Keep your powder dry | The Indian Express

Written by Duvvuri Subbarao

Published: April 15, 2020 3:45:15 am

Uncertainty is a defining feature of every crisis. During the global financial crisis, a big uncertainty around the world was about how much risk there was in the system, where it lay and who was bearing it.

In Sophie’s Choice, the much-acclaimed 1982 movie, Sophie, a Polish Jew, had to choose which of her two children will go the gas chamber and which to a labour camp. Like Sophie, governments battling the coronavirus are having to make a gut-wrenching choice between saving lives and saving livelihoods. Stringent lockdowns restrain the spread of the disease but that comes at the cost of people losing livelihoods as economic activity shuts down. And if governments try to contain the loss of economic activity, they risk losing lives to the virus.

This dilemma is arguably the sharpest for India. Because of our high population density and poor medical infrastructure, any laxity in prevention can result in a huge health disaster. On the other hand, an extended lockdown will force millions into the margins of subsistence, push small and large firms alike into bankruptcy, seriously impair financial stability and land us in a humanitarian and economic disaster.

Soon after the lockdown, the government announced a relief package amounting to 0.8 per cent of GDP to support the livelihoods of the rural poor and the urban informal sector, and that’s been criticised as being too little. From a study of a sample of countries, the latest issue of The Economist reports that India’s lockdown has been the most stringent while its fiscal relief package is the smallest in proportion to GDP.

A possible explanation for the government’s timid fiscal response may be the fear of spooking the market. For years, every economist and analyst has been warning the government of the dire consequences of fiscal irresponsibility, and the message must have been so hardwired into the government’s collective mind that it was unable to get over the mental overhang.

I can quite relate to that. Just two months before I took office as governor of the RBI,

Y V Reddy, my predecessor, was raising interest rates to fight inflation. But within weeks of stepping into his shoes, I was called upon to cut rates, and that too sharply, to fight the global financial crisis. The sharp reversal of mindset proved to be a challenge even for an intellectually agile RBI.

Uncertainty is a defining feature of every crisis. During the global financial crisis, a big uncertainty around the world was about how much risk there was in the system, where it lay and who was bearing it. There were big uncertainties at home too. Just to give one example, in the thick of the crisis, we were asserting that our banks were safe and sound even as storied institutions around the world were collapsing day after day. In the midst of that carnage, we were uncertain about how much markets would trust our assertion and for how long they would continue to do so.

The uncertainty of the corona crisis is much deeper. There are far too many known unknowns not to speak of unknown unknowns. We just don’t know enough about the effectiveness of the lockdowns, the age and gender profile of susceptibility to the virus, the process of recovery, the tipping point if any for mass immunity, whether the virus will attack in waves, and most importantly, when we might have a vaccine and a cure. Governments are, for the large part, having to fly blind.

Managing the trade off between lives and livelihoods in the face of this huge uncertainty must have weighed heavily on the government’s mind as it decided to extend the lockdown until May 3. There are many issues to be decided and planned on the way forward. A big issue will be an expenditure plan for relief during the crisis and stimulus after some normalcy is restored.

Even the most ardent fiscal hawks are now agreed that the government needs to abandon its fiscal reticence, and borrow more and spend more. Even the most extreme monetary purists are agreed that the RBI should fund the government borrowing by printing money. Even the staunchest advocates of financial stability are agreed that more regulatory forbearance is necessary. And virtually everyone is agreed on where additional spending should be directed.

There is disagreement, though, on how much additionally the government should borrow. One view is that the government should err on the side of taking a fiscal risk without any preset fiscal deficit number. It should simply determine what needs to be done and borrow to that extent, acting as if there were no fiscal constraint at all. In other words, act as per the diktat of the now famous three words — “whatever it takes”.

An opposing view — and one to which I subscribe — is “whatever it takes” is not an option for India. Many analysts have estimated that just the loss of revenue due to the economic shutdown will take the combined fiscal deficit of the Centre and states beyond 10 per cent of GDP. The borrow and spend programme will be on top of this. Unlike rich countries which can throw the kitchen sink at the crisis, we can’t afford to ignore the risks of fiscal excess of that magnitude, no matter the compelling circumstances. There will be a heavy price to pay down the road by way of inflation and exchange rate volatility.

Besides, as Urjit Patel wrote in this newspaper a few days ago, it’s important to keep the powder dry should there be another wave of the virus later in the year. It will be advisable for the government to fix an upper bound for fiscal deficit and operate within that. A WhatsApp group of analysts of which I am a part has estimated after some light research that for now the borrow and spend programme should be restricted to 2 per cent of GDP. I endorse that as a working target for now.

As The Economist said, to be hard-headed is not necessarily being hard-hearted.

The writer is a former governor of the Reserve Bank of India

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