Indian policymakers have not much to lose by tearing up the conventional playbook. The risk-reward ratio is in favour of being bold rather than timid.
About eight months ago, one of us wrote in Mint that sentiment and valuation in financial markets reminded him of the feeling that prevailed in the summer of 2007 before it all began to go downhill culminating in the collapse of Lehman Brothers in September 2008.
Little did he know that it would take an unseen virus this time to bring humans down to earth with fear, anxiety and trepidation along with the value of risky assets in financial markets across the world.
Unlike in 2008, this time around, real economies and real people are affected more directly with cities and countries locked down.
In 2008, financial market excesses brought the real economy globally to the edge of collapse. This time around, the real economy faces two shocks: one is the direct impact of the collapse in economic activity caused by the spread of the infections caused by the Covid-19 virus.
The second is the feedback effect coming from the collapse in asset prices on highly leveraged non-financial businesses around the world.
Therefore, arguably, this is a far more serious shock to the global economy than the crisis of 2008 was in three ways.
It has come at a far greater speed than humans and policymakers can cope with.
The crisis of 2008 was relatively slower in the making. Yet, the world was caught napping for the most part.
Third, this shock comes at a time when central banks around the world have run out of conventional instruments. They are forced to wade further into uncharted and unknown waters with uncertain consequences.
For India, the economic shock of the Covid-19 virus comes at a time when its economy was fragile and was beginning to embark on a slow, halting and gradual recovery.
The demand shock for crude oil caused by the virus and schisms among the oil-producing nations have collapsed the price of crude oil. That is good news for India.
Nonetheless, India faces both a huge health challenge and a further leg-down in economic growth rates instead of an improvement.
Further, the nature of the crisis threatens to create economic, social and health distress among the low-income and poor households. This can have potentially adverse consequences for social and economic stability for many years to come.
Therefore, Indian policymakers have not much to lose by tearing up the conventional playbook. The risk-reward ratio is in favour of being bold rather than timid.
Even if they are not as effective or, worse, even if they backfire, history will not judge them harshly for trying harder and unconventionally to support the economy now.
Given the twin impact on the real economy – direct and indirect – fiscal and monetary policy have to act in tandem and act quickly, without waiting for real health threats to emerge.
We already have templates from advanced economies in the West. They used to dictate (even if they did not follow them) a different policy regime for developing countries – balanced budgets, free trade, low inflation and hands-off approach to the economy.
For example, the recently elected Conservative Government in the United Kingdom is underwriting payment of salaries to the workers by the private sector.
In the United States of America, the Federal Reserve announced on Monday, 23 March, unprecedented measures to support the economy directly even before the Congress could agree on fiscal measures.
This time around, the bailout is not for banks – although that has not stopped them from clamouring for withdrawal of all regulations introduced since 2008 – but for small businesses and households.
Therefore, there is a silver lining in this crisis as it has always been the case with big tragic and destabilising events.
For example, the Great Depression heralded the arrival of the welfare state and a regulated financial sector. The latter lasted for nearly half a century and contributed to economic and financial stability.
For countries like India, the economic shock caused by the virus is an opportunity to chart their own economic path disregarding the context-free conventional economic policy wisdom imported from the West.
That can and must start with measures aimed at the poor and low-income households in the country. Now is not the time to worry about incentive distortions.
There is no option but for the governments to assume the role of the ultimate risk bearer. And like with the financial crisis, or for that matter any crisis, time is of essence.
Never before has the original idea of the Keynesian stimulus of “dig-earth-fill-earth” assumed greater relevance. Fiscal policy has to take the leadership role. The sovereign has to take over the risks that, otherwise, cannot be mitigated. But, the central bank has an important role to play as the Federal Reserve had demonstrated on Monday.
This is a ‘consolidated balance sheet approach’. The Fed and Treasury are working hand-in-glove as buyer of last resort of all US dollar assets. It tells you that, in a fiat money world, central banks will completely align their response with governments in monetarily sovereign currency areas. Whatever the government wants to do to marshal real resources toward a crisis, the central bank will facilitate.
Like the Federal Reserve Board, several economists have already crossed the intellectual Rubicon and have understood the gravity of the situation.
Fiscal policymakers should focus not on aggregate demand but on social insurance. …. Considering the difficulty of identifying the truly needy and the problems inherent in trying to do so, sending every American a $1000 check ASAP would be a good start. … There are times to worry about the growing government debt. This is not one of them. Externalities abound. Helping people over their current economic difficulties may keep more people at home, reducing the spread of the virus. In other words, there are efficiency as well as equity arguments for social insurance. Monetary policy should focus on maintaining liquidity.
I propose temporarily stopping time. This means that today’s date, Tuesday, March 17th, 2020, will remain the current date until further notice. This also means that everything that happens in time (e.g. mortgage due dates, payrolls, travel bookings, stock market trading, contractor gigs, concerts, sporting events) will be paused. It also means that all of these events remain on the books, and will continue as planned once time is resumed.
The Systemic Risk Council, consisting of former central bankers and academics, lists out the principles that should govern decision-making by fiscal and monetary authorities in these times:
(i) Provide direct aid to business sectors that are vital to addressing the health crisis, or essential to reviving the economy when the health crisis eventually subsides
(ii) Provide direct aid to households who lose work or, for other reasons, cannot cope financially even though they remain healthy;
(iii) Prepare plans, even if not published, for providing Capital-of-Last-Resort support to distressed but essential businesses for which funding support is not enough, but whose failure would unnecessarily impair economic prosperity once the health crisis has passed
While the above three points might appear mostly fiscal in nature, it is clear that the Federal Reserve Board had not waited for the American government or the Congress to act. It has acted on all the three points above.
So, unlike Mankiw’s suggestion that monetary authorities focus only on providing liquidity, they have shown that there is a bigger role for the central bank in its role as the lender of last resort and, in the case of the Reserve Bank of India, as a banking regulator.
However, there is no gainsaying the fact that the measures have to be largely fiscal in nature. Many governments have already started acting in this direction.
In addition to the Bank of England’s enhanced lending facility, the UK Government has committed to do “whatever it takes” to protect the economy.
Statutory sick pay has been extended for those advised to self-isolate and the same fiscally reimbursed.
Businesses will have access to government guaranteed loans at “attractive rates”.
Small and medium businesses will be able to borrow up to £5 million interest free for twelve months.
Firms in the worst affected retail, leisure, and hospitality sectors will be given cash grants of £25,000 and offered exemptions and forbearance on tax and other statutory dues, including property tax waiver for a year.
Smallest businesses across sectors too will get £10,000 grant, and households will be provided three-month mortgage holiday.
As mentioned earlier, the British Government grants will cover 80 per cent of the salary of retained workers, up to a total of £2,500 a month, that’s above UK median earnings level.
This is the first time that the British government will help pay workers’ wages. This allows businesses to retain workers and is similar to what the German kurzarbeit, or shorter work time, scheme did and still does. Germany used it to good effect in 2008, though the important thing is that it was phased out quickly once the recovery set in.
Germany is assuming €150 bn of new debt as part of a €356 bn package (10 per cent of GDP) to rescue companies hit by the pandemic. This will not only underwrite the debt of businesses but also provide unlimited cash to struggling businesses, through KfW, the State-owned development finance institution.
It will also include a €100 bn economic stabilisation fund, WSF, which will take equity stakes to recapitalise pandemic affected companies, thereby paving the way for partial state takeovers like was done for financial institutions during the Global Financial Crisis.
Taking all these into consideration, we propose the following set of policies.
(i) Financial institutions:
1. Unlimited credit support under the Liquidity Auction Facility (LAF) of the RBI;
2. Extension of the LAF window for NBFCs;
(ii) Non-financial businesses:
1. Debt forbearance for all businesses in the worst affected sectors;
2. Stop the clock on debt servicing and, consequently, on NPA recognition for a limited period. This may also be an opportunity for India to rethink the application of Basel capital adequacy norms on its banking sector and its NPA recognition rules;
3. Government guaranteed one-year loans to non-defaulting larger businesses so that they can continue to maintain their businesses and not lay off workers and pay their salaries, etc.
4. Interest free loans up to a limit, for a year, to non-defaulting SMEs;
(iii) As recommended by the Systemic Risk Council, prepare plans for providing Capital-of-Last-Resort support to distressed but essential businesses for which funding support is not enough, but whose failure would unnecessarily impair economic prosperity once the health crisis has passed
Output loss offset
1. Use the Direct Benefit Transfer (DBT) machinery to transfer Rs 7500 every month to all households who are not tax assessees;
2. Increase the supply of food rations under the PDS by, say, 10 kg per household – this will also help run down the large excess food reserves with FCI, thereby saving on storage costs and reducing wastage;
3. Extension of NREGS to cover own-farm labour for the next four months;
4. Sick pay rebates, up to an upper limit, for businesses with less than 100 workers whose employees are forced into isolation;
5. Exemptions and forbearance on tax and statutory payments of businesses in hospitality, food, and entertainment industries;
6. A temporary deferral on recovery proceedings by banks and financial institutions
In short, the government fiscal support should be to the tune of 1 per cent to 2 per cent of GDP.
The application of the Fiscal Responsibility and Budget Management Act should be suspended for the Union and State governments.
1. Provide direct aid, as appropriate, to business sectors that are vital to addressing the health crisis, or essential to reviving the economy when the health crisis eventually subsides;
2. Offer advance market commitments (AMC) to manufacturers for a period of one year, with governments offering to buy whatever they produce as testing kits, ventilators and other critical medical equipment at a generous enough pre-committed rate. Given the equipment scarcity faced by health facilities, this would be useful in any case, even after the crisis;
3. Directions to manufacturers to repurpose their production lines to produce ventilators and medical equipment, and support them with requisite fiscal incentives;
4. A carefully designed and targeted package aimed at the health sector to quickly expand capacity of hospital beds
These measures suggested are illustrative and their coverage should be targeted based on an assessment of the damage and loss suffered by the target beneficiaries.
They could be initially announced for the next four months. However, if the pandemic persists, besides extending they may even need to be deepened.
Besides these, the central government could formulate a model set of support measures, along the lines of the package announced by the Government of Kerala and encourage other State governments to adopt.
Front-loading plan expenditures for the year, as was done by Kerala, is among the easiest measures. In return, State governments could be supported with easing on FRBM limits, lower interest rates on loans from agencies like NABARD, and an appropriate grant package.
Aside from being a social insurance in such distress, these measures are also essential to keep people at homes, especially if the lockdown extends beyond a couple of weeks.
Given the need to act swiftly and effectively, decision makers should not fuss excessively over leakages and wastage and policy makers should take a walk into the wild side.
Access to these measures should be as simple as possible. There will be resistance at all levels, both individual and institutional.
Overcoming these hesitations is perhaps the most important requirement since time is of essence.
Mindsets will have to change, and quickly at that. A delayed response, apart from sharply increasing fatalities, will also make recovery longer and more painful.
Political leadership is required, in these times, to overcome and overrule bureaucratic risk aversion. Indeed, longer-term, the corona crisis could and should pave the way for administrative and governance reforms in the country.