Moneycontrol - Indian Economy - A Battle on Two Fronts

(The following article appeared on Moneycontrol on March 13, 2020, link below:

https://www.moneycontrol.com/news/business/economy/policy-indian-economy-is-fighting-two-battles-but-its-not-that-bad-5029431.html )

The Indian economy is battling a war on two fronts now – the global market dislocation on the back of the covid-19 pandemic, and the vulnerabilities of our own domestic economy. 

The Bigger Global Battle

The first – and bigger battle for now - is clearly the fluid worldwide risk-off context. As it is, amidst trade wars and geopolitical flashpoints, the world had entered 2020 fearing an economic slowdown. The added battle against the covid-19 pandemic will almost certainly result in a sharp reduction in worldwide economic activity. That could result in bankruptcies, layoffs, and credit defaults, even as whole societies battle serious health hazards. 

As these primal fears play out, markets are experiencing sharp dislocation. Yesterday’s 10% fall in the S&P500 index exceeded any single day fall during the global financial crisis. Many established markets across asset classes are seeing a sharp drop in liquidity, as risk managers rush to the exit door at the same time. Correlations are breaking down as well – in many cases, hedges put on to manage risk are adding to pain. 

The standard policy response tools – sharp emergency monetary and liquidity easing by the Federal Reserve and promises of a coordinated global fiscal & monetary response – have so far not addressed market fears and dislocations. 

Even as India has so far – thankfully – not shown any signs of local transmission of Covid-19, our markets have caught the bug. 

We don’t yet know how the pandemic will play out. Hopefully, warm weather, medical responses and precautions will limit the extent of damage both globally and in India.  

In the meantime, extreme market dislocations can maim financial stability and economic fundamentals irreparably. At times like these, orthodox textbook prescriptions on regulating free markets may have to be ignored, at least until sanity returns. Equity markets may need temporary restrictions on short selling. Fixed income and currency markets may need decisive intervention and provision of liquidity from central banks. Monetary and liquidity easing may have to be provided to relax frayed nerves. Likewise, fiscal space may have to be found to at least protect households and small businesses in the short run. 

We must also recognize our relative strengths in this regard. India has – touch wood – not yet seen local transmission of covid-19. RBI has immense ability and firepower to control our fixed income and currency markets. While there is a large foreign participation in our equity markets, some smart regulatory intervention can douse extreme volatility here as well. We can and should step in to control a runaway dislocation. 

The Domestic Economy

The second battle, somewhat relegated to the background over the past week, is on the domestic front. India’s financial services ecosystem is still in the grips of a serious trust deficit. It is in no shape to supply credit to fund India’s much needed growth. On the flip side, many players in sectors such as power, telecom, real estate, construction, airline and shipping are simply not viable enough to demand access to credit. Finally, with serious issues around on-the-ground ease of doing business across land, labor, contract enforceability and policy reliability, job creation and manufacturing continues to struggle to take off. We risk missing the opportunity arising from supply chains moving out of China.

While the focus is currently on the Yes Bank situation, we have to look beyond that. Yes Bank will be resolved – the RBI, government and all stakeholders are fully invested to cobble together a solution. But it would be a mistake to stop there.

To paraphrase Churchill, economic growth is not won on the back of rescue plans, no more than wars are won by evacuation. 

First, we will still need a proper cleansing of the financial services ecosystem. We must recognize the true extent of the asset quality problem. We then need to put together a one-time solution to quarantine and address a bulk of the non-performing assets so identified - perhaps through a bad bank or TARP-like package. The IBC is a good piece of legislation, but given the sheer quantum of the NPA stock, relying only on it can take far more time than we can afford. Finally, we must adopt difficult reform of banking, markets and governance – including perhaps adoption of the P J Nayak committee recommendations. A bailout without tough reform will most certainly end up as good money after bad.

Second, even as we address the supply of credit, we still have to address the demand side. The viability of critical sectors such as power, telecom, real estate, construction have to be addressed, again through tough reforms. We also have to make it easier for employment generating investments, by adopting factor reforms across land, labor and contract enforceability. 

These might sound like an impractical boil-the-ocean wish list. But there may be no easier alternative path to achieving our immense economic potential. While monetary and fiscal print and spend is far easier and an immediate placebo, it does little to address the core issues described above. 

India will survive these battles – as we always have. But the current context offers us the opportunity to undertake serious reforms, and actually emerge stronger. It is up to us to show the vision, conviction, execution skills and endurance to make this our finest hour.