India needs an economic package of 5% of GDP. To avoid a financial crisis, it may need to go to the IMF
As India looks at options to come out of the lockdown—even in a staggered manner—it will need a huge package of fiscal and financial support to stabilise and revive the economy. Many people argue that India does not have the fiscal space for such a support package—since it is already running large deficits. But, India runs a bigger risk to its economy and livelihoods if it does not find ways to finance recovery and a major financial crisis as NPA’s double under this slowdown.
The upcoming IMF-World Bank virtual spring meeting may be the place to nail it down. India is facing a massive crisis—as big as the one that it faced in 1991—but, of course, of a very different nature. That was a classic balance of payments crisis. With IMF support, an exchange rate devaluation and major structural reforms, which liberalised the economy, India was able to get out of it. This crisis is no doubt different—there is no balance of payments problem—if anything, the external balance may be in surplus. India is holding vast reserves—close to $470 billion despite having used some in the past month to stabilise the rupee as FPI’s pulled over $15 billion from Indian markets. But, the forced economic shutdown may end up creating internal jobs and financial crisis which, if not addressed, may relegate the economy to a prolonged slump.
How to finance such a package given India’s fiscal weaknesses is the question? The fiscal deficit in India was already expected to be close to 4.5% of GDP—counting in the off-budget borrowing by PSU’s. With the economy now expected to drop to a growth of around 2% of GDP, revenue intake will crash by at least 3% of GDP factoring in lower tax revenues and disinvestment receipts. Lower oil prices will provide India with a windfall of around 1-1.5% of GDP depending on how long the windfall lasts. Assuming the government keeps most of this windfall and does not allow it to pass-through to consumers, this will mean the fiscal deficit would rise by around 2% of GDP. The support already provided by the government—increased health expenditure plus the PM’s Gareeb Kalyan Scheme—amounts to, at best, around 1% of GDP, and much of this is likely to be financed by re-programming existing expenditures. A third support package of 5% of GDP—4% of GDP for the central government, and an additional 1% of GDP to state governments on top of the payments of their pending GST dues—would be needed now to stabilise the economic system and set the stage for a recovery.
Industry surveys indicate that between FY20 and FY21 year-on-year (y-o-y), output in major sectors such as auto, oil and gas, metals and mining, freight and logistics, construction and textiles is expected to be at least 15-20%, and in aviation, tourism and hospitality could be as high as 30%. Sectors such as agriculture, pharma, and telecom could see small increases. These declines will then have huge implications for the financial system with NPA’s rising by 8-9% of GDP—close to double of what they are today. About 40-60 million workers are estimated to have lost jobs in this lockdown.
The new package must comprise at least five elements:
1. Loan waivers for much of the MSME companies—certainly for the micro and small companies and increases in Mudra loans.
2. Restructuring of loans to the medium and corporate sector—especially in sectors heavily damaged by the down-turn to help restart operations and survive in the downturn.
3. Recapitalisation of the banking system—at least a partial recap with a combination of new capital and recap bonds.
4. Further income support to workers displaced during the lockdown—a cash transfer scheme for returning workers of around Rs 3,000 to get them restarted could be considered.
5. Support to selected strategic sectors with special credit support—like is being proposed in most major economies. Such a plan must dovetail with a broader revisioning of India’s trade and industrial policy to propel Make in India.
Financing such a large package would mean that the combined PSBR would rise from 9% of GDP to over 14%. India cannot finance such a large deficit internally. RBI may be sitting on large reserves, but it cannot take on substantial government liabilities without affecting its balance-sheet adversely. It has just reached an agreement with the US Fed for a much needed swap facility, and should not jeopardise its market standing. Domestic borrowing is out of the question in such a market when the private sector needs funding, and FPI’s are fleeing emerging markets.
The World Bank has already signalled additional fiscal support of $1 billion. This could be doubled. The Asian Development Bank may also be willing to provide a $1 billion of support. India has not tapped the IMF since the 1991 crisis. Its quota at the IMF—roughly $5.8 billion could be tapped. The Fund allows any country 145% of its quota on request—so India could get $8 billion from this source. While India does not have a classic balance of payments crisis this time, lack of adequate action could easily turn into a major financial crisis for a financial system struggling to deal with a huge balance-sheet problem. A stabilisation programme is needed—but one which finances larger fiscal deficits—not the traditional IMF programmes which try and cut deficits. India must raise around $12 billion—close to 4-5% of our current GDP—to stabilise the economy and help shape a recovery.
Without a bold package, India could be staring at a financial abyss. India may not get a V-shape recovery, but must, at least, ensure a “Nike -whoosh” recovery. Yes, we can.
The writer is Distinguished visiting scholar, Institute of International Economic Policy, George Washington University, USA
Views are personal