INR1.7 lakh crore may be small change. India needs a big-bang stimulus to skirt recession. – ET Prime

If the recently announced INR1.7 lakh crore relief package for the poor is indeed the nature of a stimulus, it is an inadequate recognition of the magnitude of the problem at hand. The Indian economy will need a much bigger push and fiscal consolidation will have to wait for another day.

No country is even remotely concerned about the consequences of overshooting fiscal targets during such extraordinary times. Concerns of a rating downgrade, too, are unfounded. Credit-rating agencies are unlikely to hastily order sovereign downgrades unless inherent weaknesses warrant otherwise. Moreover, some of these spends are a mere front-loading of budgetary spends.

Drawing parallels between the present series of unprecedented events with the 2008 crisis would invite flawed policy responses. Rather, we are now in a 1929 like ‘Great Depression’ phase. Such times demand a big-bang fiscal stimulus. Even by conservative estimates, an additional spending of INR5 lakh crore is a necessity. If last week’s package were welfare measures and a big stimulus is on the horizon, it gives solace, but the bazooka has to arrive quick and fast if India wants to avoid a full-fledged recession. It’s imperative to revive growth at any cost.

At the risk of sounding too pessimistic, a V-shaped global recovery looks remote this time, contrary to popular perception. First, even before the epidemic, the global economy was at a standstill. Shutting down major parts of an economy leads to even more people with low wages or without any job, and replacement of failed businesses consume time. Second, the world economy has changed since social-distancing norms were first introduced a century ago to combat the Spanish Flu. These rules could have a much more adverse impact in the modern era. Third, abrupt and steep decline in commodity prices could cause more number of business failures and broken supply chains, complicating recovery efforts. These explain the rationale behind the need for a bigger stimulus package which has now become almost a norm everywhere.

However, drawing an outright comparison with developed economies like the US, which has announced a stimulus of more than 10%, could be too ambitious for a variety of reasons. Developed countries have much deeper pockets with a large formal economy and a much higher tax-to-GDP ratio, making higher leverage more affordable. Moreover, there are lessons from China, which has high public debt. Its total debt is already about 300% of GDP – some says it’s a debt bubble already.

Keeping this in mind, a fiscal expansion of an additional 3.5% as a temporary measure could be optimal for India, taking the headline fiscal deficit to 6.5%, similar to the post-global financial crisis levels.

Almost two months into the outbreak, India’s response at 0.8% of GDP is behind the curve. Its FY20 GDP growth is estimated at 5%, according to the advance estimates by the Central Statistics Office. Let us safely assume an output loss of about INR47,000 crore per day due to the lockdown, which, for 11 working days from March 24 to April 14, works out to nearly INR5 lakh crore with significant upside risks if the lockdown gets extended. It is a no-brainer that both Q4 FY20 and Q1 FY21 growth would be adversely impacted. As stated earlier, an urgent policy response can alleviate some pain.

The need for targeted public spending
Advanced and emerging economies have magnanimously loosened their purse strings this time. The US has gone to the unprecedented extent of unleashing a ‘mother of all stimulus’ – 10.5% of its gross output – even with public debt crossing 100% of GDP. Indonesia recently announced an additional 2.5% fiscal gap (taking its headline fiscal deficit above 5%) which should prompt India to think along similar lines.

Well-targeted public-spending initiatives help bring growth back on track through the aggregate demand channel. Unfortunately though, the present crisis is a tale of co-existence of both supply and demand disruptions, warranting a calibrated package with enough firepower, which addresses all the relevant stakeholders.

In middle-income economies like India, public-spending programmes are crucial. Ranked 116th in per-capita income terms with a median annual wage of just USD9,027, a pandemic of this magnitude can potentially destroy the informal-sector demand. The latest Periodic Labour Force Participation Survey (PLFS) counts 212 million casual labourers while 472 million are self-employed. If targeted properly with direct transfer of wages and employment-guarantee programmes, these segments are potential demand generators. The Centre should think of a national urban employment-guarantee scheme along the lines of its rural counterpart to catapult per-capita income and move towards a demand-led growth.

Over the past five years, leveraged households contributed to India’s growth story brought about by a credit-fueled boom led by banks and non-banks, even as overall household savings remained static. An unsecured lending boom-led new NPA cycle is imminent if job losses are rampant. A wage dole or an urban employment-guarantee scheme would help revive sagging demand while staving off a potential bad-loan crisis.

Meanwhile, corporate profitability, already on the wane, will decline further if demand remains muted. The liquidity crunch faced following the IL&FS episode could turn into a solvency nightmare if demand, too, fails them. According to a recent study, a 20% fall in Ebita (earnings before interest tax and amortisation) could result in three out of 10 firms posting an interest-coverage ratio below one, which essentially means their earnings would be insufficient to cover their expenses. This could worsen if the slowdown gets prolonged.

Firms in power, telecom, infrastructure, aviation, and construction sectors are found to be particularly vulnerable. Cash-flow issues faced by these firms will lead to default in repayment obligations, further crippling the banking sector in the process. Such liquidity and solvency issues warrant bailouts as an option.

India took long to recover from demonetisation. But there is a difference. It was not a pandemic which lacked a vaccine. Demonetisation-induced slowdown is attributable to deliberate structural changes with the singular objective of weeding out black money, expecting a bounceback once the task was accomplished. At least the small businesses and informal economy believed so. But the present crisis is unprecedented in its nature and scope, and industries, big and small, are feeling the heat. Small enterprises, which account for almost 8% of India’s GDP and employ over 450 million people, cannot be left to die for want of a support system.

What the RBI can do
In an unprecedented manner, the RBI this time fired from all cylinders and announced a series of measures – a three-month moratorium on loan repayments, relaxed working-capital financing norms, a cut in CRR, a 75-basis points repo rate cut and a targeted long-term repo operation. But the central bank shouldn’t be lulled into complacency. FIIs drained out almost a billion every day since the outbreak of the virus and to compensate this, OMOs (open market operations) at frequent intervals would be necessary.

The RBI can cut cash reserve ratio (CRR) further, do away with daily minimum requirement for a temporary period, and pay interest on idle CRR balances. Finally, it can utilise the repo facility opened by the US Federal Reserve and avail dollar funds against the collateral of US treasury holdings. This will minimise rupee volatility and provide huge relief to exporters. But without any support from the government exchequer, these would tantamount to mere tokenism. A GST waiver for stressed sectors is the least it can do at this juncture. Quantitative easing unaccompanied by fiscal stimulus is futile. Subsuming petroleum products in GST would be a real game changer.

Will bailout of stressed private firms mean a moral hazard? No, as these are extraordinary circumstances which cause business failures due to reasons beyond anybody’s control. However, relief can be accompanied by caveats to ward off criticism that taxpayer money is being thrown after failed entities. The government can state clearly that the concession granted would be temporary. It can ensure that only firms with genuine difficulties are protected and no benefit accrues to willful defaulters. Moreover, a large cause, such as a huge number of jobs at stake, confers legitimacy to bailouts, the way it happened with several big firms post the global financial crisis. Similarly, firms facing court proceedings or bankruptcy may be denied bailouts.

The bottom line
The current situation draws a parallel to the Great Depression of 1929 which led to the huge clamour for massive government spending. The year 2020 would be redux 1929 in more ways than one. Present times demand a tilt towards expansionary fiscal and monetary policies. Consolidation, as we said, can take a back seat for the time being.

(Research support from Rochelle Britto)