The Covid-19 pandemic is, above all, a human tragedy. The impact on the economy is at best second in the list of public policy concerns right now. Governments across the world have done well to sacrifice economic activity in an attempt to contain the spread of the virus. However, the economic impact cannot be ignored as the weeks go by.
The global economy has right now been hit by five big shocks.
First, the shutdown in China has put global supply chains under stress. China is the world's main producer of intermediate goods, or the stuff that goes into the gizmos that we eventually buy. Korea is an important source of global intermediate goods as well. Production across the world will be hit if inventories dry up before supply chains are humming again. The risk of dislocation increases in tandem with the complexity of the supply chain in any particular industry.
Second, individual countries will see production losses as people are forced to sit at home. It is akin to a sudden withdrawal of labour from the economy—or a general strike. Consumption will also get affected, especially social consumption such as eating out in the company of others. People can push some purchase decisions into the future, say a car or a computer. We cannot do that for a restaurant meal or movie ticket. Some types of work can be done from home. Some types of consumption can be moved online. But there are limits to such substitution.
Third, companies could come under financial stress as economic activity recedes. They will have to maintain financial obligations even as cash flows dry up. Two types of firms will be especially at risk—those with excessive debt and those that are too small to have accumulated financial firepower. Their financial troubles will hit the banks they have borrowed money from. In the case of India, the unorganized sector may need special attention, if the demonetization episode is any indication. A sharp decline in household financial wealth will also hurt.
Fourth, confidence has already taken a hit. This means that people could restrict spending even after the pandemic is brought under control, especially if there is significant economic pain in the intervening months. The time factor will thus be important.
The ability of beliefs to overpower an economic recovery will strengthen with the passage of time. The world could see an increase in precautionary savings.
Fifth, there is also an oil shock that complicates matters. Global oil prices have collapsed as a result of the friction between Saudi Arabia and Russia. This will thankfully be a positive shock for energy importers such as India. The Indian government has chosen to hike cess on fuel rather than pass on the benefit to consumers. There could be some negative feedbacks, given the number of Indians working in West Asia who send money home.
What does all this add up to? It is hard to tell. There are few models that can predict the economic impact of such a rare event, and few can guess right now how long countries will need to maintain shutdowns. It is quite obvious that there will be a substantial drop in economic growth for at least a quarter or two. Much then depends on how quickly economies normalize. We are in radically uncertain times, when probabilities are impossible to estimate.
The complexity of the situation—and its severity—calls for massive coordinated action. The current economic shock is just the sort of extraordinary event that encourages governments to use escape clauses in their fiscal and monetary rules. Lower interest rates could ease some of the financial strain on companies that have high borrowing costs, but monetary quantities such as the growth in base money, broad money and bank credit will matter as much as the price of money. The overall impact of monetary stimulus will be muted if the private sector—including households and firms—decides to save rather than spend. This would be both because of low confidence as well as the need to rebuild portfolios that have suffered because of the crash in the stock market.
Fiscal policy will be more important right now. The government will have to boost aggregate demand as production capacity comes back on stream once the shutdown orders are withdrawn. That means direct spending in sectors that have strong linkages with the rest of the economy. Fiscal policy affects the economy with a lag. So more direct intervention may also be needed. Two possibilities are direct transfers to the poor through Jan Dhan accounts and tax write backs for small firms that pay the goods and services tax (GST). India now has the digital infrastructure to move fast on these fronts.
Lenin once said that there are decades where nothing happens; and there are weeks where decades happen. We seem to be living in such a time now. It is hard to believe that it has been only a few weeks since hopes arose that the Indian economy was headed for a mild recovery. Much depends on how long the ongoing public health battle needs to be fought. The longer it does, the greater the chance of hysteresis setting in.
Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics