To understand the cost of coronavirus, we first need to understand how the economic system work, every system depends on some subsystems or components so does the economic system, and if any of the components stop working, the system fails. The components of economic systems are the markets and markets depend on institutions, individuals and governments.
Now, what was the situation before coronavirus?
The Indian economy was already going through a slowdown, because of lower demand, lower credit growth and liquidity crunch and a slowdown in the global economy, however, the economy was trying to recover from the slowdown but then it got a serious hit by COVID-19. The government has announced a lockdown of 21 days to deal with this virus. Now let us understand how it will impact the economy.
(1) on business.
Due to lockdown businesses would have to incur a big chunk of opportunity cost( i.e. revenue which they could have earned, had the lockdown not been happened ) moreover they will have to meet their regular financial commitments like interest and loan payments, etc. Which will is push their profits down and impeding the space for future investment.
(2) On salaried class
Because of lockdown employees are not able to perform their jobs, so they are sent on leaves or work from home jobs and those who are not on paid leaves will face challenges because their income source is getting hampered while their commitments like EMI, etc. Still need to be met moreover those who themselves or their relatives got infected with the coronavirus must be incurring the medical cost as well, now this money which could have created new demand and output in the economy is now being expensed for existing products which may tap the door of inflation.
Recently in the budget 2020 government announced various incentives and packages to deal with the slowdown by boosting the demand in the economy, but now all those resources and efforts have been diverted towards coronavirus, due to lockdown government expenditure has increased to provide medical facilities for the infected economic relief to daily wage earners, essential services to the people so that they don’t face any problems during the time of lockdown.
(4) impact on markets and the economy as a whole.
Because of (1), (2) and (3) above capital markets and money markets are suffering as people are withdrawing their money from these markets because of the panic, it will impact the future investment as well because if people are not saving their money in financial instruments then the savings-investment gap will rise, and to bridge that government needs to increase the fiscal deficit but currently the government is not having any fiscal space for this, because of rising expenditure and falling revenues(no business income = no taxes). Because these components are suffering, the Indian economic cycle as a whole is getting slowed further.
Now let us see, what government and RBI have done so far
1. Increased MGNAREGA wage by Rs.20
2. Rs.1000 to women, senior citizens, and persons with disabilities.
3. Insurance cover to health workers
4. Immediate cash transfer under PM- KISAN scheme
5. Rs.500 to each woman having Jan-Dhan account for 3 months.
6. Free Gas cylinders to all poor households for 3 months.
7. The government will deposit 24%(12% on behalf of the employee and 12% on behalf of the employer) of salary
Provided that the organization should have less than 100 employees and out of that 90 % should be earning less than Rs. 15000
8. Food distribution under PDS will be doubled.
9. SHG collateral-free credit limit has increased up to Rs. 20 lac from present Rs.10 lac.
10. Rs. 3.5 Cr. Have been created for construction workers and state governments are directed to utilize that fund in favor of “Registered” construction workers.
RBI Governor Presser Highlights :
1. Repo rate reduced by 75 basis points to 4.4%
2. Rev repo reduced by 90 basis points to 4%
3. GDP growth for Q4 19-20 and FY 20-21 to be affected
4. Aggregate demand may weaken
5. Future outlook uncertain and negative
6. CRR reduced by 100 basis points to 3% for 1 year to release 1.37 lakh crores
7. Min daily CRR balance reduced from 90% – 80% till 30/06/2020
8. 3.74 lakh crore liquidity injected
9. 3-month moratorium on payment of installments of Term Loan outstanding
10. Interest on WC facilities to be deferred by 3 months
11. Such deferment not to be considered for NPA
12. Revised DP calculations by reassessing WC cycle
13. All measures not to effect credit history
14. Total liquidity injection 3.4% of GDP
Let see the pros and cons of these decisions:
The government has come up with some good solutions to provide benefits directly to the poor like free Gas cylinders and doubling the PDS supply, because of these beneficiaries won’t have to buy extra groceries from the markets.
Insurance cover to health workers is another good scheme, it will provide an assurance to the corona health workers that there loved ones are financially secured.
Actually aggregate demand (C+I+G+X-M) is weakening because of lack of consumption (C) so to increase consumption they have reduced the repo rate by 75 basis points or 0.75%, to make it 4.45% first time in the history rates are so much lower, which will make the money will cheaper and people will start borrowing for consumption and existing and new business investments, mathematically it is expressed as
C = a + bY – ix
I = a + bY – ix
When i reduces, C and I increase and Aggregate demand increases
They have also reduced the cash reserve ratio by 100 basis points or 1% from 4% to 3% which will increase the money supply in the economy because banks will be able to lend 97% money of its total assets as compared to the previous 96%, mathematically it can be expressed as
MM = 1/CRR
As CRR decreases, Money multiplier increases and money supply in the economy increases.
Reverse repo rate reduction means that now banks will get lower returns on their lendings to RBI, so instead of lending to RBI, banks will prefer to lend the money to the public.
And EMI can be waived for the next 3 months so that people can use that money for their consumption and to create new demand.
But the now there is a problem that these are just recommendations not the order of RBI, which means now everything is in the hands of banks whether to implement these recommendations or not if banks think that they will incur losses so they will not implement these or they can implement these guidelines partially for Example they can waive EMI on a business loan or a home loan or commercial loan or on all three. Banks generally bypass the repo rate reduction because lending rates are quoted as WALR + spread
Where WALR is directly linked with repo rate for Example if current WALR is of ICICI is 4% and spread is 4.5% then lending rates of ICICI is4% + 4.5% = 8.5 but when repo rate decreases, WALR also decreases with some % let say new WALR is 3% now the new lending rate of ICICi should be 3% + 4.5% = 7.5 % but what banks do is they increase the spread by 1% hence ICICI keep their lending rates at 3% + 5.5% = 8.5%
In short, we should not be happy yet until banks follow these guidelines
MGNREGA is inactive because of lockdown so how will these increased wages go in the hands of the workers.
Majority of the construction workers are unregistered, but the above-mentioned fund covers only registered ones.
There is a need for immediate transfer of money but nothing has been spelled out in this regard.
What else can be done?
Middle class and MSME and corporate sectors need immediate relief hence government can provide incentives in form of tax temporary tax holidays so that they use that money for more business activities and paying salaries to their employees which will help the middle-class service sector as well.
As the country recovers from the virus, there would be an immediate need to create the demand so that businesses can start production and investment further and to create demand, government and RBI can take multiple steps like,
Supporting the banks to Increase the credit growth in the economy.
Treating the liquidity squeeze so that people have money in their hands so that demand can increase.
Keep the fiscal and monetary policy liberal at least for a year or 2, until the economy fully recovers.
This virus has impacted the entire world, it will take time for the global markets to recover from it, till then we need to keep ourselves calm and safe by following the government guidelines so that this can end soon.