Drawing parallels with 2008 is misplaced; fast action needed now that a downgrade has happened
The arrival of GDP data for the last quarter and year is the latest confirmation—if more proof was needed—that the government modelling its policy responses to the Covid-19 economic shock by drawing parallels with 2008 is grossly misplaced. In any case, a rating downgrade has just happened. This removes the fears, if any, about the consequences of larger fiscal intervention towards income support than the 0.8% of GDP considered so far. In overlooking the need for near-term demand support, and sole deployment of guaranteed credit lines, loans, and structural reforms as the main policy sustenance, the government is committing a serious error. The latter won’t work when demand and its outlook are as dire as these are. To use the virus analogy, there is not much point in making rehabilitation arrangements when desperately required oxygen is not provided to a patient on ventilator support. There is danger that the patient, suffering much co-morbidity with an unprecedented disease, may not come out of the ICU. The government should reexamine and adapt its policy strategy.
The Rs 20-trillion package is largely regarded inadequate in dealing with large-scale income losses inflicted upon the bottommost households by the lockdown. A key reason for the controlled spending, as the finance minister reportedly explained, was to avoid instability, drawing lessons from the 2008 crisis. This mindfulness to evade the pitfalls of large spending and the alternate focus upon guaranteed loan support for the weakest businesses (MSMEs) is appreciated by some. A few have argued this ensures prudent evaluation, preserves debt accumulation, while some others interpreted the spending restraint intends to retain policy space for later use when this may be needed.
Lost amidst this are present realities: That 2020 is not 2008, and that both the years as well as crises are poles apart. There are outstanding differences in the shock characteristics and context—non-trivial and critical for designing policy actions. If policy responses are set only upon the past, fail to diagnose a ‘new’ disease and overlook existing co-morbidities, such narrow sight can be hurtful.
2008 was a financial crisis. Recessions triggered by financial shocks are deep and long-lasting,with a long recovery, compared to real recessions—because liquidity problems disrupt credit intermediation, impacting investment and, eventually, growth. If financial sector weaknesses persist, structural damages follow with permanent loss of output. Policy responses in 2008 acted accordingly, in India and worldwide.
The 2020 recession is deliberately-induced due to epidemic policy. It is characterised by a sudden but extended freeze of the real economy, resulting cash flow pressures upon firms and households from suspended operations, sharp drops in employment and earnings, and overall spending. Rise in bankruptcies and unemployment have the potential to inflict permanent balance sheet damages, raising the risk of real economy problems feeding back to the financial sector via debt defaults and submerging it in crisis too. In addition, the Covid-19 shock is drawn-out with high, enduring uncertainties in many aspects, including non-economic.
Context is critical for policy formulation because a policymaker can only start from where things are, i.e., present conditions. Last Friday’s data that showed FY20 GDP growth decelerating to 4.2% marked the continuation of a downward drift for three successive years. These data barely capture any ‘lockdown’ impacts; the production shock from virus’ disruptions to supplies is concentrated into the last quarter alone.
Besides this well-known aggregate backdrop, 2020 has far more co-morbidities. One, the financial system is extremely vulnerable: Banks, public and private, are in worse health with gross NPAs at 9.3% (2.4% in 2008), lesser capitalised, loss-making; a large private bank failed this February. Blocked intermediation meant several years of credit starvation; bank credit almost ground to a halt last year as raised risk-aversion impacted the real economy. Non-banks are equally fragile, or rather more. Fast-paced lending fed credit-starved businesses, but stretched balance sheets, with eventual illiquidity and insolvencies; several large entities have failed since September 2018. Fear and lack of confidence pervades the financial system. No such issues existed when the crisis struck in 2008.
On the real side, corporate health is much weaker—profit shares in GDP range 3-4% in past six years, a steep fall from 7.8% in 2008. MSMEs, the main focus of current support, already bear high levels of stressed assets; the precise quality is unknown as most are under regulatory reprieve for nearly two years, perhaps restructured. Households, the bastion of private consumer demand, are overleveraged too; an inclusive measure assesses the stock of household debt at about 31.3% of GDP, with rapid increase in past 5-6 years and falling income growth in last three. Unsurprisingly, net household financial surplus shares in GDP in 2020 are half the 2008 level! Finally, the strained public balances are too well known for further mention, except to underline that provisional government accounts’ data on Friday showed the fiscal gap 0.8 points larger at 4.6% of GDP! In conjunction with public debt stock in excess of 70% in relation to aggregate output, India is in a full-blown fiscal crisis. Moody’s has recognised this.
2008 was heralded by several years of above-9% GDP growth from all sources, robust fiscal position (central deficit was 2.54% of GDP, 2007-08), amongst other things. Ceteris paribus does not hold for 2020 because high indebtedness, weak balance sheets, credit starvation, slowing investment and growth describe it differently. The government should squarely recognise the 2020 crisis is superimposed upon an existing growth crisis of structural proportions. It can’t act as if it were 2008. Even when remembering the last chapter from history, policies have to respond accordingly.
Failing to spend now, when 60% of aggregate demand is alarmingly damaged from loss of jobs, livelihoods and pay-cuts of the low-paid and younger white collar workers, professionals, daily-wage earners, and so on is a glaring lapse; many of these have high spending propensities. Then, there is the pandemic-induced depression in demand due to voluntary restraints, prevalence of milder containment measures throughout its duration. It is clear the economy will operate below-capacity for longer than one year, layered above the existing or pre-Covid slack. This makes the demand outlook grimmer, uncertain.
Many point to medium-term growth improvements from structural innovations. That is distant. The economy will languish in the interval because consumer demand will remain depressed, investment won’t grow and recovery will be slow. If recovery slows down, then the present shock could become structural, enmesh the real and financial sectors.
In such a setting, adequate and direct income support is desperately required. Flickers of demand give firms a reason to stay alive, encourage them to avail those credit lines. Debt-laden businesses are unlikely to contract further debt when repayment prospects remain uncertain; they might shut shop instead—there are reports of MSMEs closures. Even large, unlocking factories are opting to wait for demand before increasing production as per early reports.
What exactly is the time or condition the government is holding firepower for is difficult to understand. That makes it seem that all rehabilitation arrangements are made and tonic-spending will be given once the patient recovers. But, the fiscal oxygen required to get off ventilator support and out of the ICU is not being given! Give that oxygen, and hopefully, the tonic will be a self-sustaining, upward spiral that follows.
The author is New Delhi-based macroeconomist