Thursday, May 7, 2020

Pandemic Economics: Q&A 3

Some of these questions were recorded by Tushar Chakrabarty, of Cogencis Information Services Ltd

Q 1.        The COVID-19 pandemic has led to an unprecedented crisis for the economy. What are the steps that the government needs to take in the short term to provide relief and in the medium term to revive growth?
Ans 1: The primary objective of the Union and State Governments during the lock down and post-lock down transition to normalcy, must be ensure against starvation and mass bankruptcy. Union Govt should ensure that the Lock down is treated as a Force Majeure by the legal system. Govt must understand the legal asymmetry created by the lock-down, in which production and sales are banned by law, but legal obligations like rents, interest, wages must be met. State & UT Governments must not bankrupt firms by adding to these obligations through arbitrary orders and notifications to pay 100% of wages to 100% of employees. Government should suspend all financial obligations of the private sector to the Govt for the duration of the Lock down and the transition period. They must also clear all pending dues, to strengthen the financial position of MSMEs and companies.
  Once a semblance of normalcy is restored to the economy, economic reforms will be critical to the speed of recovery to potential growth rate of the economy. Among these are Tax (GST, DTC) and expenditure reforms(subsidies to DCT), Agricultural trade, labor and land reforms, SEZ/CEZ, EXIM policy, tariffs & duties, incentives for skilling (apprenticeship act) and R&D (double deduction)

Q 2.        So far, RBI has done most of the heavy lifting in responding to the crisis. Do see more scope for monetary response by the central bank?
Ans 2:  RBI must ensure against any transmission of financial contagion from insolvent financial organizations to illiquid financial organizations by providing assured medium-long term liquidity. It must also ensure that short term liquidity is available in all financial markets, financial instruments, and companies. The playbook is well known since the Global Financial Crisis of 2008, and the RBI Deputy Governor in-charge of Monetary and Economic policy, who was, senior advisor in the office of Executive Director, IMF, during my tenure as ED, is familiar with all the studies, analysis, discussions and post-mortems, which took place there0000. The Pandemic following, on the growth recession triggered by NBFC bankruptcies, however, adds new challenges, which must be navigated by “feeling the stones at the bottom of the river.”.

Q 3.        What are your views on a Fiscal stimulus? Do you think the response of the Govt has been timely and adequate or is the government right given the lack of Fiscal space?  
Ans 3:  Conventional discussions of Fiscal Deficit, Fiscal Stimulus and Fiscal Space have little connection to an Indian economy in lockdown.  During the lockdown only Essential Commodities, constituting 40% of GVA and 55% of employment could be produced, sold and bought. Manufacturing, mining, construction, and allied services (MMCAS) constituting 50% of GVA and 35% of employment could not be produced, sold or bought even if one had unlimited income or liquid financial savings. Except for direct cash transfers to the starving, any fiscal expenditure or tax reduction, has only financial effects, either increasing savings or reducing household/company debt, with zero (0) effect on real economy.
Q 4. Is extending tax relief an option that the government can look at given the already strained condition of its finances?
Ans 4   With many companies and MSMEs facing losses and bankruptcy we need to be clear about the meaning of “tax relief.” In the case of Companies, there is a case for suspending the MAT and suspend GST related obligation during the lockdown and the post-lockdown transition to normalcy. With tax revenues down dramatically, due to lockdown mandated closure of industry, It should also undertake “revenue-negative” tax reform, to provide a short-term stimulus & boost to animal spirits, while raising the medium-long term buoyancy of tax revenues. Simplification of GST and Direct Tax Code (Personal Income tax) will benefit Household industry and SMEs the most.

Q 5         How much deficit expansion do you expect in FY21? Do you think that the government needs to revise fiscal targets to give a clear picture on growth and fiscal deficit?
Ans 5:  During the Global Financial Crisis, when I was Chief Economic Advisor, the approximate breakdown of the fiscal stimulus was one-third tax revenue decline due to fall in GDP growth, one-third accelerated Government expenditure due to faster implementation of farm loan write-off and one-third tax reduction. During the Pandemic, the tax decline (automatic stabilizer) is likely to be much higher at ½ to 2/3rd. Expenditure is likely to contribute little, as development-Project expenditure is halted during lockdown, and will/should be re-directed to ensure against starvation/personal distress and mass firm bankruptcy. The remaining half to one-third should be used for “revenue-negative” reform of GST and PIT-DTC (direct tax code) and subsidy-DCT (direct cash transfer) reform.
Q 6.        A lot has been said about RBI directly purchasing government bonds to help finance the fiscal response to the pandemic. What is your take on the central bank monetizing the government’s deficit? Should the government look at issuing COVID-19 bonds to deal with the current crisis?

Ans 6:  I believe RBI should buy all issues of Government securities which the market is unable or unwilling to take. In other words, RBI should ensure that there is no increase in the real interest rate on Government securities during the crisis, as they anchor the interest structure.  If COVID-19 bonds help convey the logic of monetization in an unprecedented crisis of this nature, and thus facilitate the direct placement of government debt with the RBI, then they should certainly be issued.

Q 7.        Where do you see India’s growth rate in the current financial year?
Ans 7:  The Pandemic has resulted in the greatest economic uncertainty in the World since the Great depression. In my decades of macro fore casting I normally give a GDP forecast range of plus-minus 0.5% and a maximum of plus-minus in periods of crisis. In this pandemic, not only the range expanded, but its more sensible to call them scenarios. In April 2020 we gave three scenarios for FY21 based on lockdown ending on May 3; A pessimistic scenario of 0.4% growth, an optimistic one of 3.9% growth and a likely scenario of 2.2% growth. With the continuing Pandemic and the extension of the lockdown by two weeks, these are adjusted down to -1.5% (pessimistic) to 2.5% (optimistic). 

Q 8.        What steps can the government and the RBI take to ensure that NBFCs can tide over the current situation?
Ans 8: The best way for government to ensure that the short, medium and long term liquidity provided by RBI monetary and credit policy reaches the households and firms affected by the lockdown is to offset the extra risk created by the Government mandated lockdown. The best way to do is through risk sharing, Credit Enhancement or partial collateral guarantees (up to 50%) which leaves the micro-analysis and detailed lending decisions to the Banks and Financial institutions.

Q 9.        Several states have asked the Centre to provide relaxation in the fiscal deficit targets under the FRBM Act. Do you think that the current situation warrants that measure?
Ans 9:  To the extent that Union and State Govt revenues decline due to fall in GDP growth, these act as Automatic stabilizers. In my view automatic stabilizers should be exempt from FRBM targets and most emphatically in the current pandemic crisis. The Union Government must apply this principle both to itself and to the States and allow temporary exemption from fiscal targets equal to the extent of these GDP related revenue declines, so that Automatic stabilizers perform smoothly. On the expenditure side I do not see a big increase of State government obligation, more of a short-term reorganization of expenditures. They latter should include suspension of DA and possible reduction in salaries and wages for those Govt servants sitting at home during the lockdown.

Q 10.      What should be the exit strategy from the lockdown?
Ans 10:  Physical Distancing rules must remain in operation till July end in the entire country. This includes ban on all public gathering (public or semi-private) of more than 5 unrelated adults, 2 meter (6 ft) distancing and personal & social hygiene rules. Govt should facilitate physical distancing by promoting a scheduling/appointment App that makes it easy for sellers of goods and services to schedule and space out customers online and thus make distancing easier.
     Social Lockdown should continue in red zones, but Economic Lockdown must be phased expeditiously. The lockdown must be lifted for Manufacturing, Mining, Construction and Allied Services (MMCAS) even in red zones, as this is critical for smooth functioning of domestic supply chains. Special arrangements must be made for transport of workers to and from work in red zones. Sales of all goods must be facilitated by allowing all shops and establishments to do home delivery, including through drones. However, Contact Services (including dense, retail & wholesale, markets), where there is the greatest danger of viral contagion, should remain locked down in red zones.

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