Economic dislocation

FY21 will be a difficult year for all stakeholders

Fiscal 2020-21, which starts today, is likely to be one of the most difficult years in recent decades. Along with the rest of the world, India is engaged in containing the spread of Covid-19, which will entail severe economic implications, although it is difficult to gauge the extent of the damage at this stage. Even if the lockdown ends as scheduled, recovery in economic activity will take time. The fact that the global economy is slipping into a sharp recession will only make things difficult for India. Since these are still early days and economists are in the process of gauging the fallout, growth estimates vary significantly. Nomura, for instance, expects the Indian economy to contract by 0.5 per cent in 2020 and Moody’s Investors Service has sharply cut the growth forecast for calendar 2020 to 2.5 per cent from 5.3 per cent estimated barely a fortnight ago. While the estimates will keep changing with fresh information, the Union Budget’s assumption of 10 per cent growth in nominal terms looks far-fetched at this point.

Lower growth itself will put enormous pressure on government finances. Besides, the government needs to make large interventions at various levels to contain the damage being caused by the pandemic. While the government has announced a package for the most vulnerable section of the population, it might need to do a lot more to ease the pressure on both common citizens and businesses. The Reserve Bank of India has also taken a number of steps, including a significant reduction in policy rates, infusing liquidity, and moratorium on interest payments. But this may not be enough to save businesses, especially the small and medium enterprises. Businesses would also need government support. It is possible that a number of firms will fold up, and lenders will be affected big time. Bankruptcies and cash-flow issues could affect asset quality in the banking system and require capital infusion. Both the central bank and government would need to be alive to the damage. Policy intervention, to a large extent, will also determine how quickly normalcy is restored after the lockdown is lifted. Financial contagion, bankruptcies, and a significant rise in unemployment will prolong the slump.

However, one of the biggest weaknesses for India is that the government finances are stretched and will limit its ability to take countermeasures. For instance, the government invoked the escape clause in fiscal management rules before the impact of Covid-19 was visible in India. In fact, the government will find it difficult to meet even the revised deficit target for 2019-20, which ended on Tuesday. Direct tax collection, for instance, reportedly fell short by about Rs 1.5 trillion. Although the government is not in a position to spend like some of the advanced economies, such as the US, it will still need to increase expenditure. Fiscal expansion at this stage would be inescapable, but will increase financial stability risks. Even though it has not materially changed its borrowing programme for the fiscal year, the government should start working on a wider macroeconomic strategy to not only contain the damage, but also enable smoother recovery.