Covid haze in an Indian maze

We’re all in this together” is a common sentiment do­ing the rounds globally amid the battle against Covid-19. Countries are all facing similar challenges like a sudden stop to economic activity, small businesses hit particularly hard and a collapse in financial markets.

The faint silver lining for India is that it is running a few weeks behind several other countries in terms of the spread of the virus, and can learn much from their experience. The relatively early lockdown was an example of this. But it is important to acknowledge some differences. India’s unique characteristics may lead to different outcomes, or at least raise uncertainty regarding the outcomes, making it a complicated job for policymakers.

One, there are big question marks on how widely the virus will proliferate in India. A recent academic study (suppo­rted by a grant from the National Na­tural Science Foundation of China) looking at inter-city variations in China pointed out that warmer temperatures and humidity can slow the proliferation of the virus. This is a positive for India, which grapples with oppressive heat over the summer months. Sadly, the same report also showed that high population density and low per capita in­come (taken as a proxy for the capacity of the public health system) can more than offset weather-related advantages.

The optimists point out that India’s relatively early lockdown can blunt the challenges of high population density. The pessimists respond that the large migration of labourers back to their villages since the lockdown was ann­oun­ced was counterproductive. The truth is that given so many cross-currents, it is hard to predict exactly how the virus proliferation will pan out in India.  

Home Minister Amit Shah and Defence Minister Rajnath Singh chair a meeting with the Group of Ministers to review the measures related to Covid-19, in Delhi (PTI Photo)

 
Policymakers may be tempted to conserve much of the firepower in their policy arsenal, using it only if things become really bad. The problem with this approach is that long periods of uncertainty in themselves can be very costly. For example, people could begin to defy the lockdown if they become increasingly unsure about their sustenance. And perhaps authorities should expend further resources before things become even more severe. Increasing cash and credit outlays to workers and firms should be an immediate priority.  

Two, the large dislocation in India’s workforce could make it hard to restart activity. The recent mass exodus of labour from urban centres means that the lockdown is not a simple switch that can be turned on and off. Labour will only gradually return to work and activity could take time to restart even when the virus fears are behind us.

 
Policymakers will therefore have a proactive role to play in the long-drawn-out recovery process in addition to their firefighting role right now. Partnering with other entities — NGOs, private corporates and local governments — through the process may be a good idea.  

Three, the large informal sector — involving day labourers and one-man shops which typically operate in cash — do not have access to the same safety nets as the formal sector does. As much as 85 per cent of Indian labour works informally and a lion’s share of Indian firms are in the informal sector. In these difficult times, the formal sector can evoke the Force Majeure clause in its legal contracts, citing the unforeseeable nature of the Covid crisis, and get a breather. A large cinema chain recently decided not to pay rent across all its theatres, evoking the clause.

The informal sector does not have this luxury. Will a displaced tea stall shack find its spot again when the proprietor returns from his village a few months down the line?
The “social capital” content, or simply put, the “goodwill” inherent in India’s informal contracts, will be put to its biggest test over the next few months. Policymakers will have to be prepared if the outcome is grim.

Four, the blow to the financial sector could be serious. India’s financial system has had a rocky few years. The recognition and provisioning for high loads of bad debt at banks took a toll over 2015-18, ending with a fallout at the shadow banks. A risk-averse financial system ensured that credit growth was weak all through 2019, and RBI rate cuts weren’t sufficiently transmitted through to lending rates.

Now if this already fragile financial system gets punched by the Covid crisis, and loans turning sour rise further over the next few months making India’s banks even more risk-averse, they may not be able to lend freely, when credit is most needed. Worst case, the medium-term growth potential of the economy could come under a cloud.  
  
There is an important takeaway for policymakers here. Simply relying on banks to transmit the announced monetary stimulus to the corporate sector may lead to disappointment. Banks may be unwilling to extend loan repayment moratoriums to companies that the RBI has asked for. The banks may also not be willing to lend freely, despite the RBI incentivising them to do so.

In such a situation, the RBI could consider reaching out to endangered firms and sectors directly by opening up some targeted special lending facilities, a measure that is permitted in the RBI Act, but rarely used.

Bringing this all together, we think the authorities should be proactive in imparting a meaningful stimulus qui­ckly. Cash and credit availability will be key — ensuring businesses get the necessary working capital and displaced workers are provided with the basic minimum sustenance.

For small firms, the government may need to provide loan guarantees, and the RBI could start providing funds directly to select sectors. A temporary GST rate cut may be a good idea to support demand. For individuals, cash transfers to Jan Dhan account holders need to be increased further. This will not just act like an unemployment benefit, but also help them in the process of returning to work.

Finally, to make all this possible, there should be an explicit understanding that if need be, the RBI will directly monetise a part of the fiscal deficit by purchasing the bonds the government issues to cover its deficit.
The author is chief India economist, HSBC Securities and Capital Markets (India) 


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