Building liquidity infrastructure and protecting incomes required in the short term; rebuilding trust in the long term.
- By Akhilesh Tilotia
The first part of this article (bit.ly/3bdsI9D) discussed the possible impacts of social distancing. As supply chains get disrupted, the effect will be as much social as economic. Public health systems across the world are gearing up to cope with this challenge.
The fundamental premise of social distancing is that individuals keep a distance from one another. This premise is based on division of labour, which intricately links up the economy to social interactions. Any lack of social interaction can create significant break-ups in the economic links, which flow through supply of goods and services and credit and trust. Distrust can disrupt the system: this is not dissimilar to how the markets ‘gummed up’ post the great financial crisis (GFC). Hence, the policy response must focus on keeping the system working until it stabilises.
Unlike earlier episodes (demonetisation, GFC, Spanish flu), there is no time dimension attached to Covid-19. Each of the above issues lasted either a few weeks or a year and beyond, but we don’t know how long the current predicament can last.
Businesses will feel the impact across the board: (1) Revenues could stall or fall, led by pricing declines and volume compressions; (2) Costs could remain elevated as gaps are filled with last-minute arrangements; (3) Working capital cycle could come undone; (4) Liquidity and credit may be challenging to find as the ratios that comfort a banker (growth, margins, working capital days) could be trending poorly. Coupled with lesser productive employees who try out the new office-at-home, this could lead to material challenges across P&L, balance sheet and cash flow. Small changes in the external environment can rapidly convert a healthy company into a sick one. It might be impossible to predict in which sectors such challenges may emerge next and with what ferocity. A constant vigil and rapidly periodic assessment is needed.
Different business ecosystems will have vastly different inherent abilities to withstand revenue shock. Businesses with high-capex and low-margins, which rely on significant asset-sweating (say, airlines), may not be able to hold on for an extended period of low or no revenues before deferring payments. Businesses with low asset-turnovers, but high margins (say, service industries), may be able to sustain for longer. Since this type of spread and lock-down is unprecedented, it is not analytically clear which supply chains are most at risk. Comparisons with the 1-3 month disruption at the time of demonetisation or a 3-6 months disruption during the GFC could offer some leads.
Liquidity infrastructure: Creating liquidity lines is essential—such credit lines will be useful as the supply chain convulses, creating sudden, unanticipated requirements for funds. But the need for liquidity will face the concern of financiers on the ability to repay. A societal solution (fiscal or regulatory) for liquidity needs to be found. It could take various forms like deferring or partially condoning taxes, a line of credit from the government (a Kisan Credit Card equivalent for all citizens linked via UPI), increased drawdown limits or term extensions for loans, etc. Liquidity challenges could lead to solvency issues across businesses and industries—avoiding such precipitation will require building the liquidity infrastructure.
Liquidity solutions: Reducing interest rates will help, but cannot bring cash where it is required. As doubts on the viability of companies take hold, what will be more critical for them is access to cash than the price. While monetary and fiscal policy authorities can help bring down systemic costs of funds, building the pipeline of liquidity will require the banking and financing system to step up. They, too, will be as concerned about the quality of credit and its sustainability: offering liquidity to troubled sectors will require specific forbearance dispensations from the authorities. Every sector may require its unique solutions ranging from offering holding capacity (agriculture), creating liquidity within the supply chain (auto), to financing end-buys (real estate).
If the social distancing were to last longer than a few weeks, the biggest challenge would be faced by the informal and unorganised workforce. Those with a variable economic activity could find themselves redundant. This will happen both at sectoral level where consumption is either denied or deferred and at individual level where small enterprises face the brunt. Income support will be crucial, especially in sectors that are front and centre (aviation, hospitality, retail). As people stay indoors, the informal segment dependent on serving others (taxi-drivers, small shops with perishables) will find that customers are nowhere to be found.
It is easier to give income support to formal sectors—via a tax cut or other forms (deferring taxes, relaxing timelines for payment). Companies could be incentivised, too, to advance salaries to employees or borrow against retirement benefits.
Reaching the informal segment, however, will be difficult. India will have to reimagine the DBT pipeline. It will be important to put in place a system where the Centre or states can reach out quickly for income support.
Asset and commodity prices have fallen. Central bankers in all large economies have reduced the price of money significantly by driving out-of-policy rate cuts or promised to do so. This puts savers and pensioners on a sticky wicket—at a time when asset prices are falling, they also see their regular incomes fall. India, which has seen monetary transmission being impacted by high rates of returns the government offers on its small savings schemes, will need to find a way to protect savers’ incomes. Again, targeted support may be required, especially for the elderly.
Once the social distancing phase is over, rebuilding confidence and restoring trust will be the key. Most of this will naturally start to happen. Still, some of it can be triggered by greasing the economic activity via large capital spends or social works programmes. In these times of tackling the challenge head-on, this may seem a distant requirement. But with luck and perseverance, we will have ‘flattened the curve’ in a few weeks. It is critical to survive this phase. (Concluded.)
(The author is the Head of Strategy & New Initiatives at Axis Bank. Views are personal)