The biggest concern for India at this point is that the lockdown has done little to flatten the COVID-19 curve.
Two events over the past couple of weeks have served as a grim reminder that the Indian economy has sailed into the pandemic storm in a rickety ship. First, the GDP growth in the fourth quarter of 2019-20 (Jan-Mar) slumped to 3.1 per cent (year-on-year), while the overall growth for 2019 (calendar year) has turned out to be 50 basis points lower than previously estimated at 4.9 per cent — a far cry from the heydays of growth averaging around 9 per cent. Second, India fell off Moody’s good books — the rating agency downgraded India’s sovereign rating by a notch, reversing its earlier ebullience when India had embarked on reforms in areas of taxation and insolvency.
The calculation then was that these reforms would boost India into a higher growth orbit, which in turn would make fiscal consolidation easier. Instead, growth has declined, while fiscal dynamics have remained broadly unchanged. To add to its problems, the economy has seen an intensification of the “triple balance sheet crisis” spanning across stressed corporates, banks and shadow banks, leading to a systemic credit crunch and concerns over financial stability. As a result, long before the COVID-19 threat, there was seismic activity in India’s financial system, rocking the foundations of banks and shadow banks, with Yes Bank, one of the casualties teetering on the verge of default. Consequently, when the lockdown was announced at the end of March, an already ailing economy was in a comatose state.
Now that India is finally looking to exit the lockdown, we have to contend with the ghosts of problems past and present. For all intents and purposes, the first quarter of the current financial year is likely to be a washout, reflecting the cataclysmic impact of a catatonic economy. While there may be some resurgence in demand as restrictions are lifted, often called “revenge spending”, the appetite for such consumer spending will eventually be tempered by four major uncertainties. First, uncertainty about corporates. The crisis has caught most of them in the unawares, without scope to build adequate buffers. They have to contend with massive cash-flow pressures — of keeping the lights running for two months with minimal sales to support them. Most will have to sharply cut costs and possibly relook their whole business model, while the less fortunate ones may be pushed to shut shop.
Second, the uncertainty on unemployment. Firms currently find themselves in the unique situation of facing shortages of labour while downsizing their workforces. With migrant workers dispersed and factories under-utilised, the more formal workforce may have to face the brunt of cost minimisation. There is anecdotal evidence of corporates either axing employee payrolls or salaries, or both, in a bid to survive. Third, is the uncertainty about global growth. With the rest of the world in a quasi-lockdown, there is little support available from exports and crucial supply chains spanning across countries.
And fourth, there is the added uncertainty about financial stability. Recessions bring with them risk aversion, and with it a maddening rush of liquidity towards stronger balance sheets. This opens up a chasm between the haves and have-nots in the financial and real economies where lower-rated financial institutions and corporates will struggle to find funding given the elevated credit risks. Weaker entities may get trapped in a “ratings curse”, with lower ratings contributing to liquidity shortages, and increasing their vulnerability to cash-flow disruptions. This in turn, could increase their susceptibility to further rating downgrades, worsening their funding crunch, and burdening the financial system with more bad loans. Meanwhile, as household balance sheets come under attack, there will likely be renewed pressure on banks and shadow banks that have so far relied on the relatively safer retail portfolio as a virtual safety net. So the “triple balance sheet crisis” prior to the pandemic could possibly morph now into a “quadruple balance sheet crisis”, with stressed households joining the ranks of stressed corporates, banks and shadow banks.
What’s the antidote? The recently announced stimulus package worth around 6 per cent of GDP translates into roughly 0.8 per cent (of GDP) worth of actual cash outlays, with the rest either representing increased contingent liabilities (through implicit credit guarantees), or non-fiscal, regulatory relief (like relaxing EPF regulations). In itself, it’s a fiscally sensible package, but the focus has been more on addressing the cash-flow and credit needs of firms and the vulnerable segments of the populace as they emerge from the lockdown. Once they “survive” and settle into the new normal, the package will likely fall short of providing the much-needed demand boost to the economy. It will also most probably have to be revisited again if the second wave of COVID-19 hits and the spectre of a lockdown once again looms large.
On the monetary policy side, the Reserve Bank of India (RBI) has aggressively cut rates and injected liquidity into the system. While this was necessary, the bang is falling for the incremental rate cuts. The biggest issue today isn’t that policy rates aren’t low enough or that liquidity is inadequate, it is that the credit risks are elevated, and the spread of liquidity across the system remains inegalitarian. The credit guarantee programmes announced for shadow banks and MSMEs are steps in the right direction, but very small steps compared to the distance that needs to be traversed.
This suggests that there is more to do on both — fiscal and monetary policy fronts. The ghosts of problems past (the triple balance sheet crisis) and problems present (the demand deficit and the bad loan buildup from the pandemic shock) need to be confronted. However, lest we forget, this isn’t as much a man-made crisis, as it is a virus-made one. Without finding a cure for the health crisis, there is precious little that fiscal and monetary policies can sustainably achieve. Giving cash handouts when everyone is locked in will be subjected to a low fiscal multiplier. Similarly, doing a deep credit detox or trying to fix the funding gap between the haves and have-nots is going to be tricky if firms are going out of business.
The biggest concern for India at this point is that the lockdown has done little to flatten the COVID-19 curve. Easing the lockdown will most likely make the curve even more unrelenting, which is likely to translate into a protracted period of pain and uncertainty for consumers and businesses. So before the government and the RBI throw the kitchen sink, solving the health crisis remains the most potent economic vaccine out there. Get that in place, and in the words of Coldplay, “lights will guide you home.”
The writer is India economist and vice president Nomura. Views are personal