Macroeconomics

Covid-19: The infected economy

  • Blog Post Date 18 April, 2020
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Amartya Lahiri

University of British Columbia

alahiri@interchange.ubc.ca

India, along with much of the world, is now in a lockdown. But the cost of locking down the country is particularly high for the urban poor in India. Besides, the reality of urban living reduces the efficacy of a lockdown in containing the spread of Covid-19. In this post, Amartya Lahiri explains why a bigger fiscal package is needed to approach the direct cost of the lockdown, and how it can be financed.

 

India, along with much of the world, is now in a lockdown. In order to arrest the spread of Covid-19, more and more countries have shut down all activities except essential services.

The virus spreads through person-to-person contact. In theory, a lockdown limits the spread of the virus to families and should suppress the virus in 21 days. Measures such as social distancing and self-isolation are limited versions of this strategy. Absent this, the number infected would likely swamp the existing capacity of the health system, leading to a spike in fatalities stemming from the virus and other causes.

The problem with the lockdown approach is that it entails severe economic disruption. Since our modern production methods are organised in the form of group activities, quarantining the whole population involves shutting down nearly all economic activity. This cost is massive. As an example, a total shutdown of all economic activity in India for three weeks amounts to 5.8% of Indian GDP (gross domestic product) foregone, or US$150 billion.

The problem policymakers face is of a twin slowdown: social shutdowns slow the spread of the virus while also slowing the economy. This is a choice between Scylla and Charybdis; damage is guaranteed whatever option one chooses. 

Cost of lockdowns for the urban poor

In India, the nature of the economy complicates matters further. The average citizen works in the informal sector; is poor with a monthly income of Rs. 11,000 (US$150); has minimal savings and little to no social insurance; and lives with limited access to functional healthcare services. These factors significantly reduce the ability of the typical Indian to deal with sustained economic lockdowns.

Moreover, 25% of the 500 million urban Indians live in extremely congested slums with shared toilet facilities and limited civic amenities. It is heroic to expect that a total lockdown of cities would induce zero social contact in such slums. The reality of urban living in India reduces the efficacy of a lockdown in containing the spread of Covid-19.

The cost of locking down the country is particularly high for the urban poor. They are mostly informal workers working in the unorganised sector without formal contracts. Any disruption of the daily income flow makes survival a challenge for these urban poor since they operate with a limited stockpile of savings. 

Damage to the economy and need for a larger fiscal package

The damage this lockdown is doing to the economy will take a lot of repairing. Domestic and international supply chains of both essentials and non-essentials have been severely disrupted, and many migrant urban workers have headed back home to their villages. The time required to entice these workers to return to their urban jobs, and thus for supply chains to be brought back online, is prodigious.

Moreover, many firms will face a serious threat of bankruptcy as the enforced quarantine continues. As the lockdown has now been extended beyond the initial three-week period for another 19 days, more and more firms will face this risk. This will have the effect of extending the length of the downturn, as temporary furloughs of workers transform into permanent loss of jobs.

This economic cost is not going to be distributed evenly across the population. It is going to be particularly hard for the poorer sections of society who live with little savings and expenditures close to the bare subsistence level. This is where the government needs to become much more aggressive with its fiscal rescue plan instead of outsourcing this burden to the private sector.

The current plan announced by the Government of India consists of a US$23 billion fiscal package, which is less than 1 percent of GDP. This is just not sufficient. Countries like the USA, UK, and Germany have put in place corresponding packages in excess of 10% of GDP. Moreover, some of the items in the Indian package were already budgeted as part of ongoing government schemes. Given the scale of the shock, the fiscal package has to be at least five times larger, or about US$100 billion, so that it can approach the direct cost of the lockdown.

The spending needs to target three groups. The first are clearly the poorer households. The 360 million Jan Dhan Yojana accounts are the perfect vehicle to make most of these transfers. Rs.1,500 per month per account for three months would cost US$22 billion. It would be money well spent and not subject to the typical leakages associated with targeted transfers. As an example, the 30 million construction workers in India are covered by the Building and other Construction Workers Welfare (BOCW) Act, 1996. But since most construction workers are hired through contractors, it is the contractors who register these workers under the Act. Since there is a registration fee, not all workers are registered. Hence, targeting direct cash transfers to construction workers will end up missing several of them.

A worthy goal of policy would be to incentivise firms and businesses not to lay off workers. This is the strategy a number of countries have been pursuing in designing their fiscal packages. In India, this is unlikely to be fruitful since 85% of workers in India work as informal workers in the unorganised sector. Targeting payments to the firms in the unorganised sector is likely to be subject to massive leakages. In the Indian context, policies that send payments directly into the hands of the poorer households are much more likely to be effective.

During these uncertain times, households are likely to want to hoard cash transfers made to them. This is a natural response. The problem with cash hoarding is that it prevents demand from picking up which, in turn, can extend the economic slowdown since firms and businesses will not want to hire unless they see robust demand. To stop this vicious circle from setting in, the first-best approach would be to distribute e-vouchers that can be used for purchasing consumption goods. However, the targeted delivery of such vouchers is likely to be subject to the usual leakage problem. An alternative is to reduce GST (goods and services tax) for all goods by 3 percentage points for a three-month period. The revenue cost of this will be around US$7 billion. The temporary nature of the GST reduction may galvanise people to spend while the rates are low.

A second sector that will need assistance is the financial sector. A spike in NPAs (non-performing assets) is all but guaranteed as more loans become delinquent on account of borrower distress. Private sector credit in India is around US$1.5 trillion. If an additional two percent of loans become NPAs, it would amount to US$30 billion. Since most of this bank credit is secured with collateral, this may be the perfect opportunity for the RBI (Reserve Bank of India) to engage in a version of quantitative easing by buying up these asset-backed securities. The RBI has so far asked banks to voluntarily reschedule payments. The central bank ought to foot some of the bills directly.

The remaining US$40 billion has to be spent on the health infrastructure. Four items need urgent attention. The first is ramping up testing. Hence, acquiring more testing kits has to be priority one. The second is boosting the availability of hospital beds. The third is acquiring the required stocks of ventilators and protective equipment like gowns, gloves, and masks for the medical staff. Fourth, acquiring antibody tests is just as important as the above three items. Possession of antibodies implies immunity from the disease, which in turn means that those who possess antibodies can resume activity. This will reduce the economic disruption by making quarantines more targeted. 

Financing the stimulus

How does one finance such a stimulus? There are two obvious methods. The first is deficit spending. Given low international interest rates currently, the government should tap the sovereign bond market for at least half the amount, or US$50 billion. The RBI’s foreign exchange reserves are around US$450 billion. That will leave plenty of room to cover sudden tantrums of international creditors. An ancillary long-run benefit of issuing sovereign bonds is that it will impose greater market discipline on the government’s macroeconomic policies which, over the past few years, have shown a rising proclivity for retrograde protectionism.

In order to cover the remaining US$50 billion of the fiscal expansion, it would be wise not to tap the domestic bond market. That will just worsen already tight liquidity conditions. Instead, the government should issue bonds that are directly bought by the RBI. Effectively, this would be money financing of the deficit. While this is now a discredited strategy for normal government operations, these are not normal times.

There will be costs of opening the country in the form of new community spread of the virus. These costs are possibly not as high as people fear. For one, infection rates derived from random testing of samples in China, Iceland, and the USA suggest that mortality rate from the virus may be well below 1%, much closer in fact to the mortality rates from the flu. Second, the mortality rates of the young are significantly lower than that of the old. Hence India, with a median age of 28, is likely to be less at risk. Lastly, the alternative of no income for the most vulnerable in society will imply a potential spike in mortality rates due to reduced immunity through malnutrition or direct starvation. Sustained lockdowns are not an option for India.

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