Managing COVID-19 risk, economy and financial markets

RESPONDING TO COVID-19 CRISIS

Odisha cyclone in 1999 killed over 10000 people. Cyclones Phailin and cyclone Fani, which hit east coast of India in 2013 and 2019, were almost of the same severity, but the death toll did not cross even 100. Reason was simple. India understood cyclones much better and knew how to manage it. Better information available about the cyclone- its onset, path, speed,  intensity, direction, eye etc. was used to take all the necessary steps to meet its challenge- preventing people from going into the sea for fishing, shifting people to specially constructed cyclone shelters, stocking  adequate food and care, marshalling all response and restoration teams to attend to the devastation and the like. There was no panic. Better preparation and management of the risk saved the day for us.

COVID-19 is a new virus. Its’ cure and antidote are not known. When it struck, even basic facts like how does it spread and how fast it can spread were also not known. As a result, COVID-19 spread very fast, first in China and then wherever the concerned country ignored its seriousness or was care less. In China, over 80,000 people got infected. In South Korea, one single woman spread it in a large region. Italy ignored. Iran ignored. Both now have the sharpest growth in COVID-19 infected people and are at the largest risk of affected people multiplying rapidly. The USA, Spain, UK and some other countries in Europe which did not respond quickly and adequately in identifying and isolating the COVID-19 affected people are likely to suffer serious consequences.

COVID-19 has made people aware about the Spanish flu which struck India and the World about a hundred year before in 1918-20. About 5 crore people are said to have died in the Spanish flu disaster. Over 1.5 crore people reportedly died in India. India’s population, always a high fertility country, recorded its only decadal degrowth from 25.2 crore in 1911 to 25.1 crore in 1921. Back then, no one knew about how to manage the outbreak of Spanish flu. Result was a massive tragedy for humanity. COVID-19 cannot be allowed to be a disaster equalling even a fraction of the devastation and misery caused by Spanish flu.

While the scientists and doctors find the cure and anti-dote, the COVID-19, a natural disaster, needs to be managed following a three-pronged action plan:

a.    Stop the import of infection by not allowing arrival of infected persons from abroad and goods which might carry the infection;

b.    Identify and isolate all those infected in the country;

c.    Reorganise running of economy eliminating risk of COVID-19 infection.

From all accounts available, it seems that COVID-19 outbreak has been contained quite well in China (after lot of initial mishandling). Number of new infections and deaths have got reduced to low double digits on daily basis now. Factories are back in production with more than 80-90% workers reporting back to work. China followed the above three-pronged strategy very well. Besides containing the misery (number of deaths are less than 4000), China has also contained economic damage. Very soon, Chinese exports would possibly be in a position to not only meet her usual exports demand, but fill in for the reduced production in many other countries on account of dislocation caused by COVID-19. No wonder, Chinese markets are quite stable while the stock markets all over the world are roiled.

India has responded quite well. India has the benefit of its handling in China. We need to manage the COVID-19 as a natural disaster. We don’t have to panic. We can’t be negligent. A professional handling of COVID-19 can see India through this disaster with minimal losses of life and to the economy.

For minimising losses to life, the ask seems to be quite daunting but clear. Don’t allow a single infected person to come from abroad. Identify and isolate each infected person in India till he/she recovers to stop the spread of virus from infected person to non-infected. While lot of measures are being taken by the Government, businesses and people for stopping spread to non-infected persons, one potentially effective means can be to design and wear a COVID-19 Spread Preventing Gear. Risk of picking up the virus by touching any virus-affected place or thing and then carrying it to one by touching mouth, nose, eye or ear etc. can be eliminated by wearing this COVID-19 Spread Preventing Gear. This specially designed Gear should prevent a person from touching his own mouth, nose, eye or ear while he/she is in place where there is any likelihood of COVID-19 virus being present.

While we deal with the epidemic risk as suggested above, how do we manage our economy and financial systems for the time this risk persists, especially during the period when its likely impact is not ascertainable- may be a few months when the risk of COVID-19 remains present?

The largest turmoil post spread of COVID-19 in Europe and the north America is in the stock markets. Most of these stock markets were at their life-time peaks in January and February- even when the virus was spreading its tentacles in China. For last few days, the stock markets all over the World (except in China) are in real mess and free fall. At some places, the stock markets have fallen over 30%. The uncertainly about how it would play out and whether the Western World would be able to manage it well is at the root of this massive sell-off.

SENSEX has also lost over 20% of its market capitalisation. NIFTY tanked over 10% in first 15 minutes of trade on 13^th March to hit the circuit breaker after 12 years. Front pages of the newspapers are bemoaning the fall in the stock markets. Investors have reportedly lost trillions of rupees of wealth.  

We should simply ignore the wild swings in the stock markets. We should be worrying about only the underlying businesses. Stock market valuations which have been driven to stratospheric levels on account of ultra-cheap money of the foreign institutional investors don’t affect underlying businesses. If State Bank of India share loses 25% of its value over 2-3 days, does that reduce SBI’s business/ income even by 5%? High valuations are only hot air in most cases- there are several businesses which are earning 10% of its net worth but 1% on its market capitalisation. If the market valuations of such businesses correct- even by 50-60%- there is no loss of economic value . There is no impact on value added generated by such companies/businesses.

There is a big disconnect between the stock market valuations and real values of most of the underlying businesses. Build-up of enormous savings, most in the OECD countries and almost costless debt has driven stock market prices to dizzying and unrealistic levels. In fact, such high valuation of stocks has made raising of capital by new businesses very difficult and rare in the Indian markets, the primary reason for the stock markets to be in the first place. Let the rich sort out their wealth in the stock market.

A number of countries, including the United States, have reduced their policy rates and launched a large quantitative easing programme to flush the markets with abundant cheap money. This strategy has become a quick fix for all wealth melt-downs. There are two types of wealth/assets melt-downs- financial assets and real assets. When real assets- the real businesses or the real economy- are feared to be affected (as is the case on account of COVID-19 outbreak), cheaper funds for fixing the financial assets are unlikely to work. The reaction to the quantitative easing and rate cut measures taken in western countries seem to bear this out. Chinese markets are holding up well even without any such rate cuts or quantitative easing as the underlying businesses are not feared to be affected as badly.

We should therefore not worry at all about what is happening in equity markets. India does not need to make any rate cut to prop up stock market. The only aspect we should take care is to ensure that there is adequate liquidity available for ensuring all payments and settlements take place without any glitch.

Debt markets are not much affected. In India also, there is virtually no downward or upward pressure on yields on account of COVID-19 risk. Debt markets seem to indicate very clearly that there is enough funds and liquidity in the market for the government and businesses to raise if needed.

Any rate cut would unnecessarily reduce interest rates but would not lead to higher borrowing by businesses as there is no demand to make new investments on account of COVID-19. The underlying investment momentum of Indian economy, excluding COVID-19 situation, has been quite week (fixed capital formation has grown by less than 1% this year) and capacity utilisation ratio of manufacturing capacity is quite low. Credit fuelled consumption demand is unlikely to come in the current uncertain situation with people most likely to not go for fresh real asset purchases. On the contrary, the rate differential between foreign interest rates and domestic interest rate is the only factor which might prevent outflow of debt investments of FIIs. We should not be taking away this attraction for foreign debt to stay put. There has been some sale-off of debt by foreigners, which might get further accelerated if the rates are reduced further. Depositors would lose heart further if the interest rate cut were to lead to reduction in deposit rate, which would be most likely outcome.

Rate cut is not justified from the debt market perspective as well.

A major impact of the COVID-19 is on the central and state government finances. The fiscal deficits of the Governments (both central and state) are likely to get worse. Assumed tax revenues in the revised budget estimates of the central government was optimistic. Adverse impact of COVID-19, most severely on services, will affect GST collections. Stock market melt-down has made the central government postpone planned sell of PSU stocks in March. Massively reduced valuations are likely to affect the strategic sale of BPCL, CONCOR etc. as well. Even sale of petroleum products is likely to see a reduction. State government revenues are likely to get further hit as most state government levy VAT on petroleum products on ad-valorem basis.

The disruption in agriculture, manufacturing and construction sectors is not reported to be notable at this stage. This should keep the employment situation stable. Service economy has seen much larger disruption, which possibly cannot be helped by any fiscal support. It is, therefore, not at all advisable to expand fiscal expenditures. That would be an unnecessarily panic reaction. To signal availability of effective social safety net for poor and informal sector workers, the Government can increase allocations of social safety net programmes like Mahatma Gandhi National Rural Employment Programme (MGNREGA).

The Central Government will face larger fiscal deficit, most particularly in the FY 2020-21. We may not worry, if additional borrowings need to be raised from the market for meeting this larger fiscal deficit. The state governments have been recently permitted to raise additional 60,000 crore of market borrowings. This is welcome. A similar dispensation might be needed for FY 2020-21.

To summarise,

1.    The COVID-19 epidemic, a big natural disaster, needs to be managed following a three-pronged action plan: a. stopping the import of infection by not allowing arrival of infected persons from abroad and goods/machines which might carry the infection, b. Identifying and isolating all those infected in the country till the time they recover fully and c. by reorganising management of economy in such a manner that the risk of COVID-19 infection is eliminated but economic activities are carried.

2.    A COVID-19 Spread Preventing Gear should be designed and produced in large quantities to eliminate the risk of an uninfected person picking up the virus by touching any virus-affected place or thing and then self-infecting by touching one’s mouth, nose, eye or ear.

3.    We should not worry about the melt-down in the equity markets. There is no need to make any rate cut to prop up the stock market. We should only ensure that there is adequate liquidity available for enabling all payments and settlements to take place without any glitch.

4.    Debt markets are quite stable and unaffected. Underlying reasons for low fixed capital formation in the economy will not be addressed by any rate cut. Any rate cut might adversely affect depositors and foreign flow of debt funds. Rate cut is not required from debt market perspective.

5.    The Central Government will face larger fiscal deficit on account of revenue shortfall both on tax as well as disinvestment proceeds. This is likely to get accentuated in FY 2020-21. The Central Government should not expand fiscal expenditure except to expand some social safety net programme like MGNREGA. To cover larger deficit, additional borrowings can be raised from the market. The state governments, which are also facing similar, or may be larger, revenue deficit pressure, have been recently permitted to raise additional 60,000 crore of market borrowings. A similar dispensation might be needed for FY 2020-21.

SUBHASH CHANDRA GARG

NEW DELHI 16/03/2010