The writer is a former governor of the Reserve Bank of India
When India’s prime minister Narendra Modi announced last week that the country’s coronavirus lockdown will be extended until May, he made only a passing reference to the huge cost to the economy. Nevertheless, the lives versus livelihoods dilemma must have weighed heavily on his government’s decision.
This dilemma is not unique to India. Countries all over the world are facing similar choices. But India’s stakes are unusually high, given its high population density and weak medical infrastructure. India runs the risk of a colossal health disaster if it compromises on prevention. On the other hand, an aggressive lockdown to contain the pandemic will push millions to the margins of subsistence, driving small and large businesses alike into bankruptcy and shattering financial stability.
There is consensus that the government needs to spend more than its current fiscal package to provide cash transfers to the poor, which amounts to 0.8 per cent of gross domestic product. Critics have panned that as far too little given the enormity of the deprivation in the informal sector, where more than 80 per cent of the country’s working population finds a livelihood. But India will struggle to meet potentially huge expenditures.
Rich countries can afford to throw the kitchen sink at the crisis because they have the firepower and they issue debt in currencies that others crave. But with their already parlous fiscal positions and nonconvertible currencies, emerging markets don’t have that luxury.
India was already stretched as it entered the crisis. The loss of revenue on account of the lockdown looks likely to take the combined fiscal deficit of the central and state governments for this fiscal year well beyond 10 per cent of GDP, as against the budgeted 6.5 per cent. Borrowing for the emergency will be on top of this. Will the market not penalise India for that additional debt?
One view is that it would not — that, in a synchronised downturn where every country is breeching fiscal limits, the rules of the game should be more lenient. Given the emergency, governments should act as if there were no constraint, borrowing and spending as needed.
Unfortunately, no emerging economy can take the generosity of the markets for granted. Foreign investors vote with their feet no matter the circumstances. The IMF notes that the reversal of portfolio flows suffered by emerging markets in the wake of this crisis has been the highest on record, dwarfing outflows during the 2008 financial crisis or the “taper tantrum” of 2013. The currencies of Brazil, Mexico and South Africa have lost almost one-quarter of their value against the dollar since January. Rating agencies downgraded Indonesia last week, citing “the higher debt burden on account of the government’s strong countercyclical fiscal measures”.
Fiscal excesses inevitably trigger concerns about debt sustainability and here India is vulnerable. At 70 per cent, India’s debt-to-GDP ratio is about the highest in its peer group. It is certain to increase as debt rises and nominal GDP contracts. Could the problem be softened by the central bank directly funding government borrowing as the Bank of England has done in the UK? That would surely dent the credibility of the Reserve Bank of India and possibly reinforce the case for a rating downgrade. Global markets are much less forgiving of unconventional policies by emerging market central banks.
There is no question that India must borrow and spend more in this crisis; that is a moral and a political imperative. But New Delhi should not forget that its bruising balance of payments crisis in 1991, and a near-crisis in 2013, were, at heart, a result of extended fiscal profligacy. It should commit to a pre-determined amount of additional borrowing and to reversing the action once the crisis is over. Only such explicitly affirmed fiscal restraint can retain market confidence in an emerging economy.
