The current crisis calls for a carefully calibrated injection of demand stimulus which should be synchronized with the stages of the exit from the lockdown.
Multilateral institutions have assessed that the COVID-19 pandemic will leave the world economically worse than the 2008-09 global economic and financial crisis. The International Monetary Fund (IMF) and the United Nations (UN) have projected the global GDP to contract by (-) 3% and (-) 3.2%, respectively in 2020. As per the UN, two major emerging and developing economies, namely, India and China, are expected to show a low but positive growth at 1.2% and 1.7%, respectively in 2020. Other leading international institutions and rating agencies project this year’s global growth to range from (-) 5.9% (Deutsche Bank) to (-)1.1% (JP Morgan).
The COVID-19 induced economic crisis is quite different from the 2008-09 global economic and financial crisis in some crucial respects. The roots of the 2008-09 crisis emanated from the housing market crisis of the US and excessive lending by global financial institutions to households based on poor quality collaterals. The credit markets across the world crashed, leading to a collapse of credit demand across the countries. This was a demand-led crisis that was addressed by individual and coordinated stimulus across the G-20 countries. These countries coordinated their stimulus action by reducing interest rates and increasing their debt-financed government expenditures. In some of the economies where stimulus measures were overdone, there was a sharp rise in inflation. The longer-term outcome was an increase in the indebtedness at the global level.
Since the COVID-19 crisis may be deeper than the 2008-09 crisis, the reliance on fiscal measures would be even larger. In fact, in most developed countries, the interest rates are near zero and any monetary side stimulus may have limited effect. As such, the borrowing-based financing of government expenditure should serve to boost the demand in different countries. However, the current crisis is a combination of supply side disruptions and a sinking of demand. As demand is uplifted through stimulus, supply side disruptions may have to be simultaneously removed so that the two sides may come out of the crisis in sync. This calls for a carefully calibrated injection of demand stimulus which should be synchronized with the stages of the exit from the lockdown.
India: slipping into a fall while already on a slide
India’s current growth prospects are highly constrained as it has entered the COVID-19 crisis on the back of an economic downslide. The real GDP growth was estimated at 5% for FY20 as per the earlier Central Statistical Organisation’s release dated 28 February 2020. As more recent information for 4QFY20 becomes available, this estimate may go down significantly. The UN has projected India’s FY20 growth at 4.1%. Available forecasts for India’s FY21 growth vary from (-) 5.2% (Nomura) to 4.0% (ADB), showing a wide range of 9.2% points. This indicates significant uncertainty in the assessment of the economic impact of COVID-19 on the Indian economy.
High frequency indicators highlight significant adverse impact of the COVID-19 pandemic. Purchasing Manager’s Index (PMI) manufacturing and services contracted to unprecedented levels of 27.4 and 5.4, respectively in April 2020. Reflective of the weakness in demand conditions, growth in bank credit remained subdued at 6.7% in the fortnight ending 24 April 2020. In March 2020, Index of Industrial Production contracted by (-)16.7%, its lowest level in the 2011-12 base series. Contraction in power consumption increased considerably to (-) 24.7% in April 2020, reflecting a sharp fall in domestic demand. At (-) 60.3% in April 2020, contraction in exports was the sharpest since 1991, reflecting global and domestic supply disruptions. With respect to automobile sales, information from major players in the sector indicates zero domestic sales in April 2020. Gross tax revenues of the center contracted by (-) 0.8% during April-February FY20 with direct taxes contracting by (-) 3.5% and indirect taxes witnessing a subdued growth of 1.6%.
Fighting our way out: policy stimuli and preparing for the new normal
On the monetary side, the repo rate was reduced to an unprecedented level of 4.0% on 22 May 2020 with a cumulated reduction of 115 basis points since 27 March 2020. Other relevant rates such as reverse repo rate, bank rate and marginal standing facility (MSF) rate have also been reduced. Numerous liquidity-augmenting and regulatory measures have also been undertaken since the end March 2020. Liquidity augmenting initiatives include a reduction in the Cash Reserve Ratio, targeted long-term repos operations (TLTROs), special refinance window for all India financial institutions, and eased overdraft rules for state governments.
The RBI also increased the limit under ways and means advances (WMAs) for the central and state governments. In TLTRO 2.0, as announced on 17 April 2020, an aggregate amount of INR50,000 crores was particularly aimed at supporting NBFCs. On 27 April 2020, the RBI announced an injection of INR50,000 crore through a special liquidity facility for mutual funds. The regulatory initiatives of the RBI include permitting commercial banks and financial institutions to provide moratorium of three months on payment of instalments in respect of all term loans outstanding as on 1 March 2020 and deferment of interest on working capital facilities for three months on all such facilities. These have been extended for another three months till 31 August 2020. According to government estimates provided on 17 May 2020, the monetary stimulus through liquidity enhancement measures amounted to INR8.01 lakh crores.
A stimulus package of a cumulated magnitude of INR20.97 lakh crore has been announced during the period 26 March 2020 to 17 May 2020 for the Indian economy, of which the additional budgetary cost is limited to only 9.7% of the total package. As compared to the FY21 budget estimates (BE), both the central and state governments would suffer a significant revenue erosion due to the lower FY20 tax base and lower growth prospects in FY21. Recognizing this, the central government has announced its revised gross borrowing program for FY21 uplifting its fiscal deficit from 3.5% to 5.7% of the GDP. Additionally, borrowing limit for states has also been relaxed from 3.0% to 5.0% of their respective gross state domestic products subject to certain conditions.
While the need for a large fiscal stimulus to support relief and stimulus measures is paramount, the available resources for the government appear to be highly constrained while matching the public sector borrowing requirement (PSBR) with the sources of its financing. India has stepped into the COVID-19 crisis on the back of two successive years of fiscal slippage where the central government had to provide for a countercyclical relaxation of 0.5% points of the GDP, each from their respective targets in FY20 (RE) and FY21 (BE). India is far more handicapped at present as compared to the 2008-09 crisis when we experienced five successive high growth years over the period FY04 to FY08. The average growth rate during this period was 7.9%. In FY08, the combined fiscal deficit of the central and state governments was also at its lowest at 4.1% of the GDP.
The total PSBR is estimated at 15.60% of FY21 GDP. This includes (a) fiscal deficit of 7.1% of GDP for the center which would be required to cover the shortfall in revenues and non-debt capital receipts, the impact of lower nominal GDP growth and to accommodate the stimulus package while maintaining the budgeted expenditures, (b) fiscal deficit of 5.0% of GDP for states and (c) borrowing requirement of 3.5% of GDP of public sector enterprises. Against this, the available sources of financing consisting of excess savings from household and private corporate sectors (7% of GDP), savings of the public sector (1.5% of GDP) and current account deficit (1% of GDP) add to only 9.5% of GDP, leaving a significant financing gap of 6.1% of GDP. Some of the channels through which this gap may be filled up include monetization of fiscal deficit, borrowing from multilateral institutions including the IMF, and borrowing from non-resident Indians (NRIs).
India’s lockdown has continued for more than two months. It was characterized by minimal economic activity. Whenever the economic activities resume, they may not normalize for a long period of time. In fact, their resumption needs to be undertaken according to a well-thought out exit strategy. Different output sectors may resume activities at a different pace as the pandemic is gradually brought under control. Sectoral targeting of fiscal stimulus should be synchronized with the opening up of the relevant sectors. India’s FY21 growth would depend critically on the pace of opening up of the sectors and the effectiveness of monetary and fiscal stimulus.
There is an urgent need to reprioritize budgeted expenditures in favor of health-related expenditures including health infrastructure. In terms of rebooting the economy, new manufacturing capacity needs to be attracted in India which would require additional budgetary allocation. In fact, both revenue and expenditure side estimates of the central and state budgets, which were only recently presented in the Parliament and respective legislatures, would need to be overhauled. As things begin to normalize, there may be a need to present new full year budgets since the existing budgetary numbers have been rendered irrelevant by the onslaught of the economic pandemic.