Government Has The Right Plan To Overcome Covid-19 Economic Fallout But It May Take Time To Show Results

Government Has The Right Plan To Overcome Covid-19 Economic Fallout But It May Take Time To Show ResultsPrime Minister Narendra Modi and Finance Minister Nirmala Sitharaman.
Snapshot
  • The government has measures in place to contain Covid-19 economic fallout.

    Growth will return but it will take time for the full impact of any policy intervention to show results.

Decoding the fiscal response of the government is difficult as the Finance Minister indicated more such announcements over the coming few weeks.

Here is what we know so far though; that India will give a total stimulus of Rs 20 lakh crore, and that part of it will be fiscal and part of it will be monetary. Of this, government announced the first tranche of the stimulus on Wednesday (13 May) even as it is expected to announce further measures over the coming days.

However, the question that everyone has is whether this will improve the economic situation or not; or in other words, whether economic growth will be back post the lockdown, or not?

The answer to this is difficult as there are far too many unknown-unknowns in the near term as we do not know whether Covid-19 will return in waves or whether we will find a vaccine before that.

But should Covid-19 not return, and the economy is gradually opened up then it is easier to assess the extent of economic costs of the lockdown – and the impact on growth.

A joint exercise regarding this was done with Dr Arvind Virmani in a joint article which can be accessed here.

The key point to understand is that fundamentally, what businesses face is a cashflow mismatch as their financial liabilities have continued in the form of expenditures on rents, salaries, and fixed costs even as they are not operating their businesses and consequently are not receiving any payments.

It is this mismatch that is the root cause of the financial stress, economic stress and even the layoffs that have happened not just in India but across the globe.

The question that thus emerges is that whether the economic package announced yesterday (13 May) succeed in addressing this stress.

The answer to this is a definite yes.

One of the key things announced yesterday included credit-guarantees. The measure is supposed to provide micro, small and medium enterprises (MSMEs) with source of funds, or capital so that they can continue operating their businesses post the lockdown.

The issue of availability of credit for MSMEs has been a major reason that has limited their success to scale their operations.

Therefore, this credit guarantee scheme should be able to address the tight credit conditions that have existed in India for a while now.

One of the reasons why banks despite sitting on nearly Rs 8 lakh crore worth of surplus funds were reluctant to lend was risk aversion.

This aversion came due to the Covid-19 crisis as banks recognised their inability to identify businesses that could sustain operations.

The best solution in such a case is to not identify and therefore, to not lend out the money but park it with the Reserve Bank of India (RBI).

By announcing the credit guarantee scheme, the government has effectively addressed this risk aversion by simply ensuring that banks don’t have to worry of defaults as government will step in and take the financial hit.

This should encourage banks to, therefore, provide credit to MSMEs over the coming months and effectively enable their growth.

The other important measure was with respect to changes in definition of MSMEs that does away with the approach to take away benefits once the firm becomes large.

This is important as India has for far too long incentivised companies to remain strong. This has had an impact on their efficiency and made several of them uncompetitive compared to the global level.

Broadly, the approach on the economic front seems to be motivated by the fact that Covid-19 is a both demand and supply crisis.

Therefore, they have adopted an approach that combines supply side measures along with factor market reforms with demand measures through direct fiscal stimulus and liquidity enhancement measures. Such an understanding is important to deal with different parts of the economic challenge in front of us.

The government has definitely gotten the approach and tools in place to contain the economic fallout. However, we must be rational with our expectations.

Growth will return but it will take time for the full impact of any policy intervention to show results.

Very likely, these measures will have a positive impact on the prospects of economic recovery from the current crisis, but their long term implications, especially of the reforms are far more exciting.

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