View: Policymakers need to be prepared to fight three sets of challenges post lockdown
By Sonal Varma & Aurodeep Nandi
India, like most other Covid-ravaged countries, faces a dilemma between lives and livelihoods. The 21-day Lockdown 1.0 till mid-April was estimated to result in only around 25% of the economy being open (public utilities, financial services, essential goods and services, etc). Lockdown 2.0 till May 4 involved further opening of agriculture, construction and manufacturing, particularly aimed at the rural economy. With Lockdown 3.0 till May 17 in place, about 45% of the economy is estimated to open, although mostly in the ‘green’ and ‘orange’ zones. As India tiptoes past Covid-19 to get back to work, policymakers need to be prepared to fight three sets of challenges: health, supply chain and economic.
Health: India has so far managed to stop the rate of increase in new infection cases — the epidemiological curve — from spiking. But the curve has flattened due to India’s early lockdown decision. As we relax restrictions gradually, the risk of cases rising remains. Covid-19 will most likely be a far more elusive virus to control when people start criss-crossing the country, especially given that current hotspots are unsurprisingly also economic and financial hotspots. Until a vaccine is found, some form of social distancing has to continue, even after stringent lockdowns end.
Supply chain: Companies today have their raw material sourcing, production and distribution centres spread across the country. With much of the economy still closed (mainly in ‘red zones’), and some state governments likely to tread very cautiously when implementing resumption plans, supply chains are likely to remain frayed. Factories will have to contend with raw material challenges, labour shortages, closed dealerships and test the practicalities of working under a social distancing paradigm. Retail footfalls will remain low as individuals prioritise safety, resulting in weaker demand.
Economic: After the earthquake comes aftershocks. India’s existing triple balance-sheet crisis — of corporates, banks and shadow banks — is potentially morphing into a quadruple one: of households. As corporate profits are hit and bankruptcies rise, there will be an inevitable impact on wages, jobs and consumption. This, in turn, can snowball into renewed stress for the banking sector.
Rising credit risk premia mean that excess liquidity does not guarantee a chase towards the highyielding risky assets as return of capital becomes more important than return on capital.
back to business Excess liquidity will continue to find itself drawn to stronger balance-sheet entities, making for incredibly rough terrain for the weaker entities. The gulf between the haves and have-nots is set to widen even further. As the economy restarts, it is extremely important to have appropriate policies in place. The priority needs to be on ensuring the lack of liquidity does not morph into a solvency crisis, and to preemptively avert any dislocations for corporates, individuals and financial sectors.
More importantly, to not let our guard down against the virus. Policymakers are relying on the banking system to play the normal role of an intermediary to extend loans and invest in non-government entities. But these are not normal times. Given the capital constraints facing public sector banks (PSBs) and rising credit risk premia more broadly, the credit channel of monetary policy transmission is broken.
Instead of relying solely on the banking system, a more direct approach must be considered for effective transmission.
This could involve a government guaranteed loan scheme for vulnerable entities, RBI accepting a wider range of instruments (corporate bonds and commercial paper) as collateral under its liquidity adjustment facility, or a government-backed special purpose vehicle (SPV) that buys corporate bonds and commercial paper with the aid of a liquidity line from RBI. The liquidity line could be made conditional on benefiting entities maintaining employment.
Other fiscal measures to improve corporate cash flow, such as sharing fixed cost of companies, deferred tax burdens and lower utility costs can be considered. These would result in a larger deficit and higher contingent liabilities for the sovereign. There are ways to create some fiscal space. But the broader question to ask is whether the alternative — not addressing the core issue —is any better.
In sum, to use the phrase popularised by former US secretary of defence Donald Rumsfeld, as India’s lockdown door is unlocked, the ‘known knowns’ will be managing the health contagion. The ‘known unknowns’ and ‘unknown unknowns’ will be stopping it from spiralling into financial and economic contagion.
(Varma & Nandi are chief economist, India & Asia ex-Japan, and India economist, respectively, Nomura)
