India is now in the second phase of a national lockdown. It took the drastic step when it had recorded only 10 deaths. It seems this is giving us clear benefits in the fight against the Covid-19 pandemic, though the results are still evolving.
As of now, breaking the transmission chain through lockdown is the route most countries have taken recourse to. The medical community is researching whether contracting the virus makes people immune to it in the long term — as is the case with measles. Some recovered Covid-19 patients have relapsed. A vaccine is 12-18 months away but, in the interim, lockdown cannot be a one-size-fits-all approach. The Spanish Flu circled the world from 1918 to 1920; there were three waves of the pandemic, with the third one accounting for 8 per cent of the overall deaths.
Hence, we need to think beyond the lockdown — implement testing and tracking on a massive scale aimed at protecting the most vulnerable, and support the economy through a fiscal and monetary package. In this context, monetary policy has to take a back seat to fiscal policy. Monetary policy can only effectively make a difference in the Covid-19 crisis by stopping financial panic in fixed-income markets, and the recent Reserve Bank of India (RBI) measures, including the latest one, have gone much beyond that. The fiscal policy must complement it now!
The problem with the current Covid crisis is the significant demand contraction that has been unleashed with the lockdown massively restricting social consumption (restaurant visits, domestic tourism, mass events etc). Social consumption that is cancelled now cannot be made up later. Manufacturers, though, can reasonably hope for a rapid recovery. But fiscal support is a must to speed up economic recovery after the epidemic is over, through, say, goods and services rate cuts for sectors that have been hit the hardest. That would also encourage banks to extend credit to these businesses, knowing that they will have higher revenues once the epidemic ends.
In fact, as experience of other economies show, post-Covid-19, the banking system must be effectively used for leveraging and playing the role of financial intermediation. This is specifically true for a country like India. For example, mapping the Covid-19 affected 284 districts in India for credit outstanding reveals that such districts amounted for almost 98 per cent of the outstanding bank credit.
Thus, it is imperative to give a push to the banking system through effectively designed policies like, say, credit guarantees (not half-hearted measures like a percentage of first loss) for sectors like small and medium enterprises (SMEs), where the leverage could be significantly higher. Such funds will help SMEs realise that during these tough times when demand is low, there will be no drying up of credit from the market. Additionally, through the fiscal package, the government can help SME’s manage their fixed and variable cost by providing relief towards rental payments and wages.
It is thus imperative that banks are incentivised with adequate safeguards to lend in the current scenario. This is all the more relevant as many companies will now fully use their credit lines to build up cash reserves for the crisis, a trend already evident in India.
Independent research (Elizabeth Bogan, Princeton University) suggests that much of the argument for shutting down today is based on a 2007 study of the Great Pandemic flu of 1918-19. “Closure of schools, churches, and theaters, was associated with lower peak death rates…. These findings support the hypothesis that rapid implementation of multiple non-pharmaceutical interventions can significantly reduce influenza transmission, but that viral spread will be renewed upon relaxation of such measures.”
The cities with the interventions did flatten the curve but didn’t reduce the cases or death rates significantly even after six weeks. Does that mean that countries will continue with stringent lockdown for even longer? In that case, we will have to unleash the fiscal package quickly without any delay. All the arguments that India has limited fiscal space and it must cut its coat according to its cloth are disjointed and completely oblivious of the fact that the economic cost of a shutdown involves people dying of stress-related diseases or from hunger. For example, we know there was a significant number of deaths among those who lost their houses to foreclosure during the global financial crisis.
What could be the size of such a fiscal package? As the accompanying graph shows, India is at the top of the Stringency Index ( The Economist), but has given the least policy support to date, although countries even with large per capita income have implemented staggered packages. Thus, apart from the Rs 1.75 trillion package announced by the finance minister, of which Rs 73,000 crore was new and the rest from the current budget, the government needs to announce a fiscal package for the affected industries and sectors which are on high and medium risk. Our estimates suggest that given a labour income loss of at least around Rs 5 trillion, the minimum subsistence fiscal package must be scaled up by at least Rs 5 trillion, or 2.5 per cent of gross domestic product (GDP), over and above the incremental Rs 73,000 crore (0.4 per cent of GDP) that was unleashed in the first phase. Alternatively, India had a nominal GDP growth of 7.8 per cent in FY20 and in the current fiscal it could drop to 4 per cent. This implies even if we have to bring the economy back to FY20 baseline, the size of the fiscal package should be at least 3-4 per cent of GDP, or Rs 6-8 trillion. Even this would be sub-optimal.
Two things are important. First, how do we finance such a package? Apart from a full-fledged credit guarantee fund, issue tax-free Covid bonds. Tax-free bonds have completely dried up in recent years, and in the current equity market, such bonds will have a significant market appetite. Also, we could look at monetisation of deficit through relaxing the Fiscal Responsibility and Budget Management norms for both the Centre and states. The anathema towards such monetisation is surprising, since sustained, large-scale government bond purchases have become a part of the toolbox of central banks, irrespective of the fiscal policy stance. Second, it is now advisable to take a relook at the 90-day non-performing asset norm on a temporary basis, given the exceptional circumstances created by the Covid pandemic.
Ghosh is group chief economic advisor, State Bank of India, and Pulak is professor, IIM Bangalore. Sumit Agarwal, professor, National University of Singapore, contributed to this column. Views are personal