The Path Ahead – Battling Covid19 On The Economic Front

The spread of COVID19 has rapidly spun out of control the world over and needs to be tackled urgently. 

Though the problem is global, there are national specificities that require nuanced approaches. The nations facing the virus outbreak can be grouped under three categories at present. In the first category of countries, like Italy and Spain, the outbreak has now reached an advanced stage.

In the second category are nations like the United States (US) and India, where the disease is spreading fast. Populations in these countries are now coming under compulsory lockdown.

In the third category are countries like China and South Korea, where it had first spread fast, but after battling covid19 fairly successfully, it now seems to be under control. This category potentially offers the assurance that if nations act decisively, the disease can be brought under control. However, even so, the danger of the disease reasserting itself cannot be eliminated and vigilance becomes necessary.

Recovering Countries After Battling Covid19

Various reports from China suggest that production is being ramped up after it had declined drastically in January and February 2020. But, being the fulcrum of global supply chains, China cannot go back to full production of most items because other nations have cut back production and are importing much less from China. Therefore, Chinese exports will not recover unless other major economies, which are now in lockdown, recover. Chinese imports will also not go back to the pre-disease levels since production in the other major economies remains hampered. China can substitute some imports with internal production, though that will not be easy. If it was possible, then this would have already happened.

China will have to boost internal demand to increase its production levels. South Korea and Japan will face similar issues since they are also large exporters. The Japanese economy was already close to recession before the onset of COVID19 and the situation has only worsened.

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Consumer and business sentiments are unlikely to recover fast in these economies and, because of that, purchases by a population that has suffered grievously in China are unlikely to resume soon. Especially, discretionary items purchases are not likely to recover to the predisease level any time soon. For instance, automobile sales in China have fallen by 80% and are unlikely to recover when the sentiment is poor. Investments will also not recover given that the Chinese economy contracted in January and February 2020 and businesses are not sure of an increase in demand. Production post March 2020 will remain below full capacity with exports and consumption unlikely to recover soon. The full year growth rate thus will be negative or close to zero.

Countries under Lockdown

In countries battling covid19 that are under lockdown now, production of some services can take place from homes via the internet. But, that may also be less than earlier since most people will be operating under anxiety and their efficiency will be low. This would be true in the case of legal services, teaching, finance, and so on. Most services that require people to be in the field or in offices and workshops, will be scaled down or completely stopped, such as transportation, tourism, repair and maintenance, retail shops and wholesale depots. Even the media will suffer due to reduced travel, and its finances will be affected due to loss of advertisement as profits of businesses plummet.

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Health related services will be massively scaled up globally. Public services to keep the population supplied with essentials and security services will also see an increase. But, most of the other public services will be curtailed. The net effect will be a contraction in public services. Decision making by governments, preoccupied with the crisis, will be postponed and public investment will be a casualty.

The impact on the manufacturing sector will be quite large because people are required to go to their workplaces and that has been curtailed due to the lockdown. Apart from essentials like, the fast moving consumer goods (FMCG) and medicines, the demand for almost everything else will fall, especially the big ticket discretionary items. In such times, when the market sentiment is pessimistic, people reduce their demand for items like cars and homes. These have large backward linkages and all those linked businesses will also stall at this point of time.

The demand for essentials will rise temporarily since people are currently hoarding them in anticipation of lockdowns and given the uncertainty about the duration of the prevalence of the crisis. But, in a country like India, only the well off can do this. For many poor people, who buy on a weekly or daily basis, this is not feasible. While hoarding may lead to an increase in FMCG production as the sector will find its inventories evaporating, this can only be temporary since the spike in demand is unlikely to persist. Depending on the duration of the crisis, demand may even plummet later, so one cannot be certain.

The small scale sector will suffer more than the large scale sector, as these businesses work with a limited amount of working capital and, as their sales will decline, they will exhaust it. They will retrench workers or if they are self employed, they will lose work soon and that will reduce demand further. In India, because the small scale sector is very large, both in number and employment, the impact will be substantial. It is here that the crisis will be the deepest since these workers have the least resilience to face a fall in incomes. This could lead to a societal crisis.

The fall in employment will also manifest itself in the organised sectors. The demand for energy falls with reduced travel and production. Consumer durables and capital goods industries will also shut down partially or fully as demand plummets. Airlines are already curtailing services, airports are running at reduced capacity; restaurants are being closed and demand for taxis, autos and buses has declined. They will all retrench contract labour to reduce losses.

Countries in Partial Lockdown, battling covid19

Many businesses that are highly leveraged (especially the financial sector) will face failure. So, the non performing assets (NPA) of banks—which were already large—will rise dramatically—unless the government takes corrective action. In the Indian stock markets, the foreign portfolio investors and the Indian rich have taken the first mover advantage and withdrawn large sums of money, leaving the middle class investors and public institutions, who are still invested in the mutual funds, to take most of the losses.

Countries in different stages of lockdown will have to ensure incomes for those losing employment. Otherwise their recession will deepen into a depression. Governments will have to do this directly, through direct cash transfers and this has been announced in countries like the US, Norway and the United Kingdom. However, due to the lockdown, the availability of essentials will be critical, and the government must ensure this via a public distribution system, perhaps with the help of the army and police.

For economies like India and the US, where the number of cases is rising and partial lockdown has been enforced, the priority has to be to prevent the disease from reaching the critical stage of community spread. So, wider testing is essential, as demonstrated by South Korea in controlling the spread of the disease. For this, forging discipline in the disease tracking and tackling systems is essential. In India, with the poor state of governance and widespread cynicism, superstition and lack of scientific temper, bringing in such discipline in managing the spread and consequently the after effects of the outbreak may be difficult. There should be public stocking of essentials and assurance that it would be equitably available to all citizens. Production of essential health equipment, protective gear and required medicines needs to be accelerated.

The issue of business failure in India can be addressed by relaxing the (90 days) norm of declaration of NPAs. Expenditure on public works programs needs to be speeded up so that people continue to get work while the nation continues battling covid19. But this must be consistent with the health constraints of isolation. Urban employment generation via employment guarantee scheme is crucial. Work can be expedited on the existing infrastructure projects and on expanding medical infrastructure. Recruitment of doctors needs to be accelerated and retired medical practitioners should be encouraged to come back to work. Medical research on disease control also needs to be expedited.

Not the Usual Business Cycle

With the disruption of production continuing since mid January 2020, all over the world, the world economy is bound to enter into recession battling covid19, which will have a long term impact. This is not the usual business cycle in which monetary and fiscal policies can deliver. Fiscal policies can only slow down the decline but not prevent it, while monetary policies must be accommodative.

The situation is worse than a wartime situation. Contrary to wartime when demand, especially of military equipment, rises, overall demand, as argued above, has collapsed now. Now, only the bare essential is produced and distributed, while all other production and distribution activities are halted due to the need to isolate people. In a war, activity increases, but now activity has largely stopped. So, the usual solutions will not work. The problem cannot be solved immediately, but society has to be prevented from going into a collapse.

Government intervention has become critical to mitigate the impact of the pandemic, especially in a poor country like India. Public distribution of essentials will have to be expanded to fulfill basic needs. Incomes will have to be transferred to the poor. Given the difficulties of identification, a universal basic income can be put into place. Public health infrastructure will have to be strengthened. Support to small and cottage sector is required so that they can recover when the situation eases.

Fiscal Deficits Will Rise

Markets cannot perform most of these functions, and it is the collective that will have to deliver. Thus, government expenditures will balloon, while tax collection will contract as economic activities decline. There is no possibility of raising additional taxes at this juncture. Indirect taxes will be inflationary and further burden the poor and reduce demand. Commodity prices will fall, and the government could raise taxes to absorb the fall in prices. But, that would only be counterproductive. Direct taxes cannot be raised since profits and

incomes are already badly hit. Non-tax revenue, too, cannot be expected to contribute more since the public sector is also under stress.

Disinvestment in the present circumstances — of decline in the stock markets and negative sentiment in the markets — is unlikely to be successful. For instance, presently with the airline industry being in a state of collapse, who would buy Air India? The insurance sector will face lots of claims and its profitability will be hit. The Life Insurance Corporation of India (LICI) will take big losses in the stock markets that are collapsing, while the LICI is buying stocks to support the markets. So, the sale of its equity is unlikely to take place. The sale of Bharat Petroleum Corporation Limited, pending for a while, is also unlikely to fructify since energy prices have collapsed, profitability has been hit and share prices have dropped globally. These were the three big ticket items for raising additional non-tax revenue. The spectrum auction is also likely to be postponed given the problem of adjusted gross revenue faced by the telecom companies.

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The fiscal deficit will rise because, as argued above, revenue will be short while expenditures to tackle the crisis will rise. But this should not be allowed to act as a constraint for increasing government expenditures to mitigate the crisis. Fiscal responsibility and budget management have become meaningless. A higher deficit will not be inflationary since demand is drastically down, and there is capacity to take care of any extra demand (even for most essentials) should it materialise. In fact, a higher deficit will help maintain some demand in the economy.

Conclusions

The problem will persist for a while since there can be phases of the spread of the disease. Historically, a century ago, the Spanish flu caused more deaths in the second round. We do not yet have a medicine to take care of the disease or a vaccine to protect individuals against the disease. Thus, a V-shaped recovery is unlikely, and production may remain curtailed for months, if not for more than a year, in all the three categories of countries. This implies that the global economy is staring at a depression.

In brief, the situation rising out of battling covid19 is worse than that during a war, since demand has collapsed. Businesses and finance companies are likely to fail and employment severely impacted. To deal with the health and economic crisis, governments have announced emergency and set up special task forces on the economy. In India too, the Prime Minister announced this in his address to the nation. The budget will have to be revamped, with resources focused to mitigate the crisis confronting the marginalised sections of society in the main, if a social breakdown is to be avoided. The moot question, however, is whether the crisis will bring about a fundamental change in societal thinking, with people realising that a lifestyle change is required and crucially, a well functioning government and provision of public goods are needed at all times.