COVID-19 Could Adversely Affect Output and Prices. India Needs Both Monetary and Fiscal Policies To Handle the Pandemic, Says SBI
India has, till date, responded quite well to the coronavirus (COVID-19) crisis, though the financial markets have been significantly impacted. Though India has already taken a plethora of steps to prevent the spread of coronavirus, all eyes are now on the rise in active cases in the current week and next, as global experience shows the jump in second week of active cases is around seven times compared to first week. State Bank of India (SBI) says it thus expect aggressive social distancing to be implemented by government and states immediately.
In India, the number of active cases rose to 114 with 15 fresh cases in a single day. SBI says, when we analyse the occurrence of active cases in seven most affected countries apart from China, we have found out that in the second week, the number of cases jumps almost seven times compared to in the first week. In some countries, like Iran and Spain, even the active cases rose to 13 times in second week compared to in the first week.
Interestingly, the report points out that corona has affected population age-wise, shows that maximum fatality (74%) has been in the 65+ age group. This has the potential to lead to a demographic change the world over, feels Dr Soumya Kanti Ghosh, group chief economic adviser of SBI.
According to Dr Ghosh, There is no standard theory on how to tackle a pandemic situation like COVID-19. "The policy prescription will depend upon the possible impact across the sectors due to inoperability in sectors impacted by the pandemic.
"A global package looks expensive as the importance of individual sectors in the overall forward-backward linkage is not the same. A sector specific response notably the strategic sectors along the domestic global supply chain appears more cost effective. Concomitantly, there is need to revive consumer demand. This may be done through an employment generating package targeting the efforts to contain spread of virus," he added.
On the demand side, Dr Ghosh from SBI says, "inoperability analysis for three sectors namely transport, tourism and hotels show significant impact on demand and hence output. On an aggregate basis, we estimate that the impact of a 5% inoperability shock could be 90 basis point (bps) on GDP from trade, hotel and transport and transport, storage and communication segment, that could be spread over FY20 and FY21, with a larger impact in FY21."
On the supply side, SBI says, China is an important source of critical inputs for many sectors. "Supply shock is akin to higher price of inputs which in turn affects the price of all the commodities up the supply chain. The impact of supply perturbations in the system in terms of cost-price increase in output due to increase in prices of value-added input brought about by shutdown in China or assumed price escalation of 5% is maximum for - chemical and chemical products, electrical and non-electrical goods, metals and metal products, textiles and transport equipment about 7-8% increase in prices," it added.
SBI feels, a simultaneous demand and supply shock to the economy will also have implications for the banking sector. It says, the demand side shock is expected to lead to an output loss of 1.2% in banking and insurance combined.
According to the report, during the current COVID-19 outbreak, a combination of monetary and fiscal policy could be the best option.
"In particular, on the monetary side, the first best option is maintaining a proactive liquidity regime and facilitating stability in financial markets through unconventional measures. The monetary stance may be eased temporarily through a rate cut by Reserve Bank of India (RBI) to accommodate the possible surge in liquidity demand and shock-related price increases. An adequate supply of cash notes to banks needs to be ensured that can meet a sudden increase in the demand for liquidity."
"RBI may also need to consider a degree of prudential forbearance in specific sectors like hotel, aviation, transport, metal, auto components and textiles. Furthermore, given the risk of using currency notes in times of pandemic, incentivizing digital payments further could be an effective solution in the current circumstances," it added.
SBI says it believes the arguments of RBI cutting rates has more to do with coordinated policy actions by the central banks. "More crucially," it says, "deposit rate cuts and hence lending rate beyond a point is counterproductive and actually creates perverse flows into liability products that are offering higher interest rates.
"This could always be a recipe for future problems, if assets and liabilities are not properly matched, as the experience of Yes Bank shows."
In addition, pandemic shock has an embedded adverse supply shock angle as China is the supplier of many critical inputs. "Hence only a rate cut in current situation with no fiscal measures will lead to asset bubble and possibly no correction in demand. Concomitantly, there is need to revive consumer demand," the report says.
Commenting on fuel prices, Dr Ghosh says, on the fiscal side the nearly 30% fall in crude oil prices could lower the petrol prices by Rs12 per litre and diesel prices by Rs10 per litre in India from their present prices. The additional revenues of Rs35,000 crore-Rs 40,000 crore accruing to Centre from increasing the excise duty could be spent on providing relief to people at the lower strata who will lose income because of shutdown of commercial activity in states.
After the success of its $2 billion USD and Indian rupee sell-buy swap (RBI has received bids worth $4.67 billion), RBI has announced one more round of USD/INR sell-buy swap. "This is a welcome move as it will address dollar shortage and also push up the forward premia in the process. This could discourage speculation and clearly address the pounding of Indian markets with foreign institutional investors (FIIs) selling around $9.2 billion beginning 20th February," the report added.