Economic Impact of COVID-19

We look at the economic impact of COVID-19 and the present and future policy responses, especially in India. The challenges emanating from the pandemic and new way of doing businesses are discussed. ‘Fear factor’ may have to be tackled, which is unique to this crisis.

Isolation gave me a whole new perspective on friendship and family.

Anthony T. Hincks

Coronavirus disease (COVID-19) is a highly infectious disease spread through a newly discovered strain of coronavirus. Coronaviruses come from a large family of viruses which are known to cause illness in animals or humans.  In humans, respiratory infections like the common cold and severe diseases like Middle East Respiratory Syndrome (MERS) and Severe Acute Respiratory Syndrome (SARS) are known to come from coronaviruses.

World Health Organisation (WHO) advises that COVID-19 “…spreads primarily from person to person through small droplets from the nose or mouth, which are expelled when a person with COVID-19 coughs, sneezes, or speaks. These droplets are relatively heavy, do not travel far and quickly sink to the ground. People can catch COVID-19 if they breathe in these droplets from a person infected with the virus.  This is why it is important to stay at least 1 meter) away from others.” WHO classified COVID-19 as a pandemic on March 11, 2020 after its spread to 114 countries in a matter of weeks. A pandemic is a disease that spreads over a wide geographic area and affects an exceptionally high proportion of the population.

Response to COVID-19

Authorities across the world have responded swiftly to contain the mortality impact of the crisis. In case the reproduction number is greater than 1 for any infectious disease, the spread of the disease is exponential. Suppose, this number is 2, then it would imply that each infected person passes on the infection to two other people. Even with a low mortality rate, a high reproduction rate would lead to high mortalities. The mean estimate of several studies for COVID-19 is 2.63. This has pushed several economies to implement measures like social-distancing, quarantine, self-isolation and lockdown.

Economic Impact of COVID-19

Lockdown implemented by several countries has dismantled demand and thrown supply-chain into a tailspin. Countries, like Sweden, that have not implemented lockdowns have witnessed much higher mortality rates. Not implementing lockdown may have protected some demand but is likely to have longer-term consequences. Even without lockdown, several non-essential establishments are working at much lesser capacity across the world. As incomes have fallen and manufacturing and service entities struggle to maintain their operations, it has culminated into a volatile cocktail of both demand and supply side crises.

Fiscal stimulus measures of more than USD 8 trillion have been announced across the world to smoothen the economic impact of COVID-19. However, as pointed out by IMF Chief Economist Gita Gopinath, developing economies may struggle to find the policy space to deal with the crisis. Further, readiness of an economy to restart operations depends crucially on its health infrastructure, which again is found lacking in developing economies. An early invention of vaccine may be the only way to not have a prolonged downturn. Even though several vaccines are in testing stage, full-scale production and distribution may take anywhere between 12-18 months after successful testing.

Policy response in India

In March, Indian government announced a fiscal package of INR 1.7 lakh crore, primarily aimed at helping the poorer segment. However, as many economists have argued, this may not be sufficient. A more robust fiscal stimulus, even up to 5 per cent of GDP may be required. This may be so because the dynamics of consumption as well as businesses is likely to change.

First, lets discuss how consumption and demand may be headed for the new normal. Even if the disease spread diminishes and people start coming back to work, the way people spend money may change. The traditional Keynesian approach of demand-side crisis is for more government spending. However, even with fiscal stimulus and some amount of money in the hands of people, the traditional approach may not be as effective. Why? I would argue because of ‘fear factor’. Even with money in hand people may not go out as often to restaurants, postpone travel plans, etc. This when extrapolated to the entire world may change the dynamics of consumption behaviour. Some sectors may benefit while most may bear the brunt. For instance, online businesses may see an upside but overall there may be a new lower normal.

Secondly, businesses may require to innovate to keep them from going under. Mckinsey & Company states that companies are responding with these five steps: workforce protection, supply-chain stabilization, customer engagement, financial stress testing and nerve-centre integration. Entities maintaining necessary liquidity and having prudent cash-flow management will be more likely to weather the storm. The nature of conduct of businesses may also change, for example, companies are more likely to go for video conferences and work from home to reduce local and outside travel. This may benefit IT companies but will hurt airlines capacity utilisation. Also, any sector that has revenue based on value derived from space like theatres, restaurants, hotels and transportation will have to bear extra costs to just stay in business. Costs will have to be reduced, which is likely reduce non-essential expenditure and also restrain salary jumps adversely impacting demand even more. There may be also increased unemployment even after ‘normalcy’ returns.

The future

From a macro perspective, unemployment is likely to increase from an interplay of innovation, work from home and people with average skill sets finding it difficult to sustain their employment. ‘Fear factor’ may lead to reduced demand in several economic sectors making many businesses unviable. Thus, it is imperative that higher fiscal stimulus may be infused by governments to effectively tackle the economic impact of COVID-19. This is especially true because monetary policy may not be as effective in the throes of a downturn effected by a global financial cycle under a flexible exchange rate regime. In India, a higher fiscal stimulus and other fiscal measures may try to target the following:

  • Credit period for post-shipment bills for exporters and trade credits for importers can be extended.
  • Interest rate subvention may be offered for importers/ exporters as well as small and medium enterprises.
  • Goods and Service tax and customs duty to be reduced across the board and especially for those entities more adversely affected by COVID-19.
  • Financial Year may be extended by six months.
  • Fiscal package may be offered for industries struggling with cash flows.
  • The coverage of employment guarantee scheme and other social schemes can be expanded.
  • Infrastructure spending by government can be increased substantially.

An article in Live Mint on May 04, 2020, suggested pledging of government shares in public sector enterprises with RBI as a repo agreement. This could garner INR 10 trillion of funding, equivalent to 5 percent of India’s GDP. However, this arrangement has a fundamental flaw. Pledging of shares by private promoters and pledging of shares by government are starkly different. Private promoters, mostly, have a long-term view to save their companies. Governments on the other hand, have a short-term view until the next election. This may lead to a debt trap with easy money creating more future problems than resolving present ones. Fiscal measures are necessary but not unbridled ones. Fiscal measures where a government has constraints is a better one vis-à-vis one where there are no short-term limits. With fiscal deficit already at 4.4 per cent of GDP by end of 2019-20, any unbridled access to finance may have macro implications for financial markets, inflation, etc.

Government will also have to chalk out a plan of action of staggered reversion to the mean of economic activity. Communication will also play a key role how effectively this crisis is managed.  We all hope that crisis should be short-lived but we have to be prepared for the long-haul.

1 thought on “Economic Impact of COVID-19

  1. Good article…very informative….

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