In order to get a feel of the contours of the government’s Rs 20 lakh crore revival package, it is useful to understand the circumstances in which it is being announced. First, with the most optimistic predictions pegging GDP growth at barely over 1% for 2020-21 – compared to 5% in the previous year – a stimulus is imperative. Second, with slow economic growth over the last couple of years pulling tax collections down, the government has limited “fiscal space”. This means it can’t prime the economic pump through a massive increase in spending or a cut in taxes.
Third, monetary policy is doing what it can to stave off a collapse by flooding the economy with cash. Since 27 March, the RBI has through different sluices released Rs 525,000 crore of liquidity into the financial system. Banks, however, fear a rise in defaults due to the economic downturn and are shying away from channelling this liquidity to sectors that need it the most. They prefer instead to park their money with the RBI itself resulting in “reverse repo balances” of over Rs 800,000 crore a day on average.
Fourth, the worst affected by the collapse in growth are the small and medium enterprises (MSMEs) and India’s shadow banks or NBFCs that cater to their financial needs. While MSMEs are collectively one of the biggest employers with about 120 million workers on their rolls, they are also considered by banks to be the riskiest borrowers.
This is not because Covid has singled them out for punishment. MSMEs have been skating on thin ice since demonetisation in 2016 and the introduction of GST the following year. The implosion of Infrastructure Leasing and Financial Services (ILFS) in mid 2018 dealt a body blow to the NBFCs from which they did not quite recover. Covid has simply made things worse.
Finally, the pandemic hurts both demand and supply. Locking down is a sledgehammer blow to supply chains and hence downstream final production. A collapse in supply affects in turn the capacity to earn incomes and hits demand hard. A worker who is laid off will focus on ensuring a bare subsistence; the entrepreneur saddled with a loss will put off his decision to buy a new car. Discretionary spending plummets.
Add to this the fact that households are known to ratchet their precautionary savings up and reduce consumption in the wake of crises and you get a situation in which even if supply were to get back on its feet, producers might not find buyers to sell to.
Shorn of the hype and hyperbole, the government’s revival strategy is an “optimal” response to the constraints that this complex mesh of circumstances imposes. To start with, the government hopes that enhanced credit flow can substitute for hard budgetary spending in providing the needed fillip. A large part of the stimulus is really about activating channels of credit. The Rs 300,000 crore collateral free loan facility for MSMEs or the Rs 30,000 crore liquidity facility for NBFCs, mortgage lenders and microfinance institutions announced in the first tranche of the package are examples.
Relying on credit helps in two ways. First, it enables the government to operate within the fiscal confines. Second, it can potentially revive supply by making more working capital (perhaps the most critical input for producers) available and at low interest rates. The bet is that as that supply resumes, it would set off a virtuous cycle. A revival in production would get workers back on payrolls; they would spend more pushing demand up in the process; more demand would call for more supply and so the cycle goes.
How does the government plan to enhance credit flow? After all the decisions to lend lie squarely with banks. The government’s tack is to reduce the risk of loans going bad by turning into a guarantor for borrowers. Thus, behind every effort to get banks to ramp up lending, there is a government backstop – a promise to make good a bank’s losses if a borrower defaults. Guarantees are strange creatures. They are “fiscal” in that the government provides it. Yet they do not involve immediate expenditures and thus no immediate increase to fiscal deficit. They are “contingent liabilities” that need to be paid in future were defaults to happen.
The final assumption in this strategy: while larger firms are better able to look after themselves, it is the MSMEs that need handholding. A large fraction of this credit targeting is thus to MSMEs and their financiers, the NBFCs. An implicit belief is that smaller firms are most likely to deliver economic salvation if they revive. For one they are big employers, and secondly they are indispensable to supply chains that keep the production ecosystem in good fettle.
Stripped to its bare bones, the government’s revival plan is logically consistent. Besides, the fact that other countries such as the US and UK are also placing huge bets on credit flow and guarantees to lift their economies gives it a degree of legitimacy. Critics are however not hard to find. They ask uncomfortable questions about whether the economy has the capacity to absorb so much credit or whether loans rather than conventional fiscal expansion is the right cure. “Parkalam” as the late Congress leader Kamaraj was fond of saying. Let’s see.