[i] [ii], the external shock (GFC) induced Growth crisis of 2008-2009[iii] [iv]and the crisis induced by the SARS CoV 2 pandemic. The Growth recession of 2019 was particularly severe and could be described as a Great “Growth recession”. The issues connected with this have been analysed in the author’s research papers.[v] 

    A completely new element has been added to Crisis management and Crisis handling, by promulgation of Medically driven, Government mandated lockdowns of economic activity.  This requires further analysis and refinement of Crisis handling approaches.

External Shock Induced Crises

   What are the lessons learnt from handling Financial crisis & external shocks, with particular reference to India?  In this note we try to minimize economic jargon and put these lessons in simple terms that the general public, politicians, media and generalist bureaucrats can understand. This is done by applying a few popular analogies to explain how to deal with the current crisis

     There are five basic lessons, aspects and steps, needed to address the pandemic affecting India. (1) Slow and Stop the Pandemic from spreading. (2) Stop the Real Dominoes from falling and setting off a chain of Dominoes, (3) Stop Financial contagion from spreading through the Financial Network and freezing the network. (4) Treat the Welfare-Social aspects as you would a Flood or Tsunami. Move the threatened people to higher ground if possible, help those whose houses, farms & shops have been destroyed, rebuild their houses & livelihoods after its passed. (5) Create the Economic environment for rapid recovery of the overall economy, so that it's not trapped in low level growth equilibrium for years afterwards:

Medical Pandemic

  Dealing with the medical elements of the crisis requires advise from medical experts who know Indian health and are fully up to date on information & knowledge emerging from rest of world. 

     Spatial separation of people from each other and from those infected with the SARS CoV 2 virus has been the critical element in slowing the spread of the virus. In successful countries like Singapore, Hong Kong, Taiwan, S Korea, Japan this involved widespread use of Masks (outside home). We should not obsess about the quality of Masks, even a home made mask is better than nothing, though production & distribution of better quality masks must be stepped up. Stopping congregations of people in public, commercial & work spaces and for social interaction is another essential element. Non-family members must compulsorily practice spatial distancing (of 1-3 meters) and wear masks when physically closer, even to friends and colleagues. The third element was the identification and isolation of infected people in homes or special facilities depending on symptoms. A combination of electronic (mobile phones) and physical (police/administrative checks). And finally the health infrastructure was geared up by procuring & providing appropriate protective gear to health workers, necessary equipment like ventilators and expanding ICU capacity.

     Lockdowns are a last resort as they have a devastating impact on the economy & economic well being. As SARS CoV 2 is imported Into India through international travel ie was carried by Foreigners or Indians coming from infected countries. It's therefore a middle class (top 30%) phenomenon. Socio-Spatial distancing is needed in this category. We should be very careful in imposing lockdowns which affect production and trade within the 70% and their interaction with the lower middle class (next 10-15%). Lockdowns must be limited in time & geographical space (eg Urban concentrations).

Real Economy (Dominoes)

      It's clear that the Travel & Tourism, Restaurants, Retail Trade & Entertainment Services industries which involve Contact with other people are most directly affected by the Pandemic. Govt's Fiscal and other action, has to identify Companies/firms in these sectors, which are fundamentally solvent, from closing and setting off a chain of Closures bankruptcies(Dominoes) This involves suspension of rules & regulations, tax reductions, temporary tax exemptions, permissions to delay tax payments, interest subventions, loan guarantees, quicker payment for services etc. .[vi] These imperatives and the responsibility of Govt, multiplies manifold, during a Govt mandated lockdown.

Financial Markets and System Stability

  The nodes, channels and networks through which real problems translate into financial crises and propagate are well known since the Financial Crisis. The RBI has to provide sufficient short, medium and long term liquidity to ensure that the Banking and other critical financial institutions, all critical markets (e.g. Govt Secs) continue to function smoothly and key instruments which are normally liquid and widely used, remain largely so.  RBI also has to identify borderline institutions and devise specific measures to ensure that they don't collapse and set of contagion, and systemic failure.

      In this context, Real Repo rates are a very important tool for signaling & giving confidence to solvent financial agents, that the RBI will do whatever it takes to ensure system stability. They must be negative for duration of crisis. This is also the best (rational and easiest to implement) way to provide a cushion to solvent borrowers, including cash strapped ones. In this time of Govt mandated lockdowns and pandemic related shutdowns.

Contract Workers in & Self-Employed

 Contract workers in services facing Direct demand collapse and self-employed (street vendors, hawkers etc.) associated with them. As is well known by know, the most directly affected services are Travel(Air, rail, bus) and Tourism, Hospitality (hotels & restaurants), Retail, Entertainments. The key lesson is that help must be targeted to those directly affected. Expending highly limited Government resources/funds on poor people or workers in other sectors and geographies is not just pointless but socio-politically harmful.

  Those Households in which a member is affected by Corona Virus infection, can easily be given an additional cash transfer for meeting normal expenses.  For the rest of the poor and lower middle income ones affected by broader Pandemic crises and/or lockdown, the States must quickly invite all affected people to register for assistance with details of their Aadhar, Voter ID, mobile & bank account details, work type & place. A simple form can be devised which can be filed through multiple channels; By email, at a digital portal or at a Ration shops. These can then be provided Direct Cash transfer for duration of Crises/ Lockdown.

Post-Crisis Recovery

  The speed and extent of recovery from crisis depends critically on the policy & institutional changes made during and after the crisis. Those countries which have used crisis as an opportunity to reform policies which were slowing growth, even before the crises, have recovered relatively quickly and in a more sustained way. The Indian Economy was at the bottom of U (~5% GDP growth) before the pandemic. The pandemic could push it even lower. It's imperative to re consider the policies that we have suggested in the light of the new threats and opportunity and to reprioritize them for urgent action.[vii]

Lockdown Economics

    A lockdown is a complete Government mandated shut down of economic activity (with exemption for “essential goods & services”, like food & beverages & Pharmaceutical products and health services). This is a crisis event the World has never seen before. World Wars have seen a massive redirection of economic activity towards war fighting but never an almost complete shutdown of production. If 90% of production is shut, this means an end to the profits, wages and rents earned and the consumption of these products. All those who earned their income from the locked-down sectors have to use their cash/liquid savings (SB acts, current acts) to by essential commodities produced by the remaining 10%. The latter continue to earn income, but won’t have anything to buy besides essential commodities, and will therefore become net savers of cash.

   The longer the lockdown lasts the more Households in the Lock-down sectors will run out of cash and fixed deposits. Even those which have other assets like bonds and equity, will become poor rapidly given the collapse of asset prices in the markets. It therefore become imperative for Government to identify these marginal households on a real-time basis and keep increasing the Direct cash transfers to the affected households. This can rapidly extend from the conventionally poor to the the lower middle class in the lock-down geographies/sectors, particularly in sectors which were already stressed and cash starved.  

Conclusion

  During a crisis Govt's emergency action has to be targeted at affected workers, firms, industries & sectors, as best as possible, without obsessing about leakages; Nor do we have the luxury (unlimited funds) of indulging our pet schemed, issues & approaches (e.g. UBI, NIT, tax reduction for salaried, Uniform GST, MNREGA, MSP), which may be very relevant for normal times. The second order of business is for Govt to put those Institutional/administrative and policy reforms in place which will lead to rapid recovery of GDP growth to its Full Potential. The tragedy of crisis must be dealt with first and foremost, but a Crisis is a terrible thing to waste, from the perspective of a sustainable fast growth and sustained Welfare improvement.

Arvind Virmani

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[i] Virmani, Arvind (2020), India: Crises Reform and Growth, Economic and Political Weekly, Volume XXXII, No. 32, August 9-15, 1997, pp. 2064-2068. In Planning Commission I analyzed the BOP crisis and advised on it and then moved to DEA, MOF in November 1991 to advise on post-crisis economic reforms. Subsequently dealt with other external shocks like the Latin and Asian Crisis.

[ii] As Economic Advisor from 2007-2009 I dealt with a surge in Capital inflows, and the big spike in oil prices and the severe shock of the Global Financial Crisis on the Indian economy. Virmani, Arvind (2009), “Macro-economic management of the Indian Economy: Capital flows, interest rates and inflation,” Macroeconomics and Finance in Emerging Market Economies,Vol. 2, No. 2, September 2009, pp 189-214. Arvind Virmani (2007), “Macro-economic Management of Indian Economy: Capital Flows, Interest Rates and Inflation”, Working paper No. 2/2007-DEA, Ministry of Finance, November 2007. http://www.finmin.nic.in/workingpaper/index.asp, http://www.finmin.nic.in/workingpaper/2_2007_DEA.pdf .

[iii] The 2008 GFC shock was so unexpected and so unique that even the most brilliant generalists were dumbfounded and gave an opening for me not just to devise & suggest polices but to go public in media to explain why a host of fiscal measures were necessary and along with monetary measures, sufficient to deal with the crisis. It was also the one and only time in my Govt career that I directly cautioned the PM (through email) about a few measures taken by RBI which I didn't agree with.

[iv] After the crisis was successfully dealt with by October 2009, I spent 3 years as executive Director on IMF Board, the only economist on the Board, who had dealt personally with many crisis. I utilized this golden opportunity to study, discuss and writing about the Global Financial Crisis and the actions taken by the USA, EU, Greece, IMF and a host of other countries and World organizations to deal with its effects and the after-effects.

[v]  Virmani, Arvind (2020), Growth Slowdown, Reforms and Recovery, January 2020, Policy Paper, Foundation for economic Growth (EGROW).  https://egrowfoundation.org/research/growth-slowdown-reforms-and-recovery/ .  Virmani, Arvind(2020), "Growth Recession: J Curve of Institutional Reform, Working Paper No.1/2020, Foundation for Economic Growth and Welfare, February 2020, GrRecession_Jcurve_WP2020Feb.docx .

[vi] Finance minister has announced a list of items on which deadlines are extended and Regulatory forbearance is given in laws, rules and regulations under the charge of the Finance ministry like taxation, Company affairs an Banking.

[vii]  https://egrowfoundation.org/research/growth-recession-j-curve-of-institutional-reform/