The situation with Covid-19 is evolving and so is the response. Any measure must not be regarded as the last. The lockdowns have succeeded in flattening the curve and keeping India’s death rate per million down to 1.3 compared to that of the US at 226 and the UK at 449 in mid-May. Given India’s billions, deaths would otherwise have been in lakhs compared to the current thousands. But lockdowns did not succeed in eliminating the virus. Unfortunately, it is also impervious to the Indian heat. We have to learn to live and work with the virus under a phased lifting of lockdowns.
Medical and technology readiness has improved somewhat and there is more awareness of strategies such as tracing, social distancing, use of masks, sanitisation and hand-washing that can keep infection rates down.
It is not very useful to give a large demand boost when supply will only slowly limp back towards normal. The fall in supply with the lockdown was greater than that in demand, as demand for essentials remained intact and consumers substituted towards media and Internet-related products. Ex-ante demand must exceed supply to induce profitable production.
Therefore, the package correctly focussed more on supporting a recovery in supply. The first priority, of course, is on better food security cover for the distressed, as well as community healthcare facilities. Expanding these also generates employment, as does expansion in MGNREGA.
Packed urban centres were more exposed to foreign travel as well as to infection spread. Job losses as well as fear of Covid-19 triggered panic reverse migration to rural areas. This happened during the Bombay plague of 1896 also. Millions were killed then as the disease spread through the country. Faced with starvation in villages, labour returned in a few years. This time, hopefully, also the return will be there but not be in excess. States have had time to set up quarantine facilities. Many aspects of the package will create opportunity in rural areas.
Economists’ models tell us the best way to reduce excess migration to large cities is to improve conditions in source areas. Since big cities will continue to be red zones for quite some time, entire industrial supply chains should move to smaller cities and rural clusters. Implementing the new requirements of more spaced out work spaces will be cheaper there. Urban firms will be forced to take better care of fewer workers. Living conditions of workers will improve. Mumbai specialises in finance and media where distant work is possible.
Infections in congested agricultural mundis have allowed alternative marketing arrangements to bloom. The genie is out of the bottle, finally giving more options to farmers and consumers. Repeal of the ancient and draconian Essential Commodities Act will do the same. It will attract private investment in food processing and storage and help increase export of agricultural products. Supply-side initiatives will keep food inflation low, allowing room for more monetary stimulus. Lower interest rates also help debtors. A clear choice made in the package is that of delivering stimulus through the financial sector. Credit guarantees overcome banks’ reluctance to lend and create risk-free earning opportunities for them. The liquidity the RBI has created will begin percolating through the economy. Lower negative spillovers from bankruptcy will protect banks’ assets and reduce future government liability. In any case liabilities are easier to finance when growth and taxes recover.
The second advantage of using banks is their pricing and evaluation of credit risk helps restructuring towards viable business plans under the new conditions. There are incentives for firms such as interest subvention if loans are repaid, and for banks to carefully assess risk and ensure recovery.
The alternative view is the financial system is broken and will not deliver. Instead, government must pump more capital into it, create a bad bank and so on. But this assumes the government has unlimited resources and neglects the critical mass of reform already accomplished. It is better instead to use the financial sector and heal it in the process. Further capitalisation can come at a later stage if corporate stress persists and NPAs rise substantially. Even sanctioned loans are not being utilised since firms do not want to draw until lockdowns ease. As firms take loans, pay wages and rebuild stocks in order to restart supply to meet pent up post-lockdown demand, they will create further demand through the economy. Demand must remain one step ahead of supply as it is at present. There is space for further stimulus if demand falters at a later stage. A large share of existing transfer payments has been saved not spent.
The government will also make a large contribution to liquidity in the economy if it fast tracks all dues — with 45 days as the outer limit. This should become the practice and will reduce future cost of loans. Cash rich companies should contribute by clearing their dues to smaller firms in their supply chain. Plentiful liquidity makes it unnecessary to hoard liquidity for most firms.
There are many opportunities for those who adapt, and take initiatives instead of lobbying for help. Resilience can outlast any temporary shock. The lockdown made local MSME brands, which were more easily available, visible. Even the fight against Covid-19 has been most successful in States where local communities have been in the forefront.
With so much loss and suffering demands for help are unlimited. It is important to listen, but limited resources make it necessary to target the most vulnerable while preventing possible moral hazard and to spend where it will be most effective. Raising government debt and deficits indefinitely in an emerging market dependent on capital flows and rating agencies is a recipe for macroeconomic instability. Unwise government spending will burden future taxpayers. Both too much and too little is unwise.
Even so, the fiscal stimulus exceeds the perception. Equating fiscal stimulus to promised new government expenditure of about 1 per cent is a misconception. Excess of expenditure over taxation is the demand stimulus. As revenues fall, this will be much larger than 1 per cent. Estimates of government borrowing (fiscal deficit) vary between 6-12 per cent of GDP.
Moreover, governments around the world have used off budget warranties that stimulate private expenditure by enabling more lending. This is a smart strategy, because it helps lower interest rates for private borrowing and allows monetary cooperation without excess money growth.
If a credit-led cycle kick-starts the economy and revenues rise, less government borrowing will be required to fund the same expenditure. Growth reduces deficit ratios by raising the denominator; emphasising empowerment over entitlements sustains growth. Government debt is sustainable if the real interest rate is lower than the growth rate, and borrowing net of interest payments is reducing. The package should be complimented for enabling lower interest rates and higher growth, while keeping fresh borrowing capped, yet making sure demand remains a step ahead of supply.
The author is professor IGIDR and member EAC-PM. Views are personal