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 ).

Q&A on Economy & Trade

 Interview given to Bijoy Kumar Sing of PTI on August, 9, 2018:

Q1: What is you assessment of current macroeconomic situation in India? Some experts believe that  the macro situation is becoming more challenging in the last year of Modi  government? FDI growth hits 5-year low in 2017-18, rupee has depreciated, oil prices and inflation are rising? 

A1: Economic growth, which has been subject to many ups and downs over the past seven years, seems to be back on a recovery path. The most important indicator of this is the rate of growth of real fixed investment, an essential element of sustained, sustainable growth. On the external front some challenges such as the threat of rising interest rates and commodity prices are the negative face of a rise in developed country growth. So they are partly offsetting. The rise in oil prices due to Geopolitical factors, like Iran sanctions are however a concern.  The US-China Tariff war however provides an opportunity to increase India’s exports to the USA and to attract, labor intensive elements of the global supply chain unsettled by higher “China risk”, to India. Domestically the main risk to macro stability, is politically driven Govt consumption spending at the cost of investment and fiscal prudence. If this temptation is resisted, the country will be back on a firm 7.5% plus growth track. 

    Q2: India has emerged as the sixth largest economy replacing France? How do you see this development?

A2: in a series of papers since 2004, I had predicted the rise of China and India as economic powers (https://sites.google.com/site/drarvindvirmani/india-great-power ). India will become the fifth largest economy in 2018 and the 3rd largest, after USA &  China, by 2025 (in current US dollars). According to the index I developed for making these projections, VIPP, India will become a great power by ~ 2035. It is very important for our elites to understand both the strengths and the limitations of these developments. We must start planning our global interactions and acting like a leading power, without ignorantly imagining that we are already a Great Power (that is 20yrs away). 

    Q3: The US actions on trade have emerged as the biggest worry for global growth. What will be impact of rising trade tensions on Indian economy and what should be India's strategy?

A3: We must distinguish between US trade actions against market economies like EU, Canada, Mexico and other market economies from those against non-market China. The conventional wisdom that everyone will loose from a trade war applies to the former, but not to the latter. A single party dictatorship has dozens of ways of imposing non-tariff barriers on imports & foreign investment, that free open democracies, run by rule of law, cannot even imagine. The US-China tariff war will have some short term disruptive effects on global economy, but provides great opportunity for India to attract Labour intensive, export oriented and Indian market oriented investment from those currently located in China. The Indian Govt, private industry and PSUs must make an effort to attract them to India.

    Q4: The general elections are less than a year away and there is a possibility of populist policies being announced by both the central and state governments. Is there a possibility of slippages in the fiscal deficit?

A4: Historically every Govt pushes up what are referred to as populist expenditure in the year or so leading up to the election. The test is if they keep it modest and don’t disturb the trend in fiscal responsibility. There is therefore always a risk of fiscal slippage. At State level, this is partly linked to losses incurred by State electricity distribution. 

    Q5: Prime Minister Narendra Modi had said that demonetisation will reduce generation of black money in India. But money deposited by Indian's in Swiss banks rose by 50 per cent last year. So, how do you read the effects of demonetisation nearly two years later.

A5: The data that I have seen shows that money deposited by Indians in Swiss banks has been on and remains on a downtrend. As as demonetization, I had written the week after demonetization that it would reduce the growth rate of the economy by about 0.5-0.6% in the 6 months following the demonetization or about 1% for the year as whole (assuming the recovery takes a year). My subsequent estimates show a loss of 1.2% of GDP in the 12 months following demonetization. On the positive side I had predicted an increase in income tax compliance, which seems to be happening (as per limited data available). The effect on black money in real estate and elsewhere did take place, but seems to have been less permanent. 

    Q6: There is common perception that departures of foreign' economic advisers (Raghuram Rajan, Arvind Panagariya and Arvind Subramanian) underline the Modi administration's rejection of free trade and open market approaches to policy in favor of protecting domestic industries and farmers. Your comments.

A6: Since I retired from the post of Chief Economic Advisor at the end of 2009, my successors as CEA (Kaushik Basu, RaghuRam Rajan and Arvind Subramanian) have all returned to jobs abroad, after completing their Indian tenure. The same happened in the case of Arvind Panagriya of NIti. In my judgement this is not primarily due to any disagreement on free trade and open markets, which is indeed one of the weak points of the current Govt (I have argued for trade reform in the, Bibek Debroy edited, book, “India at 70, Modi @3.5 “ )

    Q7: Recently Commerce Minister Suresh Prabhu had said that 40 per cent of India's GDP will come from exports by 2025, and India's economy will be a USD 5 trillion economy 2025. At present, exports constitute only 18 per cent of USD 2.6 trillion GDP. Do you agree with Prabhu?

A7: An open economy is one of the drivers of growth in a connected and liberal world, which is why I have continuously argued for reform and liberalization of EXIM policy(agriculture) and of import tariffs and export duties. I continue to do so. However, given the anti- free trade sentiments sweeping the world, we have to be a little more selective and cautious in dealing with non-market, non democratic countries which find it easy to follow non-transparent policies that harm our interests. This poses a challenge for instance in concluding the RECEP agreement.

Economic Survey 2015-16: Some Issues

Growth and Jobs

Q1: The survey pegs GDP growth at 7-7.75 per cent for the coming year, which is broadly in the range of 7.6 per cent expected in the current financial year. Do you think the Survey is conservative this time, after overestimating growth in the past many years?

A1: The mid-term review late in 2015, put the estimate of growth rate for 2015-16 at 7 to 7.5%. This means that the Economic Survey predicts a rise of 0.25% points at the top end. My own forecast of growth is an acceleration of about 0.2% points in 2016-17 over the growth rate that we get for full year 2015-16 (which is projected by CSO at 7.6%).

Q2: Do you agree with the survey observation that -- "India being in the midway through its demographic dividend is providing an economic growth in terms of the working age share of the population. Hence to exploit this dividend and meet the growing aspiration of those entering the labor force, India’s Economy needs to create enough “good jobs”- jobs that are safe and pay well, and encourage firms and workers to improve skills and productivity. It may be noted that of the 10.5 million new jobs creative between 1989 and 2010, only 3.7 million-about 35 percent – were in the formal sector. In this period total establishments were increased by 4.2 million. However jobs informal sector have come down possibly due to increased use of contract labour. Thus, the challenge of creating the good jobs of India could be seen as a challenge of creating more formal sector jobs which also guarantee workers protection." 

A2: We have long known that formal sector jobs are on average of higher quality than informal employment. Many of us have also argued that many labour policies that restrict flexibility of labor in the formal sector, including to reduce workers when there is no product demand actually end up reducing the generation of new formal sector jobs. The survey updates us on this issue.

Fiscal Deficit, Subsidies

Q3:  The survey finds that  meeting fiscal deficit  target of 3.5 per cent would be challenging due to OROP  and VII th pay commission recommendations. It suggests the time is right for a review of medium term fiscal frame work. It adds that there are new developments in, and approaches to, medium term fiscal frameworks around the world from which India can usefully learn. Your take on the issue and on whether the Budget should defer fiscal consolidation plan for another year?

A3: The formal FRBM technically expired in 2008, but has been informally maintained since then. A comprehensive review, updation and legal reiteration of the framework is overdue. In my view the first best policy would be to stick to fiscal targets for 2016-17 and reduce monetary policy (Repo ) rates by 75 BPS. As the latter is unlikely to happen given the the financial markets focus on nominal (instead of real) rates, the second best policy may be to postpone FD targets, while holding on to Revenue Deficit targets

Q4:  The survey says Rs 100,000 crore subsidies are going to the better-off merely on account of 6 commodities like gold, LPG, Kerosene, Electricity, railway fares, aviation and turbine fuel (ATF) plus the Small Savings Scheme. This represents substantial leakage from the Government’s kitty, and an opportunity foregone to help the truly deserving. Do  you agree? What reforms would you suggest?

A4: As I haven't done my own estimate, I have nothing to add to the economic survey's estimate. Some of us have been arguing for decades that subsidies should be targeted on the poor and deserving and channeled in a way that minimizes misdirection to the better off, bureaucratic expenditures & corruption. This was my reason for suggesting a UID based multi application smart card that would bring all subsidies under one roof(so to say).[i] I have also subsequently suggested allowing a mobile based cash payment system, that connects the cell number to the UID. A DBT system using bank accounts is an alternative which has been adopted and also serve the same purpose given spread of bank accounts to rural areas. JAM is an attempt to incorporate Mobiles into the system

 Q5:  The survey emphasizes that the Government budgeted Rs. 73,000 crore- about 0.5 per cent of GDP- on fertilizer subsidies in 2015-16. Nearly 70 per cent of this amount was allocated to urea, the most commonly used fertilizer, making it the largest subsidy after food. Distortions in urea are the result of multiple regulations. These distortions feed upon each other, and together create an environment that leads to a series of adverse outcomes.  Your views?

A5: I have myself served on several committees that recommended reform of the Urea production and  subsidy system. Unfortunately the vested interests are too strong to be easily disrupted. In the past, the share of the subsidy going to producers (vs farmers) has fluctuated between 100% to 0%. The current period when the prices of oil refinery products used in Urea production are low, provides a good opportunity for complete decontrol combined with targeted subsidy through bank accounts, mobiles or a Kisan credit card.

Social Security

Q6:  The survey also says introduction of DBT in LPG and MGNREGS have proved that use of JAM can considerably reduce leakages, reduce idle funds, lower corruption and improve ease of doing business with the government. Despite huge improvements in financial inclusion due to Jan Dhan, JAM Preparedness indicators suggest that there is still long way to go. Your take?

A6: The key common element is the use of the UID/Adhar number and a payment channel that is accessible to beneficiaries. The opening of bank accounts for the poor has definitely facilitated the use of bank accounts for making direct payments. I have long argued that the use of mobile accounts as a way of transferring funds would be a better channel because its reach among the poor is much deeper. However, forcing the administrators to open accounts for the poor before making payment can accelerate the spread of accounts.

Q7:  The survey says providing food security entails making food available at affordable prices at all times, without interruptions. In order to provide food security, in the current agriculture scenario, India has to focus on supplies which are timely and uninterrupted and affordable for the poor. Your views on that?

A7: I first analysed this issue in a 2002 paper & suggested a three tier approach depending on the degree of competitive availability of food supply shops.[ii] In urban areas where there competitive food supply is available, we should switch completely to some form of food credit cards. In remote or hilly areas where there may not be many suppliers we should continue with the full PDS system. In the other in between areas a combination of food stamps/food credit card and competing PDS outlets could be used.

Q8:  There are some new chapters in the Survey such  as Mother and Child. What do you think  of those?

A8: In 2007 paper on Child Nutrition I argued that Sewage, Sanitation and Public toilets were the most important cause of this problem in India.[iii]  I am therefore very happy that this problem is receiving attention.  However, I think more research needs to be done to determine what are the other critical elements of the problems and consequently the most effective solutions

Trade & Tariffs

Q9:  The survey suggests that India should resist calls to seek recourse in the protectionist measures, especially in relation to items that could undermine the competitiveness of downstream firms and industries. It also suggests that India should strengthen procedures that allow WTO-consistent and hence legitimate actions against dumping (anti-dumping), subsidization (countervailing duties), and surges in imports (safeguard measures) to be taken expeditiously and effectively. Your take?

A9: I agree completely with this suggestion with one caveat. China is a non-market economy which is exporting deflation through its State owned and Party sponsered enterprises. So in the short term (say during 2016) other temporary protective measures may be justified.

Q10  It  also  says higher tariff is coming in the way of benefits from FTAs. Do you agree?

A10: What the CEA said was that the imports of India (& its FTA partners) have increased in proportion to the reduction in tariffs resulting from the FTA. So for example India's imports from ASEAN have gone up more that than vice versa, because India with higher tariffs, reduced them more in per cent points.

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A version of this appeared in the Business Standard of Saturday 27th March, under the banner, "Vested Interests too strong to Reform Urea Subsidy" http://www.business-standard.com/budget/article/vested-interests-too-strong-to-reform-urea-subsidy-arvind-virmani-116022700010_1.html .

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[i]  https://sites.google.com/site/chintan1997reg/institutional-reform/uid 

[ii]  Virmani, Arvind and  P. V. Rajeev, “Excess Food Stocks, PDS and Procurement Policy,” Planning Commission Working Paper No. 5/2002PC, December 2001.

[iii]https://docs.google.com/viewer?a=v&pid=sites&srcid=ZGVmYXVsdGRvbWFpbnxkcmFydmluZHZpcm1hbml8Z3g6NzlkYzBkYzRlNzJlYTQxOA