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 ).

Economic Impact of UP Election

Introduction

    The scale of UP victory (>3/4th seat share) higher than any statistical analysis based on 2014 LS results: higher than both Surjit Bhalla's (@surjitbhalla) 60% seats and 5forty3's 2/3rd prediction. Political opposition/delaying tactics to Govt's economic policies likely to cease, both in RS and among party & affiliated organizations.  The Union Govt. will Re-Focus on economic objectives outlined in 2014 election manifesto and by the PM & his Govt. in the 2016-17 and earlier budgets. The mandate will allow the Union Govt. to accelerate Policy & institutional reform.

Policy Reforms

The Union government is likely to accelerate policy and institutional reforms that have already been announced by government, whether in the cabinet or in the budget. These include the following:

Welfare-subsidy reform

LPG reforms has made great progress. Govt has suggested at different times that other areas like kerosene, food, fertilizer, employment-NREGA would also be reformed  to eliminate corruption & admin inefficiency to reach benefits directly to poor, farmers & other needy groups.  So far these areas have been pursued very hesitantly and sporadically. Reforms are likely to be expedited so that the funds saved can be used to invest in infrastructure which promotes employment creating growth.

Strategic sales

  Strategic sales & public sector reform (PSUs, AI, ports, railway) reform to stop waste of resources into the sink hole, so funds can be used for infrastructure development. Strategic sale are opposed by vested interests (political, bureaucratic, management, labor) who enjoy the rents from Public sector while the public/tax payer pays the cost. The sweeping victory in UP will make it much easier to deal with obstructions and agitations from such vested interests, and thus accelerate the pace of change.

Labor Reform

  Labor law reforms were reiterated in the 2016-17 budget, in particular the reduction and integration of 44 odd labor laws into four functional ones. UP could also liberalize labor laws to encourage manufacturing, like Rajasthan & other BJP ruled States have started doing. 

Public Sector Bank (PSB)NPAs

        PSB bad loan problem, through decisions on sharing of losses by lender, borrower and tax payer/govt. NPAs whether at the country level or at the international level (e.g. Greece) is less about mechanisms, than about cost sharing than about appropriate sharing of costs between borrower, lender & tax payer.  Any decision will be criticized by opposition parties. However, with the Its hand strengthens by the electoral verdict, the govt is in a stronger position to deal with any criticism. The key here is too take & implement decisions quickly, rather than to search endlessly for a perfect solution (which does not exist) 

Goods & Services Tax (GST)

  The Union Govt. has an opportunity to remove some of the complications introduced at the urging of States, partly because govt did not have a majority in the Rajya Sabha.

Land Reform

   The Government can remove remaining constraints on land acquisition for infrastructure (e.g. through land pooling mechanism). It should also introduce the model land leasing law devised by NITI Ayog.

Foreign Direct Investment(FDI)

   The government has slowly and systematically eliminated unnecessary FDI restrictions and welcomed FDI. Given its announced intention to eliminate FIPB, there is now another opportunity to eliminate all FDI restrictions along with FIPB to encourage shift of manufacturing from newly-highly risky China to India.

Agriculture Productivity

    Allow the introduction of indigenously designed, tested and produced GM seeds followed by other GM seeds already evaluated, tested & cleared by the Indian regulatory agencies, which is so essential for enhancing agricultural productivity and incomes. Expedite removal of perishable goods from the APMC acts & the introduction  of e-markets.

UP administration

     There is also an opportunity to transform UP and consequently the Hindi heartland, by re-establishing rule of law, reducing corruption and accelerating economic growth.  One measure that would greatly facilitate transformation of the development paradigm, is the division of UP into 3 (or 4) separate administrative units, a halfway house to 3 (or 4) separate States. Each major sub-division (West UP, Central UP & East UP) would be under the charge of a deputy CM.  Bundelkhand admin could however be directly under the supervision of the CM. The CM would also act as a coordinator, planner, facilitator & supervisor of all major initiatives. He would also be the node between the union Govt/PMO and the DCM of the 3 quasi States.

Conclusion

      One of the results of the UP election results is likely to be a lengthening the time horizon of the policy options and institutional reforms considered by PM Modi led government from five to ten years. This implies less pressure to produce immediate results (populism) and greater likelihood of reforms that take time to work through the economy to produce visible results in growth and employment . However, the focus will remain on the reforms mentioned in the BJPs National election manifesto and the programs announced so far, with fine tuning based on the 21/2 years of running the union government.  The PMs words and actions over the past 2-3 years also suggests that he is likely to focus much more on establishing his place in history and to discourage some of his hyperactive followers from taking the law into their own hands or engage in violence and thus derail this long term objective.

Godfathers, Fathers and Mothers: A Viewpoint

    In my view, Nobel laureate and World renowned Philosopher-economist, Prof Amartya Sen was the intellectual godfather (in the sense of “godfather to a parents children”) of the UPAs statist welfare-socialism. PM Manmohan Singh and his friends and Associates had profound respect for Prof Sen’s intellectual capabilities. One could even go to the extent of saying that the former were intellectual Chela’s of the latter. Therefore, Prof. Sen’s admonitions relating to Social Welfare, Health, Education & Poverty, were treated virtually as “Gospel” or as “Ten Commandments” by the good doctor, his friends and associates.  Based on global comparative WDI data on Human Development Indicators and government expenditures, the commandments were simple and unambiguous: “Raise expenditures” on Health, Education, Child Development, Women’s development and other welfare programs.

    My observation & analysis suggests the following process thereafter: These recommendations were gladly and unquestioningly accepted by the Left wing of the Congress party whose inspiration was the Congress President, the Mother who gave birth to the UPA's Statist Welfare-Socialism (populism?).  Once accepted by the PM these issues therefore moved immediately to the Congress President led National Advisory Council (NAC) (as all politically remunerative welfare activities had to be attributed to 'the leader'). There, such programs, projects & policies were invariably sought to be loaded with numerous related and unrelated socialist objectives, statist-interventionist approaches and expenditure increases. Not infrequently the original intention of the PM, became a small part of an elaborate scheme of social engineering and business bashing.  These NAC modified (dare I say mangled) schemes, programs and laws returned to the government for execution (which then had to work out how much it would cost, where the money would come from and how they could actually be executed). The Mrs. Sonia Gandhi led NAC can therefore rightly be called the Father/Mother of this approach and can claim full credit for the programs, projects, laws, rules and regulations ordained by it.

       Experience of administering, monitoring and analyzing the numerous existing schemes was ignored or given short shrift. Experience and analysis suggested that without an improvement in the governance of multiplicity of such programs, more money would not have the effect that welfare economists sitting in the Developed countries expected.  One was convinced that without improvement in administration and reduction in absenteeism and corruption, there would be little impact of increased expenditure on health outcomes, educational achievements, pace of poverty reduction, malnutrition etc.[i]  It was suggested that governance improvement should be given equal, if not greater weight initially. The response to such doubts and suggestions was that governance issues could perhaps be addressed at a later stage.    Underlying this hint of future action on governance issues was a conviction that these socialist, welfare schemes, programs and laws would translate into a big electoral victory for the ruling party led, in the next election, by Shri Rahul Gandhi. 

    My earlier work on economic growth and the connection between economy and votes suggested otherwise:[ii] Unless growth was maintained through further policy reforms, a slowing growth rate would nullify any marginal political gains from inefficient, corruption ridden and unproductive welfare expenditures. Thus ineffective programs and slower growth would lose votes, not win them.

 

Only the potential extent of the loss was unclear till the BJP chose Shri Modi as its PM candidate for the 2014 general election. Sadly, the lessons have still not been learned by many politicians and their advisors.[iii]

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[i]  A Virmani, “Planning for Results: Public Accountability  Information System,” Working Paper No. 1/2007-PC, Planning Commission, March 2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm.

Arvind Virmani, “The Sudoku of Growth, Poverty and Malnutrition: Lessons For Lagging States,” Working Paper No. 2/2007-PC, Planning Commission, July  2007. http://planningcommission.nic.in/reports/wrkpapers/rpwpf.htm .

[ii] Series of papers on growth at,  https://sites.google.com/site/drarvindvirmani/growth & Arvind Virmani, “ Economic Growth, Governance And Voting Behaviour: An Application to Indian Elections,” Working Paper No. 138, ICRIER, July 2004.  http://www.icrier.org/page.asp?MenuID=24&SubCatId=175&SubSubCatId=233 .

[iii]  http://dravirmani.blogspot.in/2014/01/per-capita-gdp-growth-and-vote-share.html