Fiscal policy: Surviving the economic tsunami of Covid-19 recession

Impact of demonetisation on Indian economy.
Despite the mayhem it caused, demonetisation benefited the Indian economy by triggering the growth of fintechs, techfins and gig platforms.

The COVID-19 pandemic will have a lasting impact on the world economy than initially anticipated. And in India, the impact can be devastating in various ways, impacting different sectors differently. Given the prolonged slowdown and the slow economic growth, tax collections will be low, interest rates benign and there will be huge stress on balance sheets of corporates and banks. The situation in the unorganised sector cannot be any better and therefore the stress in NBFCs will also be very high. Thus, the fiscal, monetary and financial sectors will need a reset.

On the employment front, situation could deteriorate further. Illustratively, in the unorganised sector, with prolonged lockdown and lower economic activity, need for drivers, domestic help, office peons will be low. It will be difficult to project how long it will take for them to find employment. In a resource constraint budget and low spending by both the Union and state governments, allocation to education and healthcare would probably suffer the most.

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The economic impact could be widespread – The woes in fiscal, monetary, and financial sectors (banking and NBFCs) could lead to social tension with huge psychological impact on a large section of the population. Here are some ways to reduce the pain of the economic crisis.

The main challenge for the government will be to generate employment and ensure the flow of funds into the system. In the absence of productive activity or resource constraints therein, social unrest among the unemployed youth could further disrupt economic growth.

Rethink fiscal policy

There is a need to rethink the priorities of the fiscal policy. The debt-to-GDP ratio should not be a constraint in a prolonged crisis. To reduce cost, should the government replace brick and mortar educational institutions with digital classrooms? On healthcare, should the government encourage wellness centres (yoga, ashrams), rather than focusing on hospitals? And how about mental health?

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If there is no growth in productive employment in the economy, the government must spend more on MGNREGA. Large-scale unemployment could lead to social unrest that needs to be prevented at any cost. Business houses will need some policy certainty on tax, tax concessions and tax holidays. They will need some forward guidance too.

Monetary policy imperatives

Interest rates will have to be cut further to ensure conducive environment for businesses. The RBI will have to maintain high liquidity in the system. The CRR and SLR may also be lowered.

The RBI should give forward guidance to assure that interest rates will be kept at low levels at least for one more year to provide policy certainty to the business community.

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Financial sector

Given the prevailing low interest rate rates, low credit offtake, and high deposits, the RBI will face constant pressure to chalk out a bail-out plan for the banking system.

The NBFC sector will be under severe stress and will also seek a bail-out. This sector needs a detailed analysis and further delay will only exacerbates the grim situation. The NBFCs are turning out to be bottom-less pits and can take the financial sector down. The government and the regulators may need to take stringent measures to deregister some of the NBFCs.

The government scheme to extend loans to petty shopkeepers and street vendors is very important. But there is a need to ensure that it is implemented effectively without leakages.

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Banking regulation post COVID-19

Basel norms are a big impediment for the growth of banking system in India. It is certainly not suitable for public sector banks in the post-COVD period. At present, the country needs the banking sector to be expansive, but the Basel norms prescribe restrictiveness. Basel norms are international norms for commercial banks that standardise the balance sheet of commercial banks, and to ensure risk adequacy. In western world where banks operate in the private sector, Basel norms are completely justified. In India, where most of the banking is in public sector (safe and secure), should Basel norms be applicable? Basel norms restrict flow of credit and makes banks hold costly capital and India should be cautious in implementing them.

In India, Basel norms (Basel III) have strictly been imposed since 2013 – much stricter than it is done globally. This is not the right way to regulate banking in India which has a complex set of banks — government owned, private sector and foreign banks. The public sector banks are safe because the government owns them. And then many banks don’t have foreign branches and the risk factor is low compared with foreign banks that engage in aggressive banking activities. In general, even the private sector banks are safe because the RBI and the government insure the depositors to a great extent.

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Celebrate Indian Banking

The banking history of India dates back to the sixteenth century. Bank of Hindustan was established in 1770. At least 10 public sector banks have a history of more than 100 years. Allahabad Bank (established in 1865), Punjab National Bank (1894), Corporation Bank (1906), Canara Bank (1906), Indian Bank (1907), Bank of Baroda (1908), Punjab and Sind Bank (1908), Central Bank of India (1911), Union Bank of India (1919), and State Bank of India which traces its origin to Bank of Calcutta, 1806 have survived numerous challenges. They survived the first war of independence (1857), two World Wars, Great Depression (1933), the independence movement, partition (1947), nationalisation (1969 and 1980), and the global recession (2008).

India’s banks have shown resilience to survive the tribulations for more than a century. They have cogent lessons to offer to the banking industry, both domestic and global. These lessons can be distilled as Bharat Norms, and must be celebrated. It would be in the interest of the nation to replace Basel norms with Bharat norms over a period of time.

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Addressing skilling needs

Stepping up skilling efforts is key to India’s emergence post-COVID. The country needs more skilling centres, but not of the ITI variety. India’s skilling efforts must be specific to its needs. MSME sector is the lifeline of the economy with 6 crore enterprises employing 12 crore people. The current crisis will see the mortality rate of MSMEs increasing manifold. To engage the young people joining the workforce every year, the government must ensure that MSMEs are adequately financed.

There is a need to nurture the idea of MSME Universities and MSME Clinics that follows the hub and spoke model. The aim is to tackle poverty and unemployment through state-wise MSME universities that can support local producers. These must become standard knowledge hubs and study material generated must be translated and shared among other state-wise MSME universities. They should offer courses in accounting, labour laws, management skills, tax issues, sourcing of inputs and marketing of outputs to produce rounded entrepreneurs, not managers like those produced by the existing management institutes. These institutes of entrepreneurship in states must teach to market local goods globally. This could produce a large number of jobs in the country. Such institutes could bring down the mortality rate among MSMEs. A well-trained entrepreneur will be able to take more risk, and improve his/her chances of survival.

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Other issues need to be explored

The policy initiatives have mainly focused on liquidity, but solvency issues have been neglected. These could become important in next few months and need to be addressed carefully.

Another issue is the position of India in the context of global economy. There is a need to position the country in such a way that it benefits in the post-COVID world. The embassies and high commissions of India in various nations can play a catalytic role in elevating India to the status of a preferred nation compared with other Asian nations. India can follow the same incentive structure that countries such as China or Vietnam offer to attract global companies.

There is also a need to look into the sociological and psychological needs of the society, especially when families are confined to small houses/rooms without jobs/job security. The role of TV and other mass media is important, considering their reach.

Therefore, given the complexity of the situation, India needs to adopt a committee approach to understand various facets of the economy. The committees need to assess, examine and then recommend remedial steps in terms of immediate (one year), medium- (2-3 years) and long term (4 years and more) time horizon. The committee approach will inspire confidence in the market by establishing that the government is seeking constant advice from experts/scholars during the hard times.

Finally, the Narendra Modi government should stay focused on its $5 trillion economy target. COVID-19 is just a disruption in the journey — an aberration and not a permanent dent. The government must stay focused on the goal relentlessly to realise India’s potential to become a global economic superpower.

(Dr Charan Singh is a Delhi-based economist and the chief executive of EGROW Foundation.)

Charan Singh, Former RBI Chair Professor, IIM Bangalore
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Dr Charan Sigh is a Delhi-based economist. He is the chief executive of EGROW Foundation, a Noida-based think tank, and former Non Executive Chairman of Punjab & Sind Bank. He has served as RBI Chair professor at the Indian Institute of Management, Bangalore.