COVID-19 and India's Fiscal & Monetary Options


Cogencis, Monday, Mar 23

By Ananth Narayan

COVID-19 is first a medical challenge, with a sizeable human cost. Even as our good doctors and health authorities address the crisis, we must consider the implications for the economy, financial markets, fiscal and monetary policy, and regulatory interventions.


The war against Covid-19 could be long and arduous. Livelihoods will be lost, demand will slump, and businesses will struggle. Economic activity will sharply reduce, before eventually limping back once the medical emergency has been addressed. This could take a long time.

Even fiscal hawks (present company included) will attest that we need a pump now to make up for lost economic activity. In a war, we have to borrow from our future.

The usual concerns that fiscal stimulus will lead to inflation and currency weakness can be set aside for now. Any general inflation now will be supply-led rather than demand-led. On the external front, our current account is under control now, we have foreign currency reserves, and every other country is printing money anyway.

The time for us fiscal hawks to speak up will be when things improve, and we have to wean away the stimulus. The fiscal and monetary stimulus in the wake of the global financial crisis in 2008-09 was not a mistake. Instead, delaying the subsequent withdrawal of stimulus, ignoring structural reform, and allowing policy paralysis to set in were the real issues.


First, we have to set aside funds to take care of our first responders (across all essential services) and patients. Whatever it takes.

Second, we should consider a universal basic cash payment to every household, so that minimal household needs can be met even under a lockdown. A support of 3,000 rupees for every citizen would entail a spend of 2% of GDP.

Third, the flow of critical supplies and services will have to be kept uninterrupted – including food, healthcare, security, household provisions, power, telecom, money and banking. Shortage and hoarding of any kind will have to be guarded against.

Fourth, we should use this opportunity to invest in much needed infrastructure, including hospitals, healthcare, sanitation and the use of technology in education.

Fifth, we should provide forbearance for banks and financial institutions to restructure all loans and facilities where servicing is impacted by COVID-19.

Finally, our financial services ecosystem needs help. It was already severely stressed, even before COVID-19 hit us. Things will get worse. Addressing chronic stressed assets and undertaking deep market, banking, sectoral, factor and governance reform is a must to ensure that we can fund our eventual recovery and growth. The government could launch a large Alternate Investment Fund, say with 2-trln-rupee capital to start with, to slowly absorb and resolve chronic stressed assets that predate COVID-19.


As fears around the extent of COVID-19 rose sharply this month, we have seen wild movements in global and domestic markets.

In India, so far this month (till the time of writing this column on Sunday), FPIs have pulled out a record $13 bln from our equity and debt markets. Domestic mutual funds are seeing redemptions. Nifty 50 has fallen by 22%, and Bank Nifty by 30%. Some specific banks and NBFC stocks have fallen by 60-70%. Yields on even good quality short term NBFC paper have risen by over 2%. Rupee has weakened by 4%.

Again, things could get worse.

The Reserve Bank of India and the Monetary Policy Committee have immense power to control and provide relief to currency and fixed income markets. However, there are many that argue against the use of this power.

One argument goes that if FPI and domestic investors are withdrawing funds, they should pay the fair exit cost. Steep rate cuts and RBI intervention in markets, the argument concludes, should not be to bail out individual traders, fund managers and investors, particularly those who are always moaning with a gun to their head.

The second argument is that rate cuts will not spur growth in the economy now, and hence should not be resorted to. The US Federal Reserve, the argument goes, over-reacted with its sharp rate cuts and spurred further panic.

Finally, others point out that currency and risk-free rates everywhere are volatile, as risk-off takes hold globally. India is no exception, and we should preserve our ammunition.

These arguments miss some vital aspects.

First, wild movements in financial markets can impair economic fundamentals. George Soros referred to this as reflexivity. At a time when our financial services ecosystem is stressed and facing a trust deficit, we cannot have top-rated private sector and quasi-sovereign financial institution borrowing costs move up to 300 basis points over the repo rate.

Second, how we treat investors who are exiting now will have a bearing on their return. As a country, we need to continuously draw in savings into our capital markets. We cannot cut our nose to spite our face.

Third, it is a serious mistake to look at policy interest rate action through the lens of inflation and growth alone. Notwithstanding our present blinkered monetary policy framework, interest rates can impact financial sector stability as well – including our external balance and the health of our financial services ecosystem.

We would also do well not to underestimate the policy room that we have in the short run. After all, in the aftermath of the global financial crisis, our operative policy reverse repo rate dropped to 3.25% for much of 2009, with surplus banking funds consistently earning zero.

Finally, every market has a different context around why risk-free interest rates moved up the last few days. In our case, our fixed income secondary markets are tiny in relation to the actual positions held by FPI and domestic funds. Large redemptions therefore trigger exaggerated market moves, unrelated to fundamentals. There will be a time to do a post-mortem on how this context was allowed to sustain. At first glance, no one will come out looking good – neither regulators, nor market participants.

For now, however, the good news is that all this is easily addressable. What specific interventions could the authorities consider?


The policy objectives of the RBI at this stage should be clear –to ensure that market movements do not reflexively threaten financial stability.

To this end, first, the RBI and the MPC should not delay a steep rate cut of say 100 bps. They can use suitable spreadsheets and verbiage to justify the policy outcome within their inflation mandate. However, the real intent behind the rate cut should be clear. It is neither to spur growth, nor is it to address any disinflation. It is to provide much needed relief to the stressed financial services ecosystem, and to all those with debt on their books.

Next, the RBI has done an excellent job of managing rupee volatility so far. This is despite the highest ever FPI withdrawals in a single month, and significant buying pressure from offshore traders. While rate cuts could increase the pressure on the currency, we have enough currency reserves and a comfortable current account for now. While gradual rupee depreciation would address the chronic overvaluation of the currency, the RBI should perhaps continue with their current strategy of dampening volatility and preventing panic.

Third, the RBI should undertake significant open market operation purchases of bonds. We will be entering a phase of print and spend now, as the government is forced to expand its fiscal deficit. Print and spend is usually a terrible idea in normal times. But times are not normal. We have little choice but to borrow from the future, for now. The time to argue around withdrawal of stimulus will come up later, as things start to normalise.

Finally, the RBI and the government should nudge banks and financial institutions with risk and liquidity capacity to buy up good quality corporate debt. At the same time, the RBI and the government should keep the 2008 playbook ready, and if necessary, set up a special purpose vehicle that can lend to mutual funds and NBFCs against good quality paper.

Regulators have to achieve the difficult balance between appearing panicky on one hand and appearing frozen like a deer caught in the headlights on the other. When it comes to extreme dislocations, being proactive is usually the better approach to take. Clarity around context and objectives can help achieve this balance.


These are surreal times, and the context is still unfolding. We may have little choice but to borrow from our future and sustain our present economy through the crisis with some print and spend. Further, sustained financial market dislocations can reflexively threaten our financial stability.

Where these can be addressed, they should be. We should also use the opportunity to invest in our healthcare and education, and to address the core stresses in our financial sector ecosystem.



(ANANTH NARAYAN, an associate professor at S.P. Jain Institute of Management and Research, is an independent market analyst. Narayan was earlier Standard Chartered Bank's regional head of financial markets, ASEAN & South Asia)


* The views expressed by the author in this column are personal

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