A carefully crafted fiscal package can kickstart the growth process– The Economic Times

A defining hallmark of Indian philosophy is its approach to start with cynicism and end in positive action. This idea of using pessimism as a tool to derive positive action finds its exception in the Indian financial system. Notably, the opinion on public sector banks (PSBs) seldom graduates beyond cynicism. Just before the Covid-19 outbreak, PSBs were the saviours. Now, they are the cynosure of ‘all or no lending’ activities.

But instead of cynicism, it’s now really the right time to act positively. The impact of the Covid-19 lockdown on the financial system, notably on banks and NBFCs, was immediate, even before it surfaced in mutual funds. The estimates on loss of output have varied widely — from deep contraction to barely modest positive growth.

The policy response so far has been flushing the financial system with liquidity and extending support to any sector through banks so that loss is minimised. Some fiscal response in the form of income support and investment in the health sector have been undertaken. But this can’t substitute wider collapse in demand that predates the present crisis.

Banks are facing a trade-off between prudence in lending and risk aversion. This period may last for some time, but isn’t indefinite. However, the possibility of a steep rise in non-performing assets (NPAs) as suggested in some quarters is also not fully correct. The Covid-19 crisis may prompt many sectors to relook their ‘business as usual’ approach. Factoring this in, it is foolhardy to have a plain ‘everything is normal’ approach to downgrade these accounts.

In fact, the 90-day asset recognition methodology under the Basel framework could be changed to 180 days in the post-Covid scenario, with a well-laid out calendar of returning to ‘normal’. GoI’s fiscal stimulus package currently under consideration, therefore, must address the demand aspect. Both organised and unorganised sectors have enough capacity to meet supply. Banks can also comfortably supply funds, given the Rs 8 lakh crore parked in reverse repo.

What is expected is the visibility of cash flow that can be addressed with ademand-stimulating package. So, how will this package be financed? Since the geographic spread of Covid-19 is not uniform, the package could be divided in phases, with green zones receiving the funds first, which can be supplemented through the branch network of PSBs. Efforts should be to absorb the local labour at the place of residence.

On the financing front, a fair assessment shows that domestic household savings may take a dip before they recover. This leaves expanding the money base to finance public investments that have an income-generating potential as the only option. Since demand is deficient, and there is excess capacity and build-up of inventory, expansion of the money base will not be inflationary. So how should the monetary base be expanded?

Suggestions range from buying gold from the public to GoI pledging its shareholdings with RBI. While the former is difficult to execute (as past experience on gold deposits has shown), pledging shares doesn’t address the aspect of the rise in public debt that remains a point of concern. It also constraints future disinvestment efforts and creates distortion in the redemption profile.

The best way to finance this fiscal stimulus will be either to issue sovereign long-dated zero-coupon bonds with 20-year maturity, or a sovereign perpetuity bond bearing a nominal coupon of 3-4%. This will not create any pressure on redemption or debt-servicing.

The funds may be used for a wide range of purposes such as providing equity to the National Investment and Infrastructure Fund (NIIF) and capitalise banks if warranted. So, the position is still retrievable if amiddle path of prudence is taken. A carefully crafted fiscal package can kick-start the growth process, and prevent rating downgrades.

(The writer is group chief economic adviser, State Bank of India)