It may be better for governments to bear the losses upfront than after the damage is done
Neelkanth Mishra | Last Updated at May 5, 2020 23:53 IST
(This was published in the Business Standard: link)
It now looks clear that we must learn to live with coronavirus, as the active case count is unlikely to fall to zero anytime soon. This may still be possible in pockets like Kerala, where active cases have now dropped by more than two-thirds to double digits, and for the more than 300 green districts. But in most of the larger states, with active cases in thousands and cases still doubling every 8 to 12 days, assuming an early resolution would be unwise.
Thus, the curtailment of economic activity, an outcome of social distancing, necessary to fight the virus till a cure or a vaccine is available, is likely to persist for several months, if not for the rest of the year. As we oscillate between prioritising lives and focusing on livelihoods in an attempt to find the right balance between the two objectives, a new national lockdown is now unwarranted and unlikely in our view. Instead, if cases spiral up, districts would transition from green to orange and from orange to red, and vice versa if active cases start falling.
This would mean a prolonged loss of income for many workers and enterprises. The impact would not be limited to sectors seeing the restrictions, but is likely to spread to other sectors too through the consumption channel, among others. To take two examples for illustration, electricity generation was allowed even during the first and by far the most severe lockdown, but as demand fell by a quarter, generation and distribution companies were affected as well. Similarly, while fuel retailing was allowed, the nearly two-thirds drop in demand for petrol and diesel in April hurt oil marketing companies as well as upstream entities like refiners.
What would be the loss of income? The multiple cuts to gross domestic product (GDP) growth forecasts that are being undertaken by economists provide an estimate of the aggregate loss of income. In the last two months, consensus forecasts for the current year have been reduced by more than Rs 8.5 trillion. Given the lag of a few weeks in forecasters publishing revised numbers, it is quite possible that the second lockdown is not fully reflected in these projections, and very likely that the third one and the prolonged fight with the virus are not taken into account at all. The eventual loss of income therefore could be higher: Let us assume a round figure of Rs 10 trillion. Note that this is an assumption, not a forecast.
Who would bear these costs? Aggregate income in an economy is split between individuals, corporations (profits) and the government (taxes). In India, personal income accounts for about two-thirds of the total, government a bit less than a fifth, and the rest is undistributed profits for corporations. The Rs 10 trillion of GDP loss is unlikely to be distributed in exactly the same proportion though. The inability of firms to be able to stop the clock on fixed costs, such as salaries, rents and interest (as discussed in the previous Tessellatum: “Can we stop the clock?” Business Standard, March 31) means that they would suffer a higher share of losses.
Governments too would see a larger-than-normal impact, as in addition to the loss of taxes, they also bear the additional health care costs of managing the pandemic as well as of supplementing incomes for the poor, providing food, and in the case of migrant labour, shelter and transportation as well. That said, only a small percentage of India’s workforce has a salary slip, and there would be a significant dip in personal incomes as well.
How much of these losses really need our collective attention? For individuals, the loss of income is split between the drop in consumption and a drop in savings. The collective need only bother about losses of individual income where there are no savings to dip into, and consumption is the most basic need for survival, as it strikes at the very base of the social contract, and of our self-image as a nation-state. This, thankfully, is beyond debate.
The government has its challenges, but being the sovereign, it can act as the residual, with only macroeconomic constraints of future inflation and risk of currency devaluation limiting its actions.
It is while addressing the lost income for enterprises that several perplexing questions crop up: Distributive justice on one side (why should future taxpayers support private firms?), and productive capacity on the other (as one of the wisest men I know, with decades of policy experience put it eloquently, “do not look at the cost of saving a firm, look at the cost of not saving it”). These firms pay taxes, and employ people who then pay taxes, and consume, driving growth. More importantly, as firms are forced to literally eat into their risk capital, India’s medium-term growth potential gets eroded. It is anyway short of risk capital (see “In search of risk capital”, Business Standard, May 2, 2018).
Enterprises take years to build up scale, and accumulate risk capital. As the founder of Zoho explained recently: When he started more than two decades back with a handful of people, he could only target small projects that yielded revenues immediately; but now, with capital buffers in place, the firm is investing in ambitious projects that compete with the global heavyweights in software, and may yield significantly higher revenues only over 5-10 years.
Moving back to our example: Collectively, these losses need to be anyway absorbed by the nation. If they are not absorbed upfront by the state, and small enterprises are allowed to deplete capital or fail, the downstream impact in terms of lost growth and taxes can be significant. Worse, once they start defaulting on loans, they can put the financial system at risk, which may necessitate government intervention anyway. That, however, would be after the damage to enterprises and the financial system has occurred.
It goes without saying that India does not have unlimited fiscal space, but the debate must now move beyond the binaries of whether we can incur a deficit or not, to how much is necessary without creating macroeconomic instability. The risk of a rating downgrade may be higher if nominal GDP growth is allowed to fall.