Comprehensive policy response is needed to ease the economic fallout of COVID-19 outbreak

A global recession looks imminent with the outbreak of the COVID-19 global pandemic leading to a shutdown in activity across major global economies. Asset markets have seen a very sharp sell-off, increasing the risk of turning a public health crisis into a financial crisis of the same proportions as in 2008, by tightening financial conditions very sharply. Major global central banks led by the US Federal Reserve have initiated a very swift and sharp monetary policy response. A targeted fiscal stimulus is also awaited, especially in the US and the EU, to counter the adverse impact on demand. During 2008-2009, fiscal stimulus worth over 3.5 percent of global GDP was administered worldwide.

In this backdrop, India’s growth outlook over the next couple of quarters has become more uncertain on the prospects of a global recession and severe investor risk aversion. Moreover, downside risks have increased due to a local outbreak. Since the adverse impact on growth will mainly play out through further weakening of private consumption and to some extent by slowing down of already poor investment activity, a worst-case growth scenario at this stage, could be characterized as one where:

• Private final consumption expenditure growth for FY2020-21 falls to about 2.9 percent – the lowest level of growth in the last 25 years and well-below the post-liberalisation period annual average of 6.1 percent.


• Investment activity or gross fixed capital formation growth shrinks by about 2 percent - the average of 4 years where growth in investments contracted over the last 25 years.


• Exports of goods and services contract by 5.5 percent and imports contract by 8 percent - low points in the last 25 years, which makes net trade contribution to GDP positive. This drop in aggregate exports growth is worse than the 4.8 percent contraction seen during FY2009-10 in the aftermath of the global financial crisis.In this scenario, India’s real GDP growth falls to 3.5 percent in FY2020-21 from 5 percent in FY2019-20.Moreover, in all likelihood, FY2019-20 growth could be revised lower too, considering that economic activity in March would have been affected. For this scenario to play out though, the local outbreak and containment efforts would have to last over the first half of the coming fiscal year. The final outturn of growth will depend upon the length of time over which current sub-normal levels of domestic activity, especially in case of certain services, remains in place and if major cities turn to a full lockdown. It is difficult to predict by when the peak level of the local outbreak is hit and the spread is contained, but a reasonable timeline at this stage looks like another 2-3 months at least. That imparts considerable uncertainty to the near-term activity outlook.However, despite the significant uncertainty around this negative shock, the actual growth outcome will likely be better than the worse-case scenario characterized above. For one, services sector activity can resume much more quickly than the manufacturing sector, once the COVID-19 impact is contained. That would reflect in a sharp pick-up in consumption demand too, especially as demand remains pent-up.

  Base case for real GDP growth for the year FY21 therefore at this stage is still about 5.3 percent, with downside risks dominating any upside risks over the first half of FY2020-21, but a sharp recovery ensues in the second half once movement restrictions are lifted and demand recovers swiftly. The first quarter of the coming fiscal year will most likely register most of the slowdown caused due to this sudden stop of economic activity, and the real GDP growth during the quarter can dip to around 3.5 percent.

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  Policy makers response to counter this economic shock will have to be comprehensive and co-ordinated. The central and state governments and the RBI, through the use of fiscal and monetary measures, will have to ensure that a short-term clampdown of demand does not become a permanent negative shock. That in turn will require safeguarding viable businesses from bankruptcy and avoiding large job losses. Any policy efforts to counter the economic fallout of COVID-19 outbreak will have to ensure that

1. Directly affected sectors like airlines, retail, MSMEs are supported through appropriate instruments such loans / loan guarantees, debt forbearance and subsidies.


2. Fiscal measures are targeted to support healthcare spending, push rural consumption through higher pay-outs under PM-KISAN scheme, and contain the impact on urban consumption through direct pay-outs to informal sector workers. State governments in UP and Kerala have already announced schemes to help affected people.


3. Tighter financial conditions on the back of the sharp equity market sell-off, portfolio capital outflows and widening credit spreads, are eased. That can be done through lowering the Repo rate by 50-65 bps over the next 3 months, further injection of durable liquidity through more LTROs and even a 50 bps cut in banks’ CRR. We already are in an accommodative monetary policy mode and the MPC will look to administer more easing, especially as headline CPI inflation is on the decline now, helped by falling food inflation and sharply lower oil prices. Separately, the RBI may also have to consider unconventional steps like other central banks e.g. allowing repos in highly rated corporate bonds to help reduce widening credit spreads and ensure adequate supply of credit.


4. External shock transmission through severe downward pressure on the exchange rate is managed through active forex market intervention. The ongoing global risk assets sell-off is leading to large portfolio capital outflows (over $8.5 billion in March) and that in turn is exerting pressure on the Rupee. The RBI’s foreign exchange reserve position at present is much better than it was in 2018, the last time the Rupee came under intense depreciation pressure over a short span of time. And, unlike 2008-09 or 2018, India’s current account deficit (CAD) is shrinking on account of a collapse in global crude oil prices and weak domestic demand, in turn reducing the need for net capital inflows to finance the CAD.In a nutshell, this in an evolving public health emergency, which in the first instance will require policy makers to use the available space to counter the adverse impact on economic activity. And more policy space will have to be created to support the economy and the healthcare infrastructure, in case of a prolonged local breakout coincides with a global recession. This first quarter of the coming fiscal year is therefore very crucial for the Indian and the global economy.(The author is the chief economist of IndusInd Bank. Views are personal.)