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Below is the Views On Piecing together India's economic response to COVID-19 by Arvind Chari Head - Fixed Income & Alternatives, Quantum Advisors
Raghuram Rajan, the ex-Governor of the Reserve Bank of India (RBI), in an article, has stated the economic fallout from the COVID-19 crisis to be India’s ‘greatest emergency’ faced since Independence. That may not be the mainstream view yet, but many will agree that the economic situation is indeed dire and is unlike anything India has faced until now.
The initial response from economists and portfolio managers was to compare and juxtapose the likely economic impact of COVID-19 with previous economic crises like the September 2008 – global financial crisis; the period post demonetization; post taper tantrum impact of July-August 2013; period during SARS - January – April 2003.
However, as things have progressed, many have realized that COVID-19 is unlike any other shock the modern global economy has seen. The fact that it is a global crisis and that it mandates humanitarian compliance and sacrifices makes it more complicated in terms of the economic response required to fight the pandemic.
In India, the immediate reaction was to check the spread by starting with international travel restrictions, encouraging social distancing, restricting non-essential work and finally enforcing the stricter but required full country lock-down. This was despite India’s overall numbers being low and the infection rate slower than other major impacted economies. It was good to see India pro-active in its approach in tackling the initial spread of COVID-19 and which will, hopefully, pay rich dividends.
A forced lockdown continued for long though has economic consequences and the government will have to make the trade-off of prioritizing saving ‘Lives’ through tough health measures or to relax the lockdown to allow certain segments of the society to gain back their ‘Livelihoods’.
This trade-off decision is germane and immediate for India given that
a) we have had a weak and a slowing economy leading up to COVID-19 and thus incomes are low
b) the existing social safety net needed to deal with a lockdown is poor and
c) the casual laborer is the most impacted and is the most vulnerable during the lockdown and thus requires to be looked after.
I saw a Twitter poll, which questioned – “By when will India’s economy (GDP growth rate) get back to normalcy?” I asked, rather pertinently, I thought, “What normalcy?” – the normalcy prior to demonetization (7%) or normalcy back to the recent period of growth (5-6%) or the normalcy which many hoped before the 2008 financial crisis (+10%) or what some hoped post Modi’s resounding win in 2014 (8%).
It is important to understand and internalize this normalcy, as it would then determine the scale, size and nature of the required economic response to deal with the economic shock of the lockdown and the overall impact of COVID-19.
Our base case estimates put India’s GDP growth rate for FY 20-21 to be just about positive with an assumption that lockdown opens up only in June, migrant laborers return gradually to urban job centres thus impacting manufacturing and services revival and state and centre’s fiscal deficit increases to 9% of GDP from 6% of GDP.
An estimate of higher fiscal spending, efficient safety nets, better management of migrant laborers and immediate revival in activity could lead to GDP estimates ranging from 2%-5% for FY 2021.
A dire reading on the assumption of inefficient fiscal spending, migrants going back to villages on opening up of the lockdown, delayed revival in activity and spread of the pandemic in rural India continuing the lockdown will give for deeply negative growth rates, the impact of which will be devastating for many households. Even our base case estimate of fiscal spending increase of 3% of GDP seems limited, when you do a back of the envelope calculation of (Daily GDP * % of economy not functioning* days lost), which suggests a vastly higher fiscal support to buffer the economic hit.
The government’s recent ‘welfare’ spending annoucement of less than 1% of GDP, some of which are already part of the budget provisions, combining free food, free gas, cash transfers and others appear limited. But it also suggests that more may be forthcoming and that the government is readying a ‘stimulus’ package for small business and industry.
We are of the view that in the current circumstances, spending more on ‘welfare’ and less on ‘stimulus’ should be the priority. Substituing peoples’ lost income with free food, cash transfers, insurance and government work will buffer the social impact of the lockdown and also help maintain consumption demand. Economic stimulus for businesses to produce more can wait for when the lockdown is completely removed and business still struggle for demand.
Although, India needs to spend and not worry too much about fiscal deficit as a % of GDP, but given that the Centre+State+PSU borrowing remains at ~9% of GDP, the scope for a US style another 10% of GDP stimulus does not exist. The government thus will have to prioritise whatever leeway it has in increasing the fiscal deficit and not try to do everything for everyone. This also ties with my point above on knowing what is India’s normal economic growth given the recent past and act accordingly.
Too much fiscal leeway, may give us growth but will lead to a sell-off in INR. Too little, will lead to sharp mark downs in growth estimates, corporate profitability and asset valuation.
Foreign Investors will also watch how we deal with the migrant labor situation from a social risk perspective and on how fast are we able to get businesses back to some form of functioning as compared to other emerging markets.
The bond markets for now seem well supported by an all-encompassing RBI opening the liquidity spigot, cutting rates, allowing forbearance on EMIs and seeming ready to do more. At some time, there will be an ask of the RBI to support the government’s fiscal easing, directly or indirectly and the RBI is likely to abide, which will further support the government bond markets.
The problem though for the RBI remains the lack of risk capital in the economy. Banks, especially PSU banks, scarred by high NPAs and strung by low capital, continue to shy away from risk taking. Post the IL&FS crisis, bond markets for lower rated corporates and stressed NBFCs has also remained frozen. With the uncertainty now with COVID-19, risk appetite of even private banks and well run NBFCs will take a hit. The RBI thus may have to deal with this situation of very low risk taking in all segments of its credit economy into consideration in planning its response.
The only two entities which can take risks under uncertainty without worrying about too much about their balance sheets remain the Government and the Reserve Bank of India. We won’t be surprised to see the RBI taking on a larger role in guiding Credit and Currency to the markets and the government in providing Compassion and Confidence to its citizens.
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