Rukshad Davar and Rahul Datta
As the nationwide lockdown imposed by the Indian government completes one (1) month, Indian businesses are starting to feel the bite. With mounting operational costs and declining (or nil) revenues, a number of businesses are reaching a point where they are weeks, if not days away, from shutting down permanently. While the Reserve Bank of India (the “RBI”) has introduced a number of measures to stimulate lending and improving liquidity, all eyes are now on the Finance Ministry as Indian businesses look for a relief package to help them survive through these difficult times.
In this update, we analyze the impact of COVID-19 on the Indian economy, the measures introduced to alleviate the impact so far and the need for a further financial relief package.
Economic Impact of COVID-19
The US-China trade war and the lack of liquidity in the domestic market had left the Indian economy in the doldrums as growth slowed to historical lows of 4-5% over FY2018-19 and FY2019-20. However, the COVID-19 pandemic, and the measures introduced to contain its spread, have dashed all hopes of a swift recovery in FY2020-21. With the global economy facing a recession which could turn out to be worse than the 2008 financial crisis and investors fleeing to safe havens to preserve their wealth, Indian businesses have ground to a halt.
In its statement released on April 17, 2020, the RBI acknowledged that growth could slow to as much as 1.9%, if not more, in FY2020-21. At the same time, the International Monetary Fund (the “IMF”) has projected a global growth rate of (-)3% for 2020. While these projections see India as one of the better performing economies in Asia, the fall in global demand is likely to have a massive impact on Indian exports. Already, the RBI estimates that India has seen an export contraction of about 34% in March 2020.
All in all, the economic impact of the pandemic on India is likely to be to the tune of INR7-8 trillion with sectors such as trade, textiles, aviation, transport, tourism, hotels, wholesale and retail trading and MSMEs facing the brunt of the impact. At the same time, the financial sector, especially NBFCs and MFIs, and the real estate sector are also likely to suffer during this period due to a lack of consumer demand. The fall in revenues and incomes will cause a substantial fall in revenue collection by the government, which in turn, will affect the fiscal deficit in the short to medium term. Although the IMF is predicting a V-curve recovery post the pandemic, this is likely to be an optimal scenario and the actual recovery will depend on the length of the pandemic and the quality of the fiscal boost provided by the Indian government.
Measures introduced by the RBI and the Indian government
Since February 2020, the RBI has introduced several long-term repo operation (“LTRO”) packages, including the LTRO of INR500 billion announced on April 17, 2020 which specifically targeted the financial sector (NBFCs and MFIs). LTROs are essentially long-term (one (1) to three (3) year term) loans given by the RBI to banks at low interest rates. The objective of this measure is to incentivize the banks to undertake onward lending at correspondingly low interest rates. NBFCs had been requesting the RBI for direct loans to ease liquidity, however, the RBI has chosen to proceed with indirect loans through banks. It remains to be seen whether the banks efficiently pass on the benefits to NBFCs and MFIs, who in turn, will have to strive to pass on the benefits to their borrowers.
Among further rate cuts and other measures, the RBI also announced a cash infusion of INR500 billion for the All India Financial Institutions, namely, the NABARD (National Bank for Agriculture and Rural Development), the SIDBI (Small Industries Development Bank of India) and the NHB (National Housing Bank) which play an important role in meeting the long-term funding requirements of agriculture and the rural sector, small industries, housing finance companies, NBFCs and MFIs. The RBI recognized that these institutions were not able to raise sufficient funds from the market and therefore, injected much needed capital in a bid to support the rural economy.
The RBI also permitted real estate promoters to delay the repayment of loans availed from NBFCs for commercial real estate projects by one (1) year without treating the same as restructuring. This move will provide much needed relief to the real estate sector.
Separately, in its guidelines for the extended lockdown, the central government announced that agricultural and related activities will be permitted to remain fully operational in zones not demarcated as containment zones. As a significant portion of India’s population derives its income from agricultural and allied industries, this measure is likely to alleviate the financial impact on this sector and consequently, reduce the need for fiscal stimulus in a large chunk of the Indian economy.
The government has also permitted information technology-enabled service providers to operate with an employee strength cap of 50% from April 20, 2020 while industries and construction activities in rural areas (outside the limits of municipal corporations and municipalities) have been permitted to remain fully operational since April 20, 2020. Further, manufacturing and other industrial establishments in SEZs and EOUs have been permitted to remain operational in a move to boost exports while manufacturers of IT hardware, production units requiring continuous processes and manufacturers of essential goods have also been exempted from the lockdown.
The central government’s exemptions appear to be aimed at ensuring that the targeted sectors are able to rebound from the lockdown and suggest that it is attempting to reduce the need for a large fiscal stimulus as it seeks to control its fiscal deficit. However, the impact of these relaxations is likely to be offset by the fall in global and domestic demand and therefore, it is likely that the Finance Ministry will need to introduce a detailed relief package in the near future.
Expectations from the Finance Ministry
The measures introduced by the RBI are unlikely to provide a sufficient stimulus as banks and other lenders are increasingly adopting risk-averse strategies. In fact, the RBI governor has stated that there is a liquidity surplus in the economy and that on April 15 alone, the RBI absorbed INR6.9 trillion from banks as surplus under the reverse repo operations. Therefore, it is clear that the RBI envisions sufficient liquidity in the market and that the benefits provided by the RBI are not being efficiently passed on by banks and other lenders to consumers. Given this prevalent reluctance, the RBI will likely need to introduce detailed procedural guidelines to incentivize banks to pump in the additional funds into the market.
In our view, the Indian government would need to introduce an immediate fiscal package of INR2-3 trillion in the short term while the eventual requirement is likely to increase to a fiscal stimulus package of INR5-6 trillion. The measures that the Finance Ministry could introduce include:
- wage subsidies to workers engaged with MSMEs and other impacted sectors;
- contribution by the government towards payment of interest accrued during the moratorium period for businesses engaged in the affected sectors;
- relaxation of interest rates for fresh loans being utilized to deal with the impact caused by the pandemic;
- allowance for delay or exemption in corporate and personal income tax as well as in goods and service tax liability for entities engaged in the impacted sectors;
- trade reliefs in the form of higher export credits and lower import duties;
- redirection of the government’s unutilized funds from its budget to provide direct cash benefits; and
- extending direct loans to entities in impacted sectors at negligible interest rates, and perhaps, waiving these loans if the entire amount is used to pay employees in a manner similar to the Coronavirus Aid, Relief, and Economic Security Act, 2020 promulgated by the United States.
In the current global scenario, India will need to undertake a shift in its monetary policy towards fiscal stimulus to ensure that the economy is able to rebound from the fiscal loss suffered in the short term. If the IMF predicted V-curve recovery is to be achieved, the government must stimulate consumer spending and foreign investment in the medium term. So far, Indian businesses have diligently complied with the orders of the Indian government to stay at home and its advisories to avoid laying-off employees. Now, it is time for the Finance Ministry to step up and provide the fiscal relief needed by Indian businesses to ensure that they are able to sustain through the effects of the lockdown.
Rukshad Davar is Partner and Head, Majmudar & Partners, Rahul Datta is Associate, Majmudar & Partners. Views expressed are the authors’ personal.