INDIAN ECONOMY VS COVID-19

The COVID-19 Pandemic is first and foremost a human disaster in 2020 threatening lives and wellbeing of the global community. Society needs to strongly collaborate to protect people’s lives and health, manage mid-term implications and look for sustainable solutions. With the growing number of coronavirus cases in India, the government has locked down transport services, closed   public and private offices, factories and restricted mobilization, though of late restrictions are gradually being relaxed.

The economic impact of Covid-19 has been significant and broad-based. India is now the 3rd most affected country after US and Brazil in terms of confirmed Covid-19 cases. As of 27 July, India has 1.5 Mn confirmed cases with test positivity rate of 9%. The outbreak of the Pandemic has led to unprecedented situations along all fronts. Recently, IMF in its report projected the Indian economy to contract by -4.5 percent in 2020, which is the slowest Indian growth that it has in its record since the year 1961. The steady spread of the Pandemic as health crisis could require additional lockdowns to contain the disease. Growing concerns about the Pandemic could also dampen consumer confidence and stall the pace of economic revival in the country. There is a sharp downfall in the economic activity, as reflected in the industrial production, business sentiment as well as trade. The short-term growth outlook in India continues to be clouded by the global and domestic slowdown and uncertainties relating to the evolution of the Pandemic.

However, four months through the lockdown period in India, businesses have somewhat adapted to these economic uncertainties. There are visible signs of recovery in industrial activity post relaxations in few sectors, such as power consumption, fuel consumption, domestic logistics, steel, cement, auto, etc. However, gap still exists from the pre-COVID levels. Services trade in India has been relatively less impacted as compared to the merchandise trade.

The government and the Central Bank have come out with a fiscal stimulus and a number of relief measures to safeguard the economy from the adverse impact of the COVID-19 crisis. The RBI has responded proactively to ease the liquidity concerns. The stimulus package of Rs.20 lakh crore, or nearly 10 per cent of GDP has been announced by the Government to deal with the economic fallout of COVID-19 Pandemic. The stimulus is essential to support the vulnerable segments of the society and also to prevent additional structural damage to the economy amid the lockdown which has suddenly stopped the business activity in the country.

Indian Financial Market

Businesses have to raise short-term and long-term funds in order to meet their capital requirements. This makes the availability of a transmission mechanism which connects investors or lenders to business units (borrowers) for the transfer funds a necessity. The financial market is responsible for taking care of this aspect by providing a system through which the transfer of funds from the investors to the business units is facilitated.

The financial market plays the role of an intermediary between the lenders (Investors) and the borrowers (Business units). It also gives pricing information resulting from the interaction between investors and borrowers. The financial market is also responsible for providing security to dealings of financial assets.  It also responsible for ensuring liquidity in the market by providing a platform to the investors to sell their financial assets and mentioning a low cost of transaction.

Composition of the Indian Financial Market:

•          Credit Market
•          Money Market
•          Foreign Exchange Market
•          Debt Market
•          Capital Market

In the Indian Financial Market, the Government of India is the largest borrower. Instead of borrowing money from the banks, the government generally borrows money from the market by issuing and selling Government Securities (G-secs) and Treasury Bills for this purpose. Borrowing is essentially the total amount of money that the government borrows to finance its spending on public service and since borrowing is a loan, it falls under capital receipts in the budget.  (The Economic Times, 2020)

The Government of India has raised its targeted Gross Market Borrowing from Rs. 7.8 lakh crores to Rs. 12 lakh crores. This more than fifty percent increase in the annual borrowing has been brought to counter the economic stand still caused by the Corona Virus outbreak. This fiscal stimulus was necessary to support the economy of the country. This should cause the market interest rates and the overall yields to appreciate.

This stimulus package of about Rs. 20 lakh crores is around 10% of our GDP which is inadequate   to revive the country’s economy after the pandemic. Another implication of the stimulus package is increased fiscal deficit. 

The government provides a sovereign guarantee to the lending institution and hence bears no commercial risks as it can pay off any debts. Entities that bear commercial risks are private institutions (eg. DHFL, ILFS).

Asset Liability Mismatch

The Reserve Bank of India delivered relief for the financial services sector and allowed the banks to allow a three-month moratorium on the repayment of the term loans. This was done in order to reduce the financial pressure of individuals and institutions.

Due to the increased moratorium period, the asset cycle would lag behind three months whereas the liability cycle would remain where it was. For example, if A has taken a housing loan from India Bulls, the three-month moratorium would relieve him from paying the EMI of his loan for the next three months. At the same time, if India Bulls had borrowed money from another institution, India Bulls would still be liable to repay the interest as the moratorium would not be applicable on it.

This resulted in an Asset Liability Mismatch.

Role of the Reserve Bank of India

RBI as the central banker is responsible for preventing defaulters in the market. In order to help the liquidity conditions in the economy, the Reserve Bank of India has implemented several policy measures. Some of them are:

        I.            Back-to-back interest rate cuts

     II.            Targeted long-term repo operations (TLTRO)

Back-to-back interest rate cuts: The Reserve Bank of India reduced the repo rate by 75 bips and the reverse repo rate by 90 bips. The repo rate and the reverse repo rate were then again reduced by 40 bips. Now, the repo rate stands at 4% and the reverse repo rate is at 3.35%.

Commercial banks have implemented the back-to-back interest rate cut scheme on their fixed deposit investors.

        i.         Impact of rate cuts on borrowers: The unprecedented rate cuts would bring down the equated monthly instalments of the borrowers and make taking new loans cheaper.

Example: (Housing loan under a new bench mark)  

Loan Amount (₹)	3000000
Tenure (Years)	20
Current Interest Rate (%)	7.95
Current EMI (₹)	24999.92
New Interest rate (%)	7.20
New EMI (₹)	23620.47
Cut in EMI (₹)	1379.45

 

Cheaper repo rates would imply a cheaper interest rate. This would lead to an increase in borrowings. This would directly reflect in the market investment and hence would provide a greater economic support.

Targeted long-term repo operations (TLTRO): Targeted long-term repo operations are the set of operations that provide financing to credit institutions.

i.                 Liquidity Measure: The Reserve Bank of India has implemented a series measures in order to assist the ailing economy get back on its feet. The liquidity measures announced were more than Rs. 3.74 lakh crores. This liquidity boost would increase the money in circulation in the economy.  A higher liquidity implies a greater ability to pay off debts.

ii.                  Rs. 50,000 crores have been pledged to NBFCs in consideration of their financial pressure. Around fifty percent of this sum would go to the investment grade paper of the smaller NBC’s.

iii.             The states are granted more funds by the centre to fight the pandemic and help them to plan their borrowings in a better way.

iv.               A twenty percent reduction has been made in the Liquidity Coverage Ratio. Bringing it down to eighty percent. This would be then restored in phases. Banks are restricted from making dividend payments. This step was aimed at easing the liquidity woes at an institutional level.

v.                RBI has also made cuts in the CRR rates. This would increase the supply of money in the market [1% of Net Demand and Time Liability - NDTL (which is around 130 lakh crore) is around 1.3 lakh crore]. This would have a positive impact on the earnings of the bank as now they would be earning an interest on their parked money as well.

Investment Savings – Liquidity Preference Money Supply (IS-LM)

The Keynesian macroeconomics is explained by Hicks-Hansen or IS-LM model. In the IS-LM framework, money market is represented by the LM (Liquidity Preference Money Supply) part while the goods market is represented by IS (Investment Saving) part. IS-LM curves are drawn with the rate of interest on the Y-axis and out on the X-axis. The intersection points give the equilibrium conditions.                    

Expansionary monetary policies implemented by the Reserve Bank of India (eg. CRR cuts, increased liquidity, reduced LCR etcetera) shifts the LM curve to the right. This brings down the equilibrium rate of interest. This would increase the opportunity cost and people would start investing more money into the economy.

The LM curve does not solely decide the effectiveness of a policy. IS curve also plays a crucial role. If the IS curve is steep, that is less elastic, the effect of the monetary policy would be less and vice versa.