Here's Why the Centre, States and RBI Need to Act in Unprecedented Unison

The economic recession precipitated by the COVID-19 pandemic is unprecedented in its severity, and far worse than the downturn at the time of the global financial crisis. The lockdowns across the world have resulted in virtually all economic activity coming to a standstill with the exception of the provision of essential goods and services and  work that can be done digitally from home.

Other countries have tried to minimise the damage by announcing fiscal stimulus programmes of an unprecedented size. The largest stimulus package in US history of $2 trillion has been approved with remarkable speed and bipartisan consensus.

This is 10% of the GDP. There is relief in this package for everybody; direct payments to the unemployed, small firms and industries like airlines which have been severely impacted.

The present lockdown in India, will end on May 3, but the damage it has done is mind-boggling. Around 90% of workers are not in the organised sector and therefore enjoy none of the protection that workers in the industrialised countries enjoy. The extent of their vulnerability has been exposed dramatically over the last few days in urban India, where casual workers and the self-employed have lost their daily income, have hardly any savings, have been denied transport but are choosing to walk to their villages for the modest support that their families can provide. Even the announcement by the finance minister of free foodgrains for the poor did not deter the mass exodus that was building up. 

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While this, and several of the other announcements of the finance minister and the RBI governor in the first days of the lockdown were a good beginning , a holistic strategy is needed to minimise the damage it can do to the economy. This has to be  free from earlier, settled, ways of thinking, and imbued with a determination to do whatever it takes to ensure that the economy rebounds as rapidly as possible when the lockdown comes to an end.

For this, it is imperative for the government to give up looking at the fiscal deficit till the pandemic is contained.

The US decision committing over 10% of the GDP in their relief package is a good example to follow. During the World Wars in the last century, the deficits went up to well over 20% of GDP. We do not need to go that far now, but certainly  a multiple of the present 1% is immediately needed.

The immediate goal must be to ensure that testing, quarantine and treatment capacities are ramped up as rapidly as possible to be able to cope with a worst case scenario. Till  the pandemic is contained the government’s second over-riding priority must be to ensure that nobody is allowed  to go hungry. Those who have to deliver on these, which effectively means the state governments, must be allowed  to act on the premise, and with the full confidence, that there will be no budgetary constraints on their spending.

To achieve  these immediate objectives, our government  needs to adopt some of the processes and procedures that governments have used during  war time, notably the commandeering of all of the nation’s resources for the production of essential materials. President Trump has used such a provision in the Defense Production Act for production of ventilators. Prime Minister Narendra Modi should be willing to do something similar if needed.

One crucial requirement for this is the  explicit empowerment of those who have to take decisions at various levels of the bureaucracy to short circuit procedures and rules without having to  fear censure by auditors or scrutiny by other investigating agencies in the future. An efficient system of giving immediate sanctions, delegating additional powers and of granting ex post facto approvals would make all the difference. Timely delivery of results must be the sole objective.

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What the absence of such enabling provisions can do has already been demonstrated by the government’s inability to supply the 70 lakh safety kits for health workers that it had committed itself to providing in the first days of the lockdown. As of April 10, the hospitals had received less than 1% of these. Inquiries by the media have revealed that this is because contracts with 24 of the 39 firms that were asked to produce these were signed only in the first week of April. 

The challenge of getting the economy back on track after containment of the virus is daunting. Factories, shops, hotels, restaurants and transport services have been closed. Millions of migrant workers have been forced to leave their places of work. For the proprietors debt and other liabilities are rising while revenues have  collapsed. This has come after they have suffered many quarters of continuing economic downturn and declining growth rates. 

The provision of additional working capital at concessional interest rates and a continuing moratorium on the repayment of debt without the banks extracting their pound of flesh by continuing to accumulate interest payments during the moratorium period,  is a must. Alternatively an interest subsidy from the government will be needed. 

Enterprises have been given a little breathing time with the extension of the dates for various returns and compliances. The RBI has injected additional liquidity, lowered interest rates and extended time for debt repayment. But a lot more is needed for re-generating the demand for domestic goods and services instantly, that is needed for a V-shaped recovery. Latent domestic demand in India is large enough for this. Investment needs for mass affordable housing, infrastructure and restoring the environment are huge. 

At the time of the 2008 financial crisis the government had a fiscal stimulus amounting to 4% of GDP. This did result in an immediate recovery from the global recession, in 2009. A much bigger stimulus would be in order this time. Without it, the economy is certain to enter into  a long period of stagnation.

Given the shock of the present lockdown and the earlier slowdown, neither private investment nor demand is likely to pick up quickly on its own. The lesson to be learned from the 2008 experience is that  the government needs to start reducing the deficit only after the recovery gets going. This should not be difficult to do because a quick recovery will immediately start swelling both tax and non-tax revenues of the central and State governments.

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Debt servicing will therefore also  return quickly to normalcy. The equity markets will recover and, since the rupee is fortunately also depreciating after a long spell of appreciation of the Rear Effective Rate of Exchange, exports are also likely to benefit.

The RBI should encourage this by further by bringing down borrowing rates though appropriate changes in policy interest rates and the Cash Reserve Ratio.

The singular focus of all its decisions in the days ahead must be  an immediate boost in demand for existing idle capacities across the board within the country. This would then create the business case for long overdue fresh private investment.

Some concerns

One concern that the government needs to keep in mind is  how rating agencies will react to a ballooning fiscal deficit. The fact that  all but a few of the industrialised economies have already announced huge fiscal stimulus packages should take some of the edge off their concern, but a reassurance by the government that it will return to  the fiscal deficit limits set in the Fiscal Responsibility and Budgetary Management Act as soon as the economy recovers will provide the comfort that foreign investors will need to prevent a flight of short term capital from the country. 

India should have the confidence to do what it needs to. It is also worth remembering that in the short run, some further withdrawal of foreign institutional investors will complete the process of undoing the real exchange rate appreciation of the last decade.  

Since global commodity and crude oil prices are falling, a depreciation of the rupee will also not be inflationary. There could also be an increase in foreign direct investments in order to take advantage of the resulting increase in its international competitiveness. What the government must resist is the temptation, and the pressure it will come under from those who have borrowed heavily abroad, to go in for sovereign borrowing to prop up the exchange rate. This will be sacrificing the interests of the many for the benefits of the few. In any case there are other ways of sustaining the solvency of legitimate international borrowers like the airlines.  

Another spectre that is raised by an increased budget  deficit is that it might cause inflation. This is a legitimate concern in normal times. But a high deficit is needed now not to increase purchasing power in the economy but to prevent it from collapsing. The relief package therefore needs to be bold and ambitious and drawn up keeping normal concerns regarding the fiscal deficit in temporary abeyance.

Universal cash transfer

Fleshing out a relief package for the Indian economy is more challenging as the situation here is sui generis. One feature of some of the relief packages announced in developed countries has been the payment to firms of 70-90% of the wages of workers to enable retention of workers. Those rendered unemployed are getting unemployment benefits under the existing social safety nets. These have been liberally improved in some countries especially in the US. In India firms are not free to shed regular workers in a period of downturn due to the rigidity of the labour laws.

To get around this all enterprises, including the large firms, have a substantial number of contract workers. Almost all these contract workers have lost their jobs by now. They have no social security benefits. The result has been the massive movement of migrant labour back to their villages. They do not exist in easily accessible records. So directly paying firms to retain their contract workers is no longer an option. Nor is direct payment to the workers whom they have laid off, and are now unemployed. The only feasible alternative is a universal cash transfer is.

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The Central government has so far sanctioned Rs 500 and one month’s supply of free foodgrains. Some states have supplemented it. Free cooked meals are also being provided in places. Now that the lockdown has been extended for another two weeks it is imperative that a far larger universal cash transfer be made to them.

Since every enterprise, micro, small, medium and large, has been badly hit, it is difficult to grasp the enormity of the challenge. So many of them may be headed towards bankruptcy. Almost all need relief to be able to survive and recover. This is the reason that the relief packages in the developed economies which are going through a lockdown are so large. They provide to private enterprises a mix of tax breaks, grants, state guarantees for debt, concessional loans, capital infusion and measures for additional liquidity.

The relief the RBI has given, of postponing all loan repayments for  three months has provided the government with ample time to put together a proper relief package. This has to be  bold and enough to restore confidence and animal spirits in the entrepreneurs of the country. It has also to be generous. If there was ever a time for avoiding penny pinching, it is now.

Act in unison

The government, the RBI and the banks, need to act in unison in ways they have never done before. An announcement that till the next financial year, no new cases will  be sent to the NCLT for bankruptcy proceedings and that none of their loans will on any account be declared to be non-performing assets (NPAs) will alleviate much of the pessimism, bordering on despair,  that has seized the corporate sector.

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 Enterprises, both large and small, whether in industry or trade,  also need money to meet their other current costs, such as electricity bills. So Banks need to provide additional working capital liberally with a moratorium on repayment till recipients’ revenues rise sufficiently. To do this they will need a  directive from the RBI stipulating the multiple of their clients’ existing working capital accommodation that they can freely sanction.

After recovery there will, in most cases, be an urgent need – in fact no alternative — to  restructuring the debt of many more enterprises than those that are already in trouble because of the industrial slowdown after 2011. This will require  spreading repayment over a longer period to make debt servicing feasible. It may also require hair cuts – the write-off of a portion of the debt or a cut in the interest rate. Clearly, the government will need to pitch in, to persuade the RBI to allow this. An interest subsidy by the government for such debt given for the current financial year would be one way of  keeping banks healthy. 

The interest subsidy that the government will need to give will emerge from an  assessment of the repayment capacity of the enterprise. As the impact has varied across sectors, a differentiated treatment for different sectors will, almost certainly,  be necessary. A generous credit guarantee to small and medium enterprises through SIDBI (the Small Industries Development Bank of India) may be the only way forward for them. However, many  medium and large enterprises will also need an infusion of equity capital to survive and prosper in the medium term if the government succeeds in fashioning a ‘V’ shaped economic recovery. Some other governments have created a fund for this purpose in their relief packages. 

India could do the same. The Vajpayee government’s bailout of the Unit Trust of India, in which millions had parked their small savings in the ‘nineties, is a good precedent.

If  the above relief measures are implemented  all but a few enterprises will be able to respond to the revival of demand when the lockdown is over  and get going again. But the demand needs to be generated first. The surest way of doing this is not to allow it to shrink in the first place.  

This is an updated version of two articles by the author, which appeared in the Hindu Business Line, on March 30 and April 8, 2020.

Ajay Shankar was Secretary, Department of Industrial Policy and Promotion (DIPP) in the government of India. He was part of the core team which worked out the 2008 stimulus package for India.