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GS Paper: Indian Economy

  • A time for extraordinary action

    Context

    The lockdown and other movement restrictions, backed by scientific and political consensus on their inevitability, have directly led to a dramatic slowdown in economic activity across the board. What is its impact on the Indian economy? This question calls for an urgent answer.

    The methodology used to estimate the impact

    • We provide an initial, quantitative response, using a methodology that is based on the technique of input-output (IO) models, first elaborated by the economist Wassily Leontief.
    • How the model works: Such models provide detailed sector-wise information of output and consumption in different sectors of the economy and their inter-linkages, along with the sum total of wages, profits, savings, and expenditures in each sector and by each section of final consumers (households, government, etc.).
    • Crucially, it pays attention to intermediate consumption, namely consumption by some sectors of the output of other sectors (as well as consumption within their own sector).
    • Advantage of the model: The key advantage of such a model is that it allows the calculation of the impact of any change in any sector in both direct and indirect terms, which has made this model somewhat ubiquitous in the computation of the economic impact of disasters.
    • This also renders it well-suited to estimating the economic consequences of COVID-19.
    • Regrettably, the last officially published IO table for India was for the year 2007-2008.
    • In our estimates, we use the IO tables for India published by the World Input-Output Database for the year 2014 that updates the IO tables for individual countries using time series of national income statistics.
    • To calculate the impact of the lockdown, there are four different scenarios of the number of workdays lost in different sectors.
    • How daily output loss is calculated? Assuming that the estimated annual output is distributed uniformly across the year, it is possible to calculate the daily output and therefore the daily output loss.
    • The direct and indirect impacts of the lockdown are then estimated using IO multipliers which are assumed to be constant.
    • We then calculate the percentage decline in the national gross domestic product (GDP) of 2019-2020 that this impact amounts to.

    What is the impact on various sectors?

    • Loss at 7% to 33% of GDP: Model (see table) shows that the loss of GDP ranges from ₹17 lakh crore (7% of GDP) in the most conservative scenario, where the average number of output days lost is only 13, to ₹73 lakh crore (33% of GDP) in the most impactful scenario, where the number of days of lost output averages 67.
    • In intermediate scenarios of 27 and 47 days of lost output, the GDP decline is ₹29 lakh crore (13% of GDP) and ₹51 lakh crore (23% of GDP), respectively.
    • OECD estimate: These estimates also accord well with other estimates, such as those of the OECD that suggest a 20% loss to GDP for India.
    • Impact of varying lockdown period: Even assuming that sectors will have varying lockdown periods, all sectors face serious losses due to their
    • If we take the scenario where a prolonged lockdown happens, averaging about 47 days across sectors, we find that the mining sector faces the largest drop of 42% in value-added despite that sector itself being shut down for, say, 35 days.
    • The electricity sector sees a 29% fall in value-added, even though it faces no shut down per se.
    • Losses are expected across all sectors in terms of both wage compensation and the availability of working capital.

    Incorporation of feedback effect in estimates

    • The linear character of our estimates, intrinsic to IO analysis, does not allow incorporation of feedback effects and assumes that output commences where it left off without further constraints.
    • An attempt has been made to correct for this by using a varying number of days of output loss across sectors, but this is quite possibly inadequate to capture the continuing economic impact.
    • We are faced today with a unique situation where both supply and demand have collapsed in several sectors.
    • Impact on agriculture: In some sectors such as agriculture, the impact may manifest in the delayed fashion, if the anti-COVID-19 measures, or the pandemic itself, affects agricultural operations in the next the kharif season, even if, as reports suggest, much of this year’s rabi has been successfully harvested.
    • The shortfall in export not accounted for: Given the database, we are using and the initial character of our analyses we have also not explicitly accounted for possible shortfalls in exports due to lack of demand elsewhere in the world, as well as the unavailability of intermediate imported goods that are crucial for the Indian economy.
    • Nor are we able to adequately separate the impact on the informal sector, that is partially aggregated with the formal sector in the database that we are using and partially unaccounted for due to lack of data.

    Need for the huge stimulus package

    • The most striking feature of even this simple calculation is the all-round pervasive impact on the economy of the anti-COVID-19 measures that we are currently undertaking and that are likely to continue in modified form for a short period.
    • Measures such as debt relief, postponement of revenue and tax collections, immediate relief in cash and kind to the poor, and revamping and scaling up public distribution are all undoubtedly necessary but far from sufficient.
    • Our numbers suggest that the resort to huge stimulus packages that developed countries have already started putting in place is by no means mistaken.

    Way forward

    • Package for all the sectors of the economy: We need to compensate and pump cash into the hands of not only wage workers in the formal and informal sectors, and also into the livelihood activities of the informal sector.
    • But businesses too need to be primed with handouts in the case of small and medium enterprises, and with a variety of concessions even in the case of larger businesses.
    • It is critical to preserve the productive capacities of the Indian economy across the board. The annual budget of the current year, already passed, clearly cannot cope with such a massive effort and needs to be revisited by suitable parliamentary measures.
    • Caring too much about fiscal deficit will not be helpful: Redistributing expenditure, seeking to keep the fiscal deficit “under control” as it were, through measures such as cutting back on government salaries, are unlikely to be helpful.
    • Apart from sending the wrong signal to private sector employers, who have so far been exhorted to maintain salaries and wages during the lockdown, it is quite likely to lead to further reduction in demand since the government is the biggest employer in the country.
    • Ensure the key role of the state: Finally, one must note that the current crisis is not a transformatory moment for the Indian economy, even if the scale of the impact and recovery process will undoubtedly push the economy in new directions.
    • But “greening” the economy or more radical transformative measures are not particularly relevant in its current state.
    • What is needed is ensuring the key role of the state to lift up an economy that is in danger of being brought to its knees, and to restore some semblance of its normal rhythm, by an unprecedented scale of state investment.

  • A different economic approach

    Context

    The Covid-19 pandemic and subsequent 21-day lockdown by India has forced us to resolve the public health versus economic health trade-off.

    The debate over lockdown

    • No clear idea on number of lives saved: As it fights COVID-19 with its meagre healthcare resources, India has chosen to bring the economy to a near halt with no clear idea of how many lives can be saved in this manner.
    • What is going to be the cost of this decision? The 21-day lockdown will reduce the gross value added (GVA) during this period to near zero.
    • More than half the GVA is contributed by the unorganised sector.
    • A disproportionate burden of the economic cost has fallen on this large segment.
    • Debate: The suffering of the stranded migrant labourers has set off a debate: is the disruption and the economic pain justified?
    • Is it worth sacrificing the economy to save lives?
    • And at the core of such questions is a policy dilemma: should public health matter more than economic health?

    So, what should be the policy objectives?

    • In time, a vaccine will become available. But the economy cannot remain shut until that happens.
    • A prolonged lockdown will extract a huge economic cost.
    • Therefore, the policy objective must be to find ways of ensuring that the lockdown ends early without compromising on public health.
    • Following are the policies that could ensure the twin objective of not ending lockdown without compromising on public health.

    1 The policy of aggressive testing and isolation

    • The economic cost of combating COVID-19 can be reduced by combining aggressive testing and isolation, a strategy proposed by economist Paul Romer for the U.S.
    • For it to work, people must be tested in large numbers.
    • Those who test positive must be isolated. This will make it unnecessary for the rest of the population to stay home and it will allow the economy to restart.
    • After ending the lockdown too, testing of randomly selected people must go on in large numbers, so that those found infected can be isolated.
    • Eliminating the fear of isolation: The success of this will depend on eliminating the fears associated with isolation. Such fears can be reduced only if isolation facilities are good.

    2 Ramp up the manufacturing capacity

    • The second precondition is the substantial ramping up of manufacturing capacities for medical-grade masks, gloves, gowns, ventilators, testing labs, etc.
    • This ought to be on a scale large enough for domestic use and, if possible, for exports for costs to be low.
    • The strategy calls for fully operational hospitals to be constructed in every district of the country in a matter of weeks.
    • Problem-solving of an unprecedented order will be required.
    • Recently, garment manufacturers in Coimbatore were asked to explore the possibility of re-purposing production lines to make masks.
    • There’s been no progress on this front, as the special-grade fabric required is difficult to source.
    • What about the funding? In normal times, governments wrestle with dilemmas such as whether to allocate the limited available tax money to education, health, public transport or a sop that could change the outcome of the next election in their favour.
    • But during a public health crisis, all resources must be used to ramp up healthcare capacities.

    Way forward

    • Investment in healthcare can resolve trade-off: Since the state of the lockdown is not a normal condition, the usual policy levers become ineffective.
    • Loan moratoriums and cash transfers can fend off bankruptcy and defaults for a few months and buy time on non-performing assets in banks.
    • But they cannot make good the GDP lost due to the economic shutdown because liquidity and cash released by monetary and fiscal policies cannot get transmitted to the real sector during an economic shutdown unless they are funnelled into the sector that is still active, which is healthcare.
    • If the public health sector can be the economy’s main engine for six months, the public health versus economic health trade-off can be resolved. The spread of COVID-19 will slow down.
    • The economic pain of combating the virus will reduce.
    • There will be jobs, including for low-skilled construction labourers. If planned and executed smartly, the severe health infrastructure deficit will get addressed.
    • Remove the price controls: Sadly, India’s economic policies for fighting COVID-19 are the opposite of what’s needed.
    • In a crisis, the first instinct of policymakers is to slap controls. Just about everything from masks to kits has been placed under price controls.
    • This has removed the incentive for private labs to ramp up capacities.
    • The government should fully subsidise testing: At zero MRP, more people with symptoms will come forward to get tested. Private labs will quickly ramp up capacities if they don’t have to worry about losses. The number of suppliers will increase. Costs will reduce. Private enterprise and technological innovations will come up with cheaper tests that produce results quicker.

  • A niggardliness that is economically unwarranted

    Context

    The Centre can afford to step up its COVID-19 assistance to a higher scale; fiscal deficit is no worry.

    Comparison with the US

    • Unemployment benefit in the US: In the United States, for instance, where the lockdown has raised the number of persons filing unemployment claims from 2.8 lakh to 6.6 million in a matter of days, those affected can fall back on unemployment benefit.
    • Comparison of packages: The US government has approved a package of ameliorative steps costing roughly 10% of that country’s GDP to cope with the crisis.
    • In India by contrast, the Finance Minister’s package comes to less than 1% of its GDP; and much of it is just a repackaging of already existing schemes.
    • New expenditure comes to just a little over half of the ₹1.7-lakh crore earmarked for the package.
    • Migrant workers are not the beneficiary: Besides, none of the steps will help the migrant workers; not even the larger foodgrain ration which in principle could, because most of them would have ration cards back home rather than in the places where they stay.

    What can be done?

    Consider the cash transfer

    • Many economists and civil society activists had suggested a cash transfer of ₹7,000 per month for a two-month period to the bottom 80% of households to tide over the crisis, in addition to enhanced rations of foodgrains and the inclusion of certain other essential commodities within the ration basket.
    • The cost of their proposed cash transfers alone would come to ₹3.66-lakh crore, which is more than 10 times the cash transfers provided in the Finance Minister’s package.
    • Providing assistance on the scale proposed by civil society organisations is necessary; it will no doubt pose logistical problems, but not financial problems.
    • Two possible effects of cash transfer: Even if all of it is financed through a fiscal deficit for the time being, the economic implications of such an enlarged deficit would not be forbidding.
    • These implications can manifest themselves in two ways: one is through inflation, and the other by precipitating a balance of payments problem. Let us consider each of these.

       Effect of cash transfer on inflation

    • As long as supplies of essential commodities are plentiful and these are made available through the Public Distribution System to the vast majority of the people so that they are insulated against the effects of inflation, any inflation per se should not be a matter of great concern. This is the case in India at present.
    • Foodgrain stocks with the FCI: The supply of the most essential of goods, food grains, is plentiful. Currently, there are 58 million tonnes of foodgrain stocks with the government, of which no more than about 21 million tonnes are required as buffer-cum-operational stocks.
    • This leaves a surplus of 37 million tonnes which can be used for distribution as enhanced ration, or for providing a cushion against inflation.
    • The rabi crop is supposed to be good; as long as it is safely harvested, this would further boost the government’s food stocks.
    • Rise in demand of other commodities: Likewise, the supplies of other essential commodities which consist of manufactured goods and where output has been demand-constrained all along will get boosted in response to higher demand; and in special cases, imports may have to be resorted to.
    • There is in short no reason to think that inflation of a worrisome magnitude will follow if the fiscal deficit is increased.
    • What about the multiplier effect? There is an additional factor here. The increase in total demand caused by an initial increase in demand, which is financed by a fiscal deficit, is a multiple of the latter.
    • Now in a situation like the present, when even if the lockdown is lifted social distancing and restrictions on social activities will continue, the value of the multiplier will be lower than usual.
    • People, in short, would hold on to purchasing power to a much greater extent than usual because of the continuing restrictions on demand, which would act as an automatic anti-inflationary factor.
    • Of course, there will be shortages of some less essential commodities and also hoarding on account of such shortages. But since these shortages will be expected to be temporary, a result of the pandemic unlikely to last long, there will be a damper on hoarding.

    Effect of cash transfer on deficit

    • The price rise of non-rationed commodities: If inflationary expectations are strong and persistent, then the prices of non-rationed commodities may rise sharply for speculative reasons.
    • How the government can prevent the price rise? But the government can prevent such expectations, by adopting measures such as bringing down petro-product prices, taking advantage of the collapse of world oil prices.
    • A larger fiscal deficit, therefore, need not cause disquiet on account of inflation.
    • Balance of payment issue: On the balance of payments front, the worry associated with a larger fiscal deficit is financial flight caused by frightened investors.
    • Some financial flight is already happening, with the rupee taking a fall.
    • Rush to dollar: This flight is not because of our fiscal deficit but because, whenever there is panic in financial markets, the tendency is to rush to dollars, even though the cause of the panic may lie in the United States itself.
    • Using foreign exchange reserves: India has close to half a trillion dollars of foreign exchange reserves. These can be used, up to a point, to check the flight from the rupee to the dollar.
    • Restriction on capital outflow: If the flight nonetheless persists, then India will have a legitimate reason for putting restrictions on capital outflows in the context of the pandemic.

    Way forward

    • The Centre must not worry about its fiscal deficit; and since the State governments will bear a substantial expenditure burden on account of the pandemic.
    • The Centre must make more resources available to the states.
    • The centre should raise their borrowing limits, perhaps double their current limits as a general rule, apart from negotiating the magnitude of fiscal transfers it should make towards them.

    Conclusion

    If the hardships of the people are not ameliorated through larger government expenditure, because of the fear that the larger fiscal deficit required for it would frighten finance into fleeing, then the privileging of finance over people would have reached its acme.

     

  • Restarting the economy after lockdown

      (This newscard is the excerpt from an article published in the TOI, authored by former RBI governor Raghuram Rajan. It discusses a series of reformative measures to boost our economy once the lockdown restrictions are eased.)

    Context

    • Economically speaking, India is faced today with perhaps its greatest emergency since Independence.
    • The global financial crisis in 2008-09 was a massive demand shock but our financial system was largely sound, and our government finances were healthy.
    • None of this is true today as we fight the coronavirus pandemic.
    • With the right resolve and priorities, and drawing on India’s many sources of strength, it can beat this virus back and even set the stage for a much more hopeful tomorrow.

    To begin with: 21 day Lockdown

    • The immediate priority, of course, is to suppress the spread of the pandemic through widespread testing, rigorous quarantines, and social distancing.
    • The 21-day lockdown is a first step, which buys India time to improve its preparedness.
    • The government is drawing on our courageous medical personnel and looking to all possible resources – public, private, defence, retired – for the fight, but it has to ramp up the pace manifold.
    • It will have to test significantly more to reduce the fog of uncertainty on where the hotspots are, and it will have to keep some personnel and resources mobile so that they can be rushed to areas where shortages are acute.

    Restarting with caution

    • The 21 day lockdown is about a week ahead to get lifted. It is hard to lockdown the country entirely for much longer periods, so we should also be thinking of how we can restart certain activities.
    • Restarting requires better data on infection levels, as well as measures to protect those returning to work.
    • Healthy youth, lodged with appropriate distancing in hostels at the workplace, maybe ideal workers for restarting.

    Pacing up manufacturing

    • Since manufacturers need to activate their entire supply chain to produce, they should be encouraged to plan on how the entire chain will reopen.
    • The administrative structure to approve these plans and facilitate movement for those approved should be effective and quick – it needs to be thought through now.

    Most crucial: Ensuring workforce sustenance

    • In the meantime, policymakers need to ensure that the poor and non-salaried lower middle class who are prevented from working for longer periods can survive.
    • Direct transfers to households may reach most but not all, as a number of commentators have pointed out.
    • Furthermore, the quantum of transfers seems inadequate to see a household over a month.
    • The state and Centre have to come together to figure out quickly some combination of public and private participation and DBTs that will allow needy households to see through the next few months.
    • We have already seen one consequence of not doing so – the movement of migrant labour. Another will be people defying the lockdown to get back to work if they cannot survive otherwise.

    Gearing up for fiscal shocks

    • Our limited fiscal resources are certainly a worry. However, spending on the needy at this time is a high priority use of resources, the right thing to do as a humane nation.
    • This does not mean that we can ignore our budgetary constraints, especially given that our revenues will also be severely affected this year.
    • Unlike the US or Europe, which can spend 10% more of GDP without fear of a ratings downgrade, we already entered this crisis with a huge fiscal deficit, and will have to spend yet more.
    • A ratings downgrade coupled with a loss of investor confidence could lead to a plummeting exchange rate and a dramatic increase in long term rates in this environment, and substantial losses for our financial institutions.

    Channelizing expenditures

    • So we have to prioritise, cutting back or delaying less important expenditures, while refocusing on immediate needs.
    • At the same time, to reassure investors, the government could express its commitment to return to fiscal rectitude.
    • The govt. must back up its intent by accepting the setting up of an independent fiscal council and setting a medium term debt target, as suggested by the NK Singh committee.

    Boosting up Industries

    1) MSMEs

    • Many MSMEs already weakened over the last few years, may not have the resources to survive.
    • We need to think of innovative ways in which bigger viable ones, especially those that have considerable human and physical capital embedded in them, can be helped.
    • SIDBI can make the terms of its credit guarantee of bank loans to SMEs even more favourable, but banks are unlikely to want to take on much more credit risk at this point.
    • The government could accept responsibility for the first loss in incremental bank loans made to an SME, up to the quantum of income taxes paid by the SME in the past year.

    2) Large industries

    • Large firms can also be a way to channel funds to their smaller suppliers. They usually can raise money in bond markets and pass it on.
    • Banks, insurance companies, and bond mutual funds should be encouraged to buy new investment-grade bond issuances, and their way eased by the RBI.
    • The government should also require each of its agencies and PSUs, including at the state level, to pay their bills immediately, so that private firms get valuable liquidity.

    Looping in everyone’s participation

    • The government should call on people with proven expertise and capabilities, of whom there are so many in India, to help it manage its response.
    • It may even want to reach across the political aisle to draw in members of the opposition who have had experience in previous times of great stress like the global financial crisis.
    • If, however, the government insists on driving everything from the PMO, with the same overworked people, it will do too little, too late.

    Conclusion

    • Globally, it is said that India reforms only in crisis.
    • Hopefully, this otherwise unmitigated tragedy will help us see how weakened we have become as a society, and will focus our politics on the critical economic and healthcare reforms we sorely need.

  • Comparing current crisis with Great Depression, 1929

     

    With the novel coronavirus pandemic severely affecting the global economy, some experts have begun comparing the current crisis with the Great Depression — the devastating economic decline of the 1930s that went on to shape countless world events.

    Looming depression ahead

    • Experts have warned that unemployment levels in some countries could reach those from the 1930s era, when the unemployment rate was as high as around 25 per cent in the United States.
    • Currently, unemployment levels in the US are already estimated to be at 13 per cent, highest since the Great Depression.

    What was the Great Depression?

    • The Great Depression was a major economic crisis that began in the United States in 1929, and went to have a worldwide impact until 1939.
    • It began on October 24, 1929, a day that is referred to as “Black Thursday”, when a monumental crash occurred at the New York Stock Exchange as stock prices fell by 25 per cent.
    • Though the crash was triggered by minor events, the extent of the decline was due to more deep-rooted factors such as a fall in aggregate demand, misplaced monetary policies, and an unintended rise in inventory levels.
    • In the United States, prices and real output fell dramatically. Industrial production fell by 47 per cent, the wholesale price index by 33 per cent, and real GDP by 30 per cent.

    What caused Great Depression?

    The causes of the Great Depression are extremely complex and disputed to this day. The three main factors are:

    1. Financial instability and credit cycles: A period of stability encouraged more borrowing and lending than prudent, sowing the seeds for future instability.
    2. Monetary contraction, the gold standard, and bank runs: Monetary policy, driven in large part by the gold standard, tightened credit at the wrong time fueling bank-runs and economic slowdown.
    3. Debt deflation: Excess private debt created a dangerous condition where no one wanted to spend, causing deflation and economic weakening.

    Worldwide impact

    • The havoc caused in the US spread to other countries mainly due to the gold standard, which linked most of the world’s currencies by fixed exchange rates.
    • In almost every country of the world, there were massive job losses, deflation, and a drastic contraction in output.
    • Unemployment in the US increased from 3.2 per cent to 24.9 per cent between 1929 and 1933. In the UK, it rose from 7.2 per cent to 15.4 per cent between 1929 and 1932.

    Latent outcomes

    • The Depression caused extreme human suffering, and many political upheavals took place around the world.
    • In Europe, economic stagnation that the Depression caused is believed to be the principal reason behind the rise of fascism, and consequently the Second World War.
    • It had a profound impact on institutions and policymaking globally and led to the gold standard being abandoned.

    How did Great Depression impact India?

    • The Depression had an important impact on India’s freedom struggle.
    • Due to the global crisis, there was a drastic fall in agricultural prices, the mainstay of India’s economy, and a severe credit contraction occurred as colonial policymakers refused to devalue the rupee.
    • The effects of the Depression became visible around the harvest season in 1930, soon after Mahatma Gandhi had launched the Civil Disobedience movement in April the same year.

    1) Rural India mainstreamed into freedom struggle

    • The fallout made substantial sections of the peasantry rise in protest and this protest was articulated by members of the National Congress.
    • There were “No Rent” campaigns in many parts of the country, and radical Kisan Sabhas were started in Bihar and eastern UP.
    • Agrarian unrest provided a groundswell of support to the Congress, whose reach was yet to extend into rural India.

    2) INC gained momentum

    • The endorsement by farming classes is believed to be among the reasons that enabled the party to achieve its landslide victory in the 1936-37 provincial elections held under the Government of India Act, 1935.
    • This is marked as a significant event in the history of INC as it flourished the party’s political might for years to come.

    Back2Basics

    Slowdown vs recession vs depression

    •  Slowdown simply means that the pace of the GDP growth has decreased.  During slowdown, the GDP growth is still positive but the rate of growth has decreased.
    •  Recession refers to a phase of the downturn in the economic cycle when there is a fall in the country’s GDP for two quarters.   It is a period of decline in total output, income, employment and trade, usually lasting six months to a year.
    • Depression is a prolonged period of economic recession marked by a significant decline in income and employment.   It is a negative GDP growth of 10% of more, for more than 3 years.

  • States at centre

    Context

    Concerned over the impact on their revenues, several state governments planned cuts in salaries of government employees.

    State finances showing the signs of stress

    • The fiscal crisis stemming from the disruption in economic activity due to the coronavirus is now beginning to show.
    • Concerned over the impact on their revenues, several state governments planned cuts in salaries of government employees.
    • The stress to state finances stems from multiple sources.
    • First, as economic growth falters, their own income streams, for instance, revenues from petroleum products, real estate transactions, will slow down further, as will GST collections, and the amount collected through the compensation cess will not be enough to meet budgeted expectations.
    • Second, as the Centre’s own revenues also slow down, transfers to states will take a hit. It is quite likely that tax devolution to states, which has been budgeted at Rs 7.8 lakh crore in 2020-21, will not materialise.
    • Collectively, state expenditure far outstrips that by the Centre, with revenues falling short, any cutbacks in their spending, at a time when there is a need for a bold fiscal expansion, will further aggravate the economic stress.
    • Need assurance of adequate resource: Thus, states, which are at the frontline of fighting the public health crisis, need to be assured of adequate resources.

    Increase in the WMA limit will not address the issue

    • Limit increased by 30%: The Reserve Bank of India decided to increase the ways and means advances (WMA) limit by 30 per cent for state governments.
    • What is WMA? The WMA is a temporary liquidity arrangement with the RBI which helps governments tide over their short-term liquidity woes.
    • A short term measure: While states have been averse to opting for this facility in the past, and the new WMA limits may need to be revised further if the mismatch rises, this is a short-term measure, and does not address the underlying issue of significant revenue slippages.
    • Contradictory impulse: Under the existing fiscal deficit constraint, the collapse in revenues will force states to cut back on spending, imparting a contractionary impulse to the economy.

    Way forward

    • The Centre must take several steps to ensure an adequate flow of resources to states.
    • First, it must immediately clear all its pending dues to state governments.
    • Second, while it is cheaper for the Centre to borrow and transfer to states, even though the spreads between state and central government bonds have now widened, making state borrowing more costly, states must be allowed to borrow more.
    • Third, as some state chief ministers have suggested, the fiscal deficit limits imposed on states must be relaxed.

  • Opportunity in the Covid-19 crisis

    Context

    Coronavirus pandemic offers a trigger to fundamentally strengthen the Indian economy, and protect the vulnerable. This requires cooperation between the Centre and states.

    Opportunity to do things good for the medium term

    • Minimising the impact on the vulnerable: The current crisis is so terrible in its toll of life and livelihoods that the need of the hour must be minimising the health, humanitarian and economic costs, especially for the most vulnerable.
    • Rising expenditure may force hard choices: Rising public expenditures to help tens of millions of workers and their families alongside plummeting resources will inevitably force hard choices.
    • Appropriately, much of the policy discussion and the government’s first response have focussed on addressing the immediate imperatives.

    This crisis is also an opportunity to do things that are not only good for now but for the medium term as well. Few are discussed below.

    1. Revamp macro-fiscal framework

    • Massive fiscal expenditure may require: If the pandemic follows the exponential trajectory seen in other countries, the crisis is going to entail massive fiscal expenditures, perhaps up to 4-5 per cent of GDP, much more than what the government has announced.
    • Macro-fiscal targets have to be exceeded: Consequently, the basic macro-fiscal framework — for example, the Centre’s FRBM target of 3.5 per cent of GDP, and the revenue and deficit estimates for 2020-21 — has been fundamentally overtaken by events.
    • Allow states to exceed deficit targets: The Centre should immediately announce that even the states will be allowed to exceed their fiscal responsibility legislation targets because they will be in the front line of taking action against the pandemic.
    • Opportunity to review the FRBM: The crisis is an opportunity to revisit the entire framework.
    • The focus on unattainable targets, the fact that the FRBM has been honoured only in the breach, and the consequences in terms of loss in budgetary integrity and transparency need serious review, even overhaul.
    • Once the crisis ebbs, India might be looking at overall deficits well in excess of 10 per cent and debt levels much greater than those today. If the starting point is going to be so different, the old goals and targets won’t retain meaning.

    2. Remake finance and adopt a data-driven lending model

    • Going into the crisis, India’s corporate and financial sector were under severe stress — the so-called Four Balance Sheet problem.
    • This crisis will, unfortunately, add consumers and small and medium enterprises to that This will be an extremely hard — but critical — problem to address.
    • A takeover of bad loans will be unavoidable: To allow banks to revert to normalcy, a largescale takeover of their bad loans will be unavoidable not least because the current bankruptcy process will be severely inadequate.
    • Opt for the tech. driven lending model: This crisis opens the door for the new lending model proposed by Nandan Nilekani i.e. technology-driven lending.
    • What is Technology-driven lending? It uses data rather than collateral, allowing the 10 million-odd businesses with deep digital footprints (for example, based on GST invoices), to get loans from the thriving ecosystem of new financial players.

    3. Complete JAM

    • One of the major achievements of the government was to create the plumbing — Jan Dhan, Aadhaar, and Mobile (JAM) — to augment weak state capacity.
    • How JAM is proving helpful in this crisis? The state could now make cash transfers swiftly, with reduced leakages, whether as income support, scholarships or pensions, and potentially eventually implementing a Universal Basic Income.
    • In the current crisis, it is proving to be an important part of the social safety net that is helping to cushion the most adversely affected groups.
    • JAM is not complete yet: But the JAM plumbing is still incomplete because there is a “last mile problem”.
    • Not all those with bank accounts can access money either because of difficult geography or because bank functionaries give incomplete or misleading information.
    • Opportunity to fix the shortcomings: This crisis is an opportunity not just to leverage JAM to enhance cash transfers, but to empower citizens. This will require the government to identify remaining weaknesses on a war footing and fix them.

    4. Re-shape Indian agriculture

    • Need to create one market for agriculture: The need to preserve supply chains in agriculture in times of crisis reinforces the need to create one market for agriculture across India.
    • This requires eliminating legislation like the Essential Commodities Act and the panoply of resulting restrictions.
    • Phase-out subsidies and opt for DBT: Second, the crisis has shown the possibilities created by JAM and direct transfers.
    • Phasing out in cycles: Building on PM-Kisan and various state-level schemes, pernicious subsidies, especially for fertilisers and power, could be phased out over 5-6 crop cycles.
    • This could be done through small but frequent increases in fertiliser prices (the technique used to eliminate fuel subsidies).

    5. Focus on Make in India

    • The critical source for almost all the essential Active Pharmaceutical Ingredients (API) used to manufacture drugs, the ability also to fight death, is largely made in China.
    • India was once a major producer of such APIs but lost ground to China.
    • Frame intelligent industrial policy: The crisis should be the opportunity to go on war footing to do intelligent industrial policy — incentives, regulatory help, trade policy — that would resurrect India’s manufacturing capability.
    • Previous Make in India attempts have shown lackadaisical results.
    • Focus on the pharmaceutical sector: The crisis creates the momentum to focus the effort on one sector, pharmaceuticals. As a result, the ability to save lives could be Made in India, again.

    6. Establish migrants as full citizens

    • Need to change the place-based benefits to person-based benefits: The plight of migrant workers reinforces the need to move from immobile place-based benefits to mobile person-based benefits, which is possible as the JAM infrastructure is strengthened.
    • Portability of benefits: This will require portability of benefits, including access to the PDS, Ujjwala and Ayushman Bharat.
    • The crisis has highlighted the travails of migrant labour and their second-class status.
    • The large gap between the organised and unorganised sector worker: It reflects a broader chasm between the few securely employed in the organised sector and the vast majority subject to the vicissitudes of the unorganised sector.
    • Differences not just in the levels of income but in their volatility as well as differential access to social insurance (healthcare, pensions) distinguish these two classes.

    7. Upgrade Health

    • Weakest state capacity in health and education: State capacity over 70 years in India has been weakest in the areas of education and health.
    • The COVID-19 pandemic must lead to a serious strengthening of the health infrastructure for dealing with pandemics.
    • Set up an apex institution on the lines of US’s CDC: To start with, India needs an apex institution like the US’ Centers for Disease Control with a network across all the states.
    • They should invest in disease surveillance systems, set up diagnostics labs, be able to gather real-time data and analyse them etc.
    • The Taiwan model, which has been so successful in this pandemic, could be studied.
    • More fundamentally, the crisis is a wake-up call to address India’s severe limitations in the provision of basic health.
    • Focus on basic public health: Creating tertiary health facilities must be subservient to strengthening basic public health and early childhood care.

    8. Build a National Solidarity Fund

    • The severe downturn in economic activity ahead will savagely hit the informal poor.
    • How would the Solidarity fund be set up? The government should consider a Solidarity Fund with a one-time annual contribution coming from the wealthy and the employees in the organised sector.
    • Contribution to the fund: This contribution can take the form of taxes or elimination of middle-class subsidies identified in the Economic Survey of 2016.
    • The wealthy could contribute via a wealth tax with thresholds set by property values say above Rs 5 crore.
    • Salaried employees in the public and private sectors could contribute via a small, progressive tax on salaries and pensions.
    • Middle-class subsidies that could be eliminated include interest and tax deductions for small savers, favourable taxation of gold and other luxuries.
    • Wealth taxes and elimination of subsidies for the rich should, in any event, be part of the long-run reform agenda to reduce growing inequality.

    Conclusion

    These examples illustrate how the crisis can be converted to an opportunity to fundamentally strengthen the Indian economy, and protect the vulnerable. A common thread to many of these actions — indeed prerequisites for their success — is cooperation between the Centre and states. Central direction combined with flexibility and nimbleness in the states and local bodies is India’s way through the crisis and beyond.

  • The battle to set oil prices

    Context

    The global economy, grappling with the COVID-19 pandemic, is now facing an energy war, with crude oil prices crashing in the international market.

    Developments that contributed to the fall in oil prices

    • First, Crude oil prices tanked, as the Organisation of the Petroleum Exporting Countries (OPEC) and its alliance partners failed to reach any consensus on cutting back production to levels that would enable prices to remain stable.
    • Second, the U.S., as the largest oil producer today, has stayed away from the OPEC-plus arrangement, hoping that production cuts by OPEC-plus countries will help it increase its market share.
    • Russia refused any production cuts, unleashing an energy war with Saudi Arabia. There has been a spectacular fall of around 30% in crude oil prices.
    • The International Energy Agency (IEA) has scaled down global demand for oil, a move not taken by the energy watchdog since 2009.
    • COVID-19 Factor: Demand for oil had already weakened owing to the global economic slowdown, and this weakening has become more pronounced due to the COVID-19 pandemic, which has hit China’s economy and reduced consumption by the world’s largest importer.

    The US-Russia oil war

    • Denying market share to the US oil producer: Russia’s decision to reject any production cuts is driven directly by its strategy of denying market share to American shale oil producers.
    • Shale oil companies can sustain in high prices only: The American shale oil producers rely on higher prices in the range of $50-$60 to remain profitable because of higher production costs.
    • At $31 per barrel, not more than five American shale oil producers can remain profitable.
    • Sanctions on Rosneft: Russia also remains resentful of sanctions imposed on Rosneft, which is building the gas pipeline project Nord Stream 2 across the Baltic Sea, carrying Siberian gas to Germany, a major consumer.
    • Delay in completion of the pipeline: This pipeline was delayed due to opposition from Denmark’s environmental activists and could not be completed before the U.S. sanctions kicked in.
    • Moscow has accused Washington of using geopolitical tools for commercial reasons.
    • The energy war over prices is Russia’s revenge, to cripple the American shale oil industry.
    • Russia’s signal to Saudi Arabia: Russia is also signalling to Saudi Arabia that its American patrons can do little to protect its oil interests and it would be prudent for Saudi Arabia to reach some understanding with Russia.
    • Both Saudi Arabia and Russia depend heavily on oil revenues — upwards of 80% of export revenues accrue from crude oil.
    • Russia and Saudi Arabia fighting for market share: Both are also fighting to retain market share.
    • Impact on India: It has been reported that Saudi Arabia has agreed to supply crude oil at lower rates to refiners in India and China, two primary customers, but refused to supply to other refiners in Asia. This will have an impact on India’s oil procurement from the U.S.

    The benefits to importing countries

    • Why the price drop matters to India? Lower crude oil prices are not necessarily bad news for oil importing countries like India, which is the world’s third-largest importer of crude oil and the fourth largest importer of LNG.
    • Collateral adverse consequences: There are, however, collateral adverse consequences like the battering of the stock markets worldwide.
    • Impact on the global economy: The global economy, already impacted by President Donald Trump’s trade war with China and other countries, including India, and the COVID-19 pandemic, may find lower energy costs helpful in overall growth.

    Benefits for India

    • From a high of $147 per barrel in 2008, crude oil prices have fallen to around $24 per barrel and may even go further southwards.
    • How much the price drop matter for India? India, with 80% of its energy requirements met by imports from the international market, stands to save ₹10,700 crores for every $1 drop in prices.
    • Non-oil related factors: While this may help manage the current account deficit, fiscal deficit and inflation, there are non-oil related collateral factors that can cause countervailing adverse economic impact.

    How long Russian and Saudi Arabia can sustain the war?

    • Can Russia and Saudi Arabia sustain the energy war for long?
    • Saudi Arabia’s production cost is the cheapest in the world and it can ramp up production to around 12 million barrels a day.
    • By offering discounts, it can undercut other producers, including Russia.
    • Domestic considerations also matter.

    Conclusion

    There is no doubt that India will benefit from lower oil prices if the cost of fuel at the pump is passed on to consumers. It will reduce transportation costs and boost demand. The consumer, however, may not benefit much since the government may choose to use this financial windfall for other purposes, like bailing out banks which have been hollowed out by NPAs to leading Indian companies.

  • Pull out all the stops

    Context

    Though there is coherence in India’s response to the Covid-19, still there is more that needs to be done.

    Sense of coherence in India’s response

    • Since last week, a sense of coherence is settling over India’s response to the COVID-19 outbreak.
    • The national lockdown, the incomes and credit support, and the three-month debt moratorium announced by the government and the RBI are the needed first steps to contain the outbreak on the one hand and lessen the economic impact on the other hand.

    Uncertainty in two important factors

    • Several laundry lists of measures have already been proffered by many, however, these are not of much help.
    • Uncertainty: Given the extreme uncertainty clouding how long and intensely social distancing policies will need to be pursued, the attendant economic impact and, crucially, how quickly and strongly the recovery can take place.
    • 1. The answer to the first depends on how much the outbreak tests the capacity of the already-stretched public health system.
    • Extending the social distancing policy: If the lockdown does not slow the spread of the virus to a rate that the healthcare system can handle, then the social distancing policies, in some form or another, will need to be extended.
    • Destruction of demand: The longer such containment measures last, the larger will be the destruction to (of) demand and the bigger the collapse in output and incomes.
    • 2. Then, there is the question about the pace and strength of the recovery.
    • Much will depend on how much damage the eventual output loss inflicts on households’ and corporates’ balance sheets.
    • Lower consumption: For example, even if a worker starts earning once the lockdown is lifted if one has incurred large debts in the interim, one’s consumption demand will naturally be much lower than before the crisis.
    • The same holds for corporates, both big and small.
    • No help from global demand: What makes the situation worse is that there is not likely to be much help coming from global demand.
    • Growth estimates: It is now expected global growth would decline to 5 per cent (annualised) in 1H20 (first half 2020), considerably more than during the global financial crisis, and rebound only partially in 2H20, leaving global GDP 2.5 percentage points below its pre-crisis level at the end of this year.

    How the uncertainty makes policy response calibration difficult?

    • Difficulty in assessing economic damage: Given these extreme uncertainties, it is very hard to assess the economic damage with any degree of conviction.
    • In fact, in last week’s policy review, the Monetary Policy Committee refrained from providing any projections for future growth and inflation, breaking from its normal practice.
    • So, if the outlook is so uncertain, how does one calibrate the policy response?
    • 1. Under-support the economy: One can easily under-support the economy, which could prolong the slowdown.
    • 2. Or over-support the economy, which could end up stoking inflation (as it did in 2010-13 when the massive monetary and fiscal easing during the global financial crisis was not withdrawn quickly) or creating asset price bubbles.

    What is the way out in such a situation?

    • Don’t try to calibrate: The way out is not to even try calibrating policies under such extreme uncertainty but to let the size of the support be determined endogenously by the extent and nature of the economic damage.
    • Falling back of first principles: This requires falling back on first principles. We know that the economic damage could be very large.
    • Delay in recovery: We also know that if the damage to households’ and firms’ balance sheets is substantial, then the recovery could be delayed and weakened.
    • Give extensive income support: This calls for extensive income support through existing government Jan Dhan and Mudra accounts to households and SMEs, and temporary tax cuts or deferments to the larger corporates.
    • Tax cuts needed: It also needs substantial cuts in indirect taxes (GST) when social distancing is relaxed.

    Problems with RBI measures

    • RBI providing support: The RBI has begun to provide support via its liquidity facility (TLTRO) and regulatory forbearance that allows banks to offer a debt moratorium to their customers for the next three months.
    • But both these measures work through banks.
    • The problem of bank turning risk-averse: Given that banks have turned substantially risk-averse because of the restructuring and bad debt problems of the last few years, the RBI likely needs to start providing liquidity directly to corporates, as recently announced by the US Fed.
    • At the same time, any debt moratorium will reduce profit and, in turn, capital, banks might be reluctant to extend it to all their customers.
    • Accommodate capital shortfall in the bank: Consequently, the RBI also needs to change regulations to accommodate possible shortfalls in bank capital because of the debt moratorium.

    What should be the scope and size of the policy support?

    • Support should be based on the extent of the damage: The scope and size of such policy support need to be determined by the extent of the economic damage, and not by perceived limits about what India can afford or those imposed by existing institutional arrangements and practices.
    • It is quite possible that the size of the economic damage ends up requiring support that widens the fiscal deficit substantially.
    • India clearly does not have the fiscal space to provide any material economic support when measured against standard benchmarks of fiscal prudence.
    • Directly funding the budget deficit: The market is on edge, and fears of eventual large government borrowing has spiked long-term interest rates despite large cuts in short-term rates by the RBI, which are likely to delay and weaken the recovery.
    • Any large bond auction by the government, even if it is offset by the RBI through open market operations, is not likely to calm market nerves and bring down lending rates.
    • The government should invoke “natural disaster” clause: What is needed is for the government to invoke the “escape” or the “natural disaster” clause in the fiscal responsibility act (FRBM) that allows the RBI to directly fund the budget deficit without having to go through market auctions.

    Conclusion

    Such a proposal is likely to raise the hackles of any fiscal conservative and there is the natural question about how rating agencies might react. As long as the government credibly commits to reversing the action as soon as the crisis is over, rating agencies and fiscal conservatives alike will likely treat this kindly, as it is a response to a crisis caused not by poor economic policies, but by an act of nature.

  • Counter-cyclical Capital Buffers (CCyB)

    The RBI has announced that banks need not activate countercyclical capital buffers (CCyB) amid slowdown due to COVID-19 outbreak.

    What is Countercyclical Capital Buffer (CCyB)?

    • A capital buffer is a mandatory capital that financial institutions are required to hold in addition to other minimum capital requirements.
    • CCyB is the capital to be kept by a bank to meet business cycle related risks. It is aimed to protect the banking sector against losses from changes in economic conditions.
    • Banks may face difficulties in phases like recession when the loan amount doesn’t return.
    • To meet such situations, banks should have own additional capital. This is an important theme of the Basel III norms.

    CCyB framework in India

    • The framework on CCyB was put in place by the RBI in terms of guidelines issued in 2015 wherein it was advised that the CCyB would be activated as and when the circumstances warranted.
    • The framework envisages the credit-to-GDP gap as the main indicator, which is used in conjunction with other supplementary indicators.
    • It requires banks to build up a buffer of capital in good times, which may be used to maintain flow of credit to the real sector in difficult times.
    • The buffer was also meant to restrict the banking sector from indiscriminate lending in the periods of excess credit growth, which have often been associated with the building up of system-wide risk.