Sunday, March 29, 2020

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. 
Note: A version of this note appeared in Mint, Monday, 30th March 2020 ).

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