Disinfect the economy

Large policy interventions required in the near term

The world is still coming to terms with the havoc caused by the outbreak of COVID-19. India decided to shut itself down completely on Sunday, but many parts of the country are likely to remain locked down for weeks, with the Railways deciding to stop all passenger trains, including suburban service, till March 31. Such shutdowns, which are necessary to contain the virus, will of course have a significant impact on economic activity. While the government has done well to announce an economic response task force under Finance Minister Nirmala Sitharaman to come up with measures to support the economy, the scale of disruption is such that solutions that would normally take months to debate in more placid times must be pushed through fast. The economy has anyway been decelerating for several quarters and government finances are already under significant stress. So, while the primary objective at the moment should be to contain the virus, the government will simultaneously need to minimise the economic fallout.

Along with the central bank, it will have to intervene at multiple levels. For instance, a number of businesses will face a cash-flow crunch and find it difficult to survive. Regulatory forbearance alone may not be sufficient to save a large number of small businesses. The pandemic has also caused a severe disruptive impact on both the demand and supply side, which has the potential to derail the growth story. Further, a lot of businesses have borrowed from abroad and will find it difficult to roll over credit because of a shortage of US dollars in the global financial system. Given the state of the Indian banks, it will not be easy to refinance those businesses domestically. The Reserve Bank of India has taken some steps, but will need to do a lot more in the coming days. For example, to ensure liquidity in the economy, the RBI may need to consider changing the definition of recognition of non-performing assets for some time. A moratorium on debt repayments may also be required to help companies tide over their immediate cash flow issues. 

The government will have to step in to compensate for loss of income, particularly in the unorganised sector. A direct cash transfer has been advocated by economists and commentators, which could be a good way to meet the crisis. The Uttar Pradesh and Kerala governments have taken some good initiatives on this aspect. It may also be worth considering suggestions made by industry associations that a fiscal stimulus of around 1 per cent of gross domestic product, amounting to Rs 2 trillion, would be required to put money in the hands of people through the Aadhaar-based direct benefit transfer. But the steps have to be thought through carefully as the government will have to contend with a shrinking tax kitty. It is by now clear that fiscal expansion is unavoidable, but that’s a big challenge as any significant increase in deficit would push up the cost of money and affect businesses that are already under stress. It is also important to recognise India’s macroeconomic limitations. Unlike advanced economies, fiscal and monetary stimulus after the financial crisis did result in economic instability in India. Therefore, while large policy interventions would be warranted in the near term, policymakers should make sure that the way out of the current crisis doesn’t lead India to another one.