Policymakers must refrain from the repeating the policy mistakes of the past as the global economy is not prepared to bear the consequences of such excesses.
- By Barendra Kumar Bhoi
The proximate cause of the global meltdown of equity prices in March 2020 is the spread of Covid-19—the novel coronavirus, suddenly emerging as a pandemic with its epicentre in Wuhan, China. Covid-19 has already wiped out more than one-third market capitalisation globally in the first three weeks of this month. Heightened uncertainties prevail around the world as this crisis is not yet over. Not only financial markets, global leaders, too, are at their wits’ end to contain the impact of Covid-19 as there is a double whammy—health emergency, and financial instability, which may become an economic crisis going forward. There is neither a standard treatment for those infected with Covid-19 nor any vaccine that can protect those who are healthy.
The crisis this time is certainly different—a ‘black swan’ event suddenly emerging from the health sector, and spreading more rapidly than a wildfire, irrespective of geography, and social structure. It, hence, threatens all of mankind. More than 3.5 lakh people have been tested positive globally, covering about 160 countries, with deaths surpassing the 10,000 mark. In many parts of the world, leaders have been forced to take extreme measures like declaration of a national emergency, leading to lockdown of all activities except essential services, apart from social distancing. Economic activity has come to a grinding halt in many parts of the world due to the pandemic.
India, too, has taken several drastic measures, like the Janata Curfew on March 22, followed by a nation-wide shutdown of all economic/social activities for three weeks from March 25, 2020. It is not clear at this stage whether the lockdown shall continue further or not. Besides the declaration of a public health emergency, a host of policy measures are lined up for implementation to contain the adverse impact of Covid-19.
The sub-prime crisis of 2008, which snowballed into a global financial crisis (GFC), lasted for more than a decade. Covid-19 may not last as long, but it may leave behind a trail of unprecedented devastation on mankind, which may have enduring impact on the economy. While the sub-prime crisis was man-made, Covid-19 is a natural disaster.
However, many experts believe that it is the outcome an unprecedented human encroachment on nature. The global economy was slowing down even before the emergence of Covid-19. Although the impact of the viral pandemic is uncertain, it will accentuate the process of global slowdown further. Due to sheer helplessness, policymakers may resort to accommodative public policies for quite some time, even if Covid-19 is quickly contained.
This time, public authorities have limited policy space. The US Fed and the Bank of England have already reached zero lower bound (ZLB) of the policy rate. Europe and Japan have been operating at ZLB for quite some time. The fiscal policy space is equally limited due to high debt-GDP ratio in many jurisdictions. When there is a natural disaster or supply-side problem, the fiscal authority is expected to play a key role in supporting growth. Due to lack of policy space, fiscal authorities may look forward to monetary authorities to go for quantitative easing (QE).
This arrangement has met with limited success as monetary policy instruments are blunt and, therefore, an ineffective substitute for fiscal policy. The outcome of the ultra-accommodative monetary policy that most developed countries have pursued for a long time has led to an asset-price bubble around the world. This had to be corrected, and was waiting for a trigger. The same mistake is likely to be committed once again, as central banks are lined up for QE to combat the impact of the novel coronavirus.
A financial crisis may emerge at any time, and from any sector, regardless of whether the disaster is man-made or natural. If policy space is not created at the earliest opportunity, responding to the crisis may be difficult. Had there been timely normalisation of public policies after the GFC, policymakers would have had adequate ammunition to fight the present coronavirus crisis. Growth of the financial cycle due to QE, independent of the real business cycle, is not sustainable. Notwithstanding stringent regulations, the financial sector, globally, is highly vulnerable today. A combination of tight regulations and easy monetary policy is not suitable for monetary policy to be effective.
One hopes public authorities will carefully evaluate policy options, and refrain from the policy excesses of the past. Both monetary, and fiscal policies are rule-based. Marginal deviation from rules may be absorbed by financial markets, but systematic ones, and for a long period, may expose public authorities to helplessness in the time of a crisis. The global economy is hardly prepared to bear the consequences of repeating policy errors.
In India, fiscal stimulus of at least Rs 2 lakh crore is needed, given the severity of damage done by Covid-19. The government can temporarily suspend fiscal consolidation and raise fiscal deficit to 4% of GDP—50 bps above the escape clause, which may provide roughly Rs 1 lakh crore. The remaining amount may come from the oil sector, given the recent hike in import/excise duties on crude oil.
RBI has been proactive in liquidity management, which may continue. Rate action is anticipated on, or before, the next monetary policy announcement on April 3. At least 50 bps cut in repo has been factored in by market participants, besides regulatory forbearance. In fact, the rate cut was overdue, but held back due to a temporary spike in CPI inflation. Rate action can be taken anytime, depending on circumstances, but a fiscal push is more desirable right now. Detailed public policy response is awaited from the prime minister’s Economic Response Taskforce, appointed to protect the economy from the Covid-19 attack.
( The author is Visiting Fellow, IGIDR & former Head, Monetary Policy Department, RBI. Views are personal)