Is Our Fiscal and Monetary Response to COVID-19 Risk to Economy Good Enough?

Is Our Fiscal and Monetary Response

to COVID-19 Risk to Economy Good Enough?

ECONOMIC DISRUPTION OF COVID-19

Measures taken to contain and eliminate passive transmission risk, more than the manifested active risk of the COVID-19 virus to human factors of production- both the owners/entrepreneurs and workers- have disrupted the economic and financial systems the world over. Few countries like South Korea and Japan decided to track down the carriers- symptomatic or asymptomatic of COVID-19 virus and isolate them. Most countries did not have this ability to do so or were too overwhelmed by the severity of risk. These countries decided to isolate every family in their homes to find out who is a carrier and who is not.

India also decided to lock down every human being last week in their home to contain and eliminate this risk of virus transmission. This meant that almost entire production system also got locked down. You need human labour to produce goods and services in factories and establishments and to deliver these to the consumers. Even the most automated plant cannot operate without some labour. India exempted only essential services initially. After three days, realising that agriculture produce, including food on farms, would turn into waste (rabi harvesting was going on at many places), the government exempted farm work from lockdown. Yesterday, the government has permitted non-essential goods to be transported.

Impact of lockdown on Indian economy

A good chunk of economy is still locked out. Mining is mostly closed. Construction is totally stopped. Most factories which produce automobiles, machinery, consumer durables and so on are shuttered. Millions of small factories and enterprises are non-functional. Almost all of the retail trade, transport, travel and hospitality businesses are down and out. Construction, small businesses and service establishments producing these goods and services employed crores of workers. These workers are suddenly out of job. More than 2/3^rd of the production system has either stopped production totally or scaled down substantially.  

On an average, about 8-9 percent of GDP is produced in a month. GDP is another name for the total national income (aggregate of all household income). As we are growing at about 5% a year currently, a month of closure of 2/3^rd of production system is enough to make our GDP growth turn into negative. If workers receive even 50% of this income, loss of wages can be of the order of Rs. 7 to 8 lakh Crore. This loss of wages is a matter of life and death for most of the labour in informal sector. There is no wonder than crores of migrant workers are desperately trying to go back from their places of work to their only safety net- their villages where they might have some land to work upon and shelter to live.

The measures to save human lives from COVID-19 epidemic can result into making the economy a casualty- making both the nation and her people poor. If the COVID-19 risk to the economy is not managed properly, India might see crores of people becoming jobless and fall back in poverty. Nation’s march towards a 5 trillion-dollar economy can get hurt severely.

FISCAL RESPONSE

Finance Minister has announced fiscal response in two instalments so far.

First, on March 24, FM announced a slew of measures relating to compliances, reduction in fees/interest rate on tax returns etc. and filing deadlines. Dates of filing of tax returns, applicability of Vivad Se Viswas scheme, filing of GST returns for the months of 2021 first quarter etc. were extended. These measures are procedural in nature and did not constitute any real fiscal package.

Rs. 1.7 lakh crore package targets non-workers

Second, on 26^th March, FM announced a ‘1.70 Lakh Crore relief package’ under the umbrella of a new Programme called Pradhan Mantri Garib Kalyan Yojana. Under the programme, the central government funded components targeted mostly the non-working population. These measures included- 5 kg of rice/wheat and I kg of pulse free for three months per member, ex-gratia of Rs. 1000 to 3 crore senior citizens, poor widows and poor disabled persons, Rs. 500 per month for three months to 20 crore women Jan-Dhan account holders and increase in minimum wage rate by Rs. 20 a day to MGNREGA workers.

Over 10 crore workers are estimated to have been put out of jobs on account of lockdown, mostly in the construction and informal sectors of the economy. Many of these workers are eligible for the schematic benefits announced by the FM. But there is no link of these benefits to their loss of jobs on account of COVID-19 lock-down and cessation of production activities. These measures also make no distinction between the workers affected by this lockdown and those who are not affected.

Other elements of this package- giving orders to the state governments to use Building and Construction Workers Welfare Fund ‘to provide relief to construction workers’ and District Mineral Funds for ‘supplementing and augmenting facilities of medical testing, screening and other requirements in connection with ‘preventing the spread of COVID-19 pandemic as well as for treating the patients affected with this pandemic’ are more symbolic and will not cost the central government anything. The increase in limit of collateral free loans to Self Help Groups organised by women from Rs. 10 lakhs to Rs. 20 lakhs is also quite symbolic.

There is one measure in the package which has some relation with the workers affected by the COVID-19 epidemic. The government announced that the government will pay the entire provident fund contribution (12% employer and 12% employee) for three months for all wage-earners earning below Rs. 15000 per month in businesses having less than 100 workers. While a good number of workers in construction and informal enterprises are likely to be members of the EPFO and thus eligible to receive this support from the government, there are two major shortcomings in this measure. First, this measure does not put any cash in the hands of the affected workers and therefore is not available for consumption. Second, if the workers lose wages for the period of disruption, no amount is likely to be needed for being deposited in the provident fund accounts.

Cash cost of the package is likely to be smaller

The cash cost to the Government of India is likely to be much smaller. Additional foodgrains will come only from the quantity procured by the FCI, at best from the quantity which is sold in the market. The government gets only about half of the economic cost of wheat or rice sold in the market. Therefore, real additional fiscal burden is only to the extent of actual realisation from the foodgrains sold in the market. Likewise, the MGNREGA wages in many states is higher than the revised minimum wages of Rs. 202 per day. Further, the number of days of work under MGNREGA have not been increased.

The 26^th January package is likely to cost the Government of India a lot less than the projected sum of Rs. 1.7 lakh crore.

An economic package needed for affected businesses

Our country needs to respond to the real loss of GDP/value added/income and to provide for the costs of re-starting and re-building businesses. Our country also needs to provide emergency transitional assistance to the workers who have lost their jobs on account of the measures being taken to contain COVID-19.

For designing an appropriate package for affected businesses, we should classify over 8 crore Indian businesses in three broad categories.

First, the businesses which are not affected adversely (some might have seen increase in their turn-over/ profitability). Many ecommerce, health sector, food and other essential supply businesses and financial sector entities like banks etc. will fall in this category. We should have discrimination ability. These businesses need not have any fiscal assistance from the government.

Second, the businesses which have been shuttered. These businesses- construction industry, mining industry, travel and tourism, most retailers, transport and other road side sellers, factories producing cloths, footwear and so-called non-essential items etc.- are losing their total turn-over in the current lockdown. While they would earn no income but they would have to still meet a number of costs like rent, maintenance, interest payments etc. These businesses are likely to lose much of their working capital as well. These businesses deserve to get fiscal assistance for meeting the costs for the period of closure and for a part of the loss of profit/income.

Third, are the businesses which fall between the two categories mentioned above. Trucking businesses, agriculture equipment machinery businesses, seed and other input providers for agriculture, packaging industry, warehousing businesses and the like have only part of their operations currently going on. These businesses need to be given some fiscal support for covering shortfall in their cost coverage.

I am aware of the fact that our country has been a socialist state and providing direct assistance to the businesses has not been in our grain. Let us, however, remember that over 85% of our GDP/ value added/ income comes from the private sector businesses. The lockdown is a public health emergency response. Whoever suffers consequences of this public health emergency response deserves to be made good by the government.

Lot of countries have announced fiscal support programme for the businesses affected in their countries. The US government is extending a very liberal financing at very low rates of interest to affected businesses. These loans would also be written off if these businesses retain their workers.

We also need to make this big departure. Let us come up with a kind of COVID-19 affected businesses support programme and extend appropriate level of assistance to the category two and three businesses outlined above.

The support provided to the businesses can also be made conditional on payment of a part of their normal wages (say 50%) during this period of lockdown, which may be covered as part of the fiscal support extended to the businesses.  

A fiscal package for workers

Over 10 crore affected workers also need fiscal support. A cash payment of Rs. 1000 per affected worker per month and another Rs. 1000 per affected worker in kind (considering that it is difficult for most of these workers to be able to procure ingredients for even cooking their food in temporary shelters where many of them are presently sheltering) would provide minimum support to these affected workers.

Size of fiscal package for businesses and workers

A 5% loss of GDP would amount to about Rs. 10 lakh Crore for India. An economic support package (it would be wrong to call it stimulus- we are fighting to keep the existing businesses at their current level of operations) of about Rs. 5 lakh Crore is what India needs for saving our businesses and workers from collapse and poverty.

MONETARY RESPONSE

The RBI was late in coming up with monetary measures. It was only on 27^th March that Governor unleased the package. When it came, it was a blockbuster. A Cash Reserve Ratio (CRR) cut of 1%, Repo cut of .75%, Reverse Repo cut of .90%, Long Term Targeted Repo Operations (LTTRO) of Rs. 1 lakh crore and a few other measures. These measures are expected to provide about Rs. 3 lakh Crore of liquidity to the markets. These measures would also lead to notable reduction in cost of funds. The RBI perhaps could not have done anything more for unleashing liquidity into the system and bringing down the cost of funds.

Will these conventional package work?

The measures were, however, all conventional. The question which needs to be asked is whether this massive infusion of liquidity work?

Our financial system is essentially a bank-based system. The businesses raise their loans largely from the banks. Some funds are raised from non-banks and some from the mutual funds in the form of loans against assets and subscription by them to the bonds or commercial papers issued. The banks also subscribe to some bonds and papers issued by the businesses and non-banks. The banks also provide lines of credit to non-banks to fund small businesses. About 75% of the credit extended to the businesses is directly or indirectly funded by the banks.

The households also borrow. They borrow for housing loans (mortgages) and other consumer durables like cars, television, refrigerators (consumer assets). The banks extend lot of these loans directly. The housing finance companies (HFCs) and non-banks also provide mortgage and consumer loans. HFCs and non-banks depend, to a significant extent, on credit lines from banks and subscription to their bonds by banks for raising resources to lend. The banks are pivots around which the credit system for households also operate.

The RBI has released sizeable funds to the banks and the banks fund the loans to businesses and households. Normally, this should be quite a straightforward matter that the liquidity unleased by the RBI would get translated into extension of loans by banks to businesses and households. The reality is quite different.

The banking system has been in massive crisis for last few years- most notably the public sector banking (PSBs) system, which still has over 60% of financial sector assets in India. The PSB credit grew only 3% in first half of the current year. Some of the PSBs are still under Prompt Corrective Action (PCA) framework restricting them from making loans. The government has pumped in about 3 lakh Crore of capital in PSBs. Yet, there has been negligible lending growth by the PSBs. Private sector banks have been doing better but the blow-up of Yes Bank has shaken the foundations of the private sector banks to some extent.

The PSBs have been quite wary of extending loans to even investment grade credits for large businesses. The lockdown has destroyed the profitability and credit of numerous businesses which were very good credit earlier. Will the PSBs, flush as they are with the liquidity thrown at them by the RBI, lend to the businesses adversely affected by COVID-19 shutdown.  

The government and RBI had earlier encouraged PSBs to pick up mortgages and other consumer assets of non-banks at fair value with the government extending a first loss guarantee of 10%. The size of the facility was small at Rs. 1 lakh crore. About 8 months have gone since that facility was created. Even 25% of the facility has not been subscribed to, as per reports.

The RBI has placed a huge leap of faith in the banks to use the gush of liquidity to extend credit to the businesses and households. Their call may remain unanswered.

Alternative way of extending credit to businesses and households

Is there another way of achieving the objective of making credit reach to businesses and households?

When the RBI unloads buckets of liquidity on banks, it does not assume any risk. The banking system carries all the credit risk. If the loans extended by the banks using the liquidity provided by the RBI default, it is the banks which suffer loss of income and profit. The RBI does not. Quite naturally, the banks remain shy of extending credit, even when they are flush with money.  

Many central banks have started buying mortgages and other consumer assets, in troubled times- packaged as securitised assets based on pool of inflows from underlying assets. They buy these assets from banks and other financial institutions. These institutions focus on originating loans, packaging in securities and then selling off to the central banks. The banks not only get funded but a part of the credit risk also gets passed on to the central bank. Banks and other financial institutions’ incentive to lend under such structures change. Credit flows in the economy.

The US Fed is holding about $1.5 trillion of such assets. They have declared that they would buy much more. RBI used to lend to financial institutions earlier. It had a number of refinancing lines. Possibly, the time has come for the RBI to also buy securitised assets to direct real flow of credit to the households.

For businesses, the central banks elsewhere are extending refinancing supports to mutual funds and other financial agents, besides the banks. The central banks are also buying bonds issued by the corporates. In times like this, buying corporate bonds and extending refinance lines to money market agencies like mutual funds and non-banks might actually result into flow of funds to the businesses.

RBI needs to come up with another game-changing policy comprising of newer instruments like corporate bonds, securitised mortgages and other consumer loan- based assets besides resuming extending of refinancing lines to financial institutions and the banks. This alternative system is likely to work and possibly the right answer.

CONCLUSION

COVID-19 is an enormous passive transmission risk. To contain this, it is necessary to segregate the infected persons. National shutdown is the right response. This has, however, shuttered most of the businesses rendering crores of workers jobless. About 2/3^rd of our production system is adversely affected which is likely to result into loss of 5-6% of annual GDP a month. About 10 Crore labour is also out of job. We will have to have a more calibrated approach to restart our businesses.

Fiscal package announced by the government has so far targeted non-workers largely. Additionally, some compliance related relaxations have been made besides extending deadlines for filing returns etc and reducing fines and penalties. A situation like the present calls for major fiscal support to be extended to affected businesses and workers.  India needs an economic support package of about Rs. 5 lakh Crore for saving our businesses from collapse and to get these back on their feet and for cushioning the workers during the period of disruption.

RBI has unleashed a flood of liquidity and also brought down the cost of funds for banks. However, the banks are unlikely to lend, certainly not to the lakhs of businesses whose profitability and creditworthiness has been severely dented by the disruption. The RBI needs to DOPT new instruments like buying corporate bonds, mortgages and other consumer asset-based loans for ensuring credit to reach to these businesses and households.

SUBHASH CHANDRA GARG

MARCH 30, 2020