As the Dow Jones Industrial Average suffered its worst trading day since 1987 amid the coronavirus pandemic, the United States and a few other economies are now closely edging towards a recession, given the scales of business and commerce shutting down.
With a 30-day travel ban announced by Trump on all US-Europe travel to contain the spread of the virus, most business dependent on global air traffic have taken a hit already. Also, as small and medium scale businesses shut down, cancellations and postponements of public activities will drastically reduce consumer spending across countries and bring the velocity of spending down.
What we can now see is a trilateral series of simultaneously operating shocks surfacing from the COVID-19 pandemic. In no particular order, they are – an initial supply side shock imposed from China’s shutdown, a fiscal shock for countries where there is a declared public health emergency and an oil price shock with prices of crude oil cut to encourage higher consumption amidst weakening global demand.
The financial markets at the moment are reacting to these shocks in continuum and are likely to remain extremely volatile for a significant period of time; at the very least till the number of infected cases start coming down across nations.
In the meantime, if the US in particular continues to see a rise in infected cases in the near future, the global financial situation could get far worse than a recession – in fact, much worse if compared to the fall out seen from the 2008-09 financial crisis.
In response so far, despite immediate rate cut measures taken by the Fed and many other central banks in other nations, monetary-policy supported stimulus, on its own, has a limited role to calm financial markets and in addressing the structural economic fallout of a pandemic like COVID-19.
How is the pandemic likely to affect India’s own growth trajectory?
Forecasting with high quantitative accuracy is difficult, simply because its hard to trust many of the underlying assumptions of forecasting growth models.
In a recent analysis, economists Hugo Erken, Raphie Hayat and Kan Ji view the COVID-19 shock as a black swan event – where the occurrence of the event might be unlikely but its impact is big. In trying to assess the pandemic’s impact on India’s GDP, they use a designed scenario-building model, which is often used as a methodological tool in many disaster impact assessments.
Some critical observations emerge from their scenarios. Firstly, they expect a substantial economic slowdown, estimated a global growth level of 1.6% which is around 0.8% less than the previous OECD estimate of 2.4%.
For India, they expect growth to come down to 5.3%, from the previous estimate of 5.7%. India’s exposure to China, according to Erken, Hayat and Kan ji, is limited as compared to many other Asian economies. The largest impact is likely to be on the currency markets: the Indian rupee, which has depreciated significantly due to the high risk amongst investors globally (raising the demand of US $ vis-a-vis all emerging market currencies).
Secondly, in a scenario of a wide spread case of virus-infections across India, the slowdown effect on India’s growth could be more profound at around 0.7% in 2020-21, leading to an overall growth estimate of 5%. While these estimates might or might0 not be totally accurate, they do present a higher probabilistic scenario that seems currently likely.
My own view is that the composition of growth in India across sectors might significantly change if the global containment of virus doesn’t happen on expected lines. We are still in the dark on whether the virus can be contained effectively within a short period of time. It is unclear if that will only fully happen when vaccines become common, which could take more than a year to develop and be distributed.
A few more months of lockdown in travel, restricted mobility of goods, and retail business shutdowns in the US, across Europe and parts of China, might inhibit many of India’s key sectors.
For now, there are explicit negative-externality costs to some critical Indian sectors (pharmaceuticals, agrochemicals, electronic equipment, automotive components, etc), while offering a thin silver lining of opportunity to some sectors (textiles, garments, etc.) to boost domestic production and replace broken parts of supply chain networks emerging from China’s isolation.
I don’t completely agree with Erken, Hayat and Kan ji’s view on India’s exposure, in terms of trade, being limited to China. At an international level, it is also important to recognise how China, apart from being a major exporter and importer of goods, remains a vital transit point for many developed nations in facilitating movement of ships, cargo and trade logistics across nations in both South and Southeast Asia. India’s exposure to Chinese imports has drastically increased in recent years.
In 2018 alone, China exported goods worth $90.4 billion to India and accounted for around 14.63% of the exports (CII). China is now the biggest source of intermediate products for India that is worth $30 billion a year. According to Trade Promotion Council of India, approximately 85% of active pharmaceutical ingredients (APIs) imported by Indian companies are from China. India’s agro-chemical industry has been badly hurt already and a longer disruption in supply of Chinese imports (for fertilisers) can substantively lead to price rise once the Kharif season starts in June.
At the same time, if Indian companies producing dyes, pigments, basic chemicals such as polyvinyl chloride can boost production in weeks to come, they can benefit by contributing to the void induced in domestic industrial demand. India was also in the midst of signing a limited trade deal with the US, and in the current scenario, the trade deal might take more than few months to actualise – and trade in services remains already affected. In consumer durables too, Indian manufacturers use 75% Chinese components for items like TVs, and almost 85% Chinese components for smartphones. Important components such as mobile displays, open cell TV panels, open circuit boards, memory and LED chips are all imported from China. It is difficult to substitute intermediary imports in a short span of time. Moreover, at a time when India’s consumption demand and (domestic) private investor sentiment is extremely weak, an exogenous shock from a COVID-19 pandemic, can further dampen industrial production levels.
It is important to see the COVID-19 disruptive shock on the global economy – unlike the 2008-09 financial crisis – as both a supply and demand-side shock. And the intersectionality between these two need to be better understood for an effective policy design to be worked out and executed in response.
Why so? If one goes to a cinema theatre, one buys not only a movie ticket to watch a film but also spends money on some popcorn or snacks, or on a meal before or while being at the cinema. Similarly, if a restaurant stops receiving customers (who decide to stay home and eat) is more than likely to shut shop and let go of people it hired for work, the multiplier effect of consumer spending on business investment-employment generation gets affected.
Most employment created today – in both developing and developed nations, remains largely visible in form of contractual jobs with many new jobs created in the “gig economy” segment (Uber, Ola, Swiggy, Uber-Eats etc.). And a pandemic crisis shutting down restaurants, movie theatres, and imposing sanctions on mobility of people, renders many jobless who have no alternative source of income in hand.
Less consumer spending is already hitting each sector hard in the US, and with a weakening of aggregate demand, a vicious Keynesian cycle of low investment and high unemployment will subsume an economy into a recessionary state (depending on how it takes to contain or treat the virus). Nation-states, with support of international financial institutions, would therefore institute more direct cash transfer schemes in form of unemployment pay benefits, wage subsidies to those outside the salaried net of pay, while providing tax-relief to small and medium scale enterprises.
What could be worse in a context like the US, where the cost for medical equipment and testing for treatment (including COVID-19) is not free and is largely borne out from employer’s insurance or as out of pocket healthcare expenditure by people, is how most of them might not be able to pay for even basic medical treatment, if required.
This puts enormous pressure on the state to secure and pump enough public funds to afford for all that maybe needed in containing and treating the virus.
How does one think of responding to an economic shock like COVID-19?
American economist Barry Eichengreen, in a recent column, argues how immediate economic stabilisation may require a more decentralised financial policy response from governments, giving greater discretionary autonomy and fiscal stimulus to public health authorities. They are after all the first nodal agency responsible for the virus’ containment and in ensuring availability of medical equipment for testing and treatment with relief to all concerned.
Volume of public funds required to address a healthcare emergency of such magnitude-across most affected nations will exponentially rise, as the second wave of the infected cases emerge in countries like US, UK, Italy and other parts of Europe. From providing higher number of hospital beds, oxygen tanks, respirators, intensive care units with supplies of protective suits, masks, testing kits etc., most healthcare departments and state-systems will run short of getting these arranged in less time.
In such a scenario, nation-states might benefit from ensuring radical, institutional measures to help mobilise sufficient financial and human resources in prioritising the medical response to the virus spread.
For example most affected countries, can consider establishing a National Health Finance Corporation (NHFC) that can function as a time-bound special purpose vehicle.
The NHFC, as Eichengreen suggests, at least in the US, can provide emergency funding to the Centers for Disease Control (CDC), the National Institutes of Health, the Department of Homeland Security, and the Department of Defense as well as many state and local governments, health insurance companies, medical firms, non-profits and service organisations.
An NHFC proposal in its governance form and financial architecture could be viewed as a remodelled version of the Reconstruction Finance Corporation -created in response to the Great Depression to support plans under the New Deal (under Roosevelt) and helped stabilise the banking sector under the Hoover Administration (1932).
The advantage of having such an institution now -as a crisis response policy measure, would be to create an efficient one-stop-shop for all financial resources needed for public health authorities and respective state, local governments.
Why a national agency like NHFC might help?
One key lesson to be learnt from countries like South Korea, Taiwan, Japan in effectively dealing with COVID-19 is knowing how conventional federal agencies- in crisis mode, are less equipped to take immediate action due to layers of bureaucratic authorities, that often delay prompt decision making. A nationalised corporation like the NHFC can function with more discretionary power at hand, and have the flexibility to also raise funds from both public and sources in making sure that health services are available where needed.
To further minimise the recessionary growth picture-surfacing from the economic fallout of COVID-19’s trilateral shocks, some targeted policy interventions-if coordinated in consultation with institutions like the IMF and World Bank, can help.
As IMF chief economist Gita Gopinath also argues, “Households and businesses hit by supply disruptions and a drop in demand could be targeted to receive cash transfers, wage subsidies, and tax relief, helping people to meet their needs and businesses to stay afloat. Italy has extended tax deadlines for companies in affected areas and broadened the wage supplementation fund to provide income support to laid-off workers, Korea has introduced wage subsidies for small merchants and increased allowances for homecare and job seekers, and China has temporarily waived social security contributions for businesses. For those laid-off, unemployment insurance could be temporarily enhanced, by extending its duration, increasing benefits, or relaxing eligibility. Where paid sick and family leave is not among standard benefits, governments should consider funding it to allow unwell workers or their caregivers to stay home without fear of losing their jobs during the epidemic.”
Central banks might need to continue providing greater liquidity to ensure that the financial sector of most affected countries remain stable to perform basic credit creation functions and restore confidence in lending to borrowers, especially the small and medium scale enterprises, over a period of time. Coordinated fiscal steps through the creation of government owned special purpose vehicle like NHFC may help in creating coordinated, inter-sectional fiscal policy responses to not only ensure containment of the virus, but also ensure timely cash transfers to affected citizenry in cautiously addressing the demand and supply side effects of the shock.
Once the virus is contained, and most restrictions are taken out, with rise in consumer spending, commodities (like oil) will stabilise in value too.
Deepanshu Mohan is assistant professor of economics at Jindal School of International Affairs, O.P. Global Jindal University.