The much needed fiscal policy during covid 19 lockdown in india

There are multiple measures implemented by the government to stimulate the economy in the covid 19 induced pause in the economic activity. The question is whether they are effective and is there a magic pill which could resolve all the issues

All stimulus should have the desired effect on increased spending and resultant surge in economic activity. Unlike a developed economy, India cannot afford to provide unemployment packages like PPP (paycheck protection programme) as their tax collections are abysmally low. Indias tax to GDP ratio is c.10% as compared to US-24% UK- 34%. Also a significant majority of the labor force is outside of the payroll system in India which is evidenced by the low personnel registered for employee security schemes like EPF,NPS etc. It means that it is virtually impossible for India to have a payroll based stimulus as it would basically ignore most of the labor force.The fact that India dont have an universal health care system compounds the impact in case of surge of covid 19 cases. Thereby it is prudent for the government to have a strict lock-down to prevent a pandemic and the medical resources of State and Central Governments being overwhelmed. It provides the government a breather and focus their initiative in mitigating the constraints imposed on the economy by such strict lockdown measures.

FISCAL MULTIPLIER

Any macroeconomic study is incomplete without analysis of the desired fiscal multiplier effect of a stimulus package. It is defined by the marginal propensity to consume ("MPC") of the beneficiaries of the scheme. If the government has limited resources as is the case for India with lower tolerance for increased fiscal deficit, they should look for a package which could act like a adrenaline shot to the comatose economy.

The poor families usually tend to have the highest MPC as they usually spend most of their revenues on sustenance. It is the same essential goods and services which are allowed to operate in the lockdown. Thereby it would be an accurate assessment that any stimulus directed toward the families of the Public distribution system (PDS) i.e ration card holders below a certain level of income should have the desired impact of increased economic activity. Grocery stores also employ labor with a higher MPC thereby leading to the compounding effect of the stimulus i.e the fiscal multiplier.

CONSTRAINTS

Will the families be allowed to spend primarily on the essential goods - what if they have a outstanding loan and rental payments

The Government did announce a moratorium on rental collections but it needs to be strictly implemented and extended till the lock-down restrictions are eased. A prolonged moratorium is required on both rental and loan repayments (inc. interest) as it defeats the purpose of any benefit package if most of it used to pay a landlord or loan shark who doesnt have the desired MPC/fiscal multiplier effect.

If only essential goods and services are available then people with higher income usually tend to save as there are basically limited avenues to spend other than food during the lockdown

Thereby any benefits directly provided to individuals or families should be directed towards increased propensity to buy groceries and eliminate any redirection to leverage or rental costs.

FIRMS

The above direct stimulus to individuals through PDS or bank accounts can help to sustain the poorer section of society who are the hardest hit for a few months but what about firms. The actual engine of production for the economy, what is the impact of strict lockdown measures on them

There are three key factors which needs to be considered

a) Low margin industry - High fixed cost

b) High inventory

c) Largest employment - direct and indirect

First we need to accept that the government cannot allow a large number of firms to go bankrupt due to the govt lockdown as it would create a comatose climate which would be far more difficult to recover than the covid 19 pandemic. Thereby the Government should drive the initiative to hit the above three factors.

Any industry with high fixed cost ratio would be crippled and are most likely to go bankrupt. Even-though they can prevent working capital issues by reducing inventory or even laying off temporary staff but they cannot avoid the fixed costs like borrowing, property,plant and equipment maintenance and depreciation.

Firms carrying large unsold inventory either in the form of raw materials or finished goods would find it difficult to restart operations as the carrying cost of inventory would significantly impair their cash flows.

Large employers primarily in the manufacturing sector would require the most support as they would be the most likely to lay off permanent staff and reduce their purchase orders which would in turn precipitate a vicious cycle of supplier side unemployment who are primarily in the medium and small sector

FISCAL MEASURES

The government needs to announce a funding mechanism where the RBI directly invests in firms based on the above factors. A designated bank needs to be created under the supervision of RBI which is government funded. This "Covid 19 Bank" should extend long dated instruments carrying a reasonable coupon rate with contingent convertible and a mandatory redemption feature after 5 years. This would be the much need capital infusion required for the indian industry.

The current blanket announcement of 20 lakh crore loans targetting small and medium sector through an already struggling banking sector would only add to the ever increasing NPA issues. It is difficult for a listed banking institution to carry such higher risk on their balance sheet even if it is guaranteed by the RBI/Govt due to the higher capital costs associated with the same and its resultant impact on capital ratios.

Thereby this stimulus needs to be extended by the government directly through its segregated "covid 19 bank" rather than putting the onus on the banking sector. also there is no point in targetting small and medium enterprises as evidenced in the manufacturing sector they are usually engaged in the supplier or distribution side of large enterprises. If the orders from large enterprises dry up then there is no point of any stimulus. It is imperative that we target firms based on the above three key factors and target them for covid 19 financing instruments.

Usually financing for Large industries would help them to maintain their purchase orders and also meet the sale orders when demand picks up post easing of lockdown which brings us to the next important point ...... timing.

TIMING

The above fiscal measures shouldnt be implemented at the same time. Cause there is an inherent synergy between lockdown, stimulus and increased demand. In the initial phase of intense lockdown where only essential goods and services are allowed to operate, the focus should be on the fiscal multiplier stimulus like direct money transfer to high MPC families through the PDS and banking infrastructures with strict implementation of rent and loan moratorium which needs to be extended till the end of lockdown.

During the next phase of the lockdown when the restrictions are eased for industries to operate with minimal or reduced capacity, the first tranche of funding through the Covid 19 bank needs to be extended to firms based on the above three key factors. It is important that the funding is extended in a staggered manner which is coinciding with the gradual easing of the lockdown. There is no point in a giving a bulk amount to an enterprise with no vision on when they will have the opportunity to restart their operations.

This staggered cash flow funding which is in effect a capital instrument would provide the much needed breathing space for the industry to meet the increased demand on the projected consumption post lockdown.

In case there is extended lock-down due to non flattening of the covid 19 spread then the above industry fiscal stimulus needs to be on hold.

To reiterate i believe the following key features are required to restart the Indian economy

a) Immediate and regular stimulus to PDS families during lockdown.

b) Strict implementation of Rent and Loan payment holidays during lockdown

c) A Separate Covid 19 bank created with govt funding under the supervision of RBI

d) Staggered funding timed with the easing of lockdown of long dated instruments with contingent convertible and mandatory redemption feature after 5 years

e) Targeted funding to firms based on the three key factors