Both Demand and Supply are Hit, and Need Support

Both Demand and Supply are Hit, and Need Support

Currently, the entire world is fighting a war against a silent, invisible enemy, the coronavirus SARS-CoV2 that has caused the COVID-19 pandemic. It does not respect national boundaries. There is no vaccine or known cure for this ailment currently. Given the highly contagious nature of the disease (relative to the usual seasonal flu), policymakers all over the world are emphasizing the urgent need to ‘flatten the curve’ of its spread to prevent healthcare systems from being overwhelmed by the surge in numbers requiring critical care at any given point in time. The cases of America, Italy, China, Spain and Iran show how quickly the situation may spiral out of control, unless adequate advance steps are taken.

In addition to the enormous human suffering, this pandemic has had and will further have huge economic consequences. Ironically, the more successful the isolation measures to contain the spread of the disease, the bigger will be the economic burden.

The economic costs will arise from both the demand and supply sides. As national and international supply chains get disrupted, production (and employment) will fall. This is a supply shock. The corresponding fall in income (both current and expected future income) will generate a demand shock in the form of a fall in current expenditure. This, however, would be mitigated in the initial weeks to some extent as there would be some additional panic buying of essential consumer products and medical supplies/equipment to stock up for anticipated future shortages.

So, the immediate sales of some products (like food, medicines and sanitary products) and some businesses (like retail grocery stores) may temporarily go up, which will be followed by sharp declines later. But it will also mean a restructuring of demand away from other products (like consumer durables), which will cause an immediate decline in demand for products like cars and two-wheelers.

That is why the stock market values of different firms and sectors would move in different directions. For example, the stocks of some pharma companies may go up while those of consumer durables and banks would suffer a decline. It is obvious that the biggest immediate sufferers would be the airlines, shipping, hotels, and leisure industries. Also, different countries’ stock prices would be behaving differently, depending on how severe the impact of the pandemic is and how closely connected a country’s production system is to the global supply chains.

From that point of view, India may well be less affected than some other South-East Asian economies heavily dependent on intra-Asian (especially China-centric) supply chains and markets and also some of the European economies closely integrated into an intra-EU division of labour.

Compared to the beginning of the ‘Great Recession’ in 2007, the world is much more leveraged (though household debts have fallen in many countries) now. Our financial sector, as well as the corporate sector, is under a much bigger load of NPAs, compared to the pre-2007 days. So, any further defaults in payments will seriously strain the over-stressed banking and corporate sectors.

In addition, the huge falls in stock prices will immediately generate an adverse ‘wealth effect’ in all countries as consumers and producers would feel themselves poorer than before. This will induce them to cut back on their current expenditures. It is near certain that Japan and most of Europe will go back into recession as a result of this pandemic.

Inevitably, all governments will have to go in for additional monetary, fiscal and income support measures to mitigate the adverse economic impacts. Monetary policy has reached its limits in many advanced economies, already having their policy rates hovering around near-zero or even negative territories. So, nothing much can be done there.

Consequently, fiscal policy will have to do the heavy lifting. With borrowing rates at near-zero levels, governments, as well as reputed companies, can borrow at low cost to tide over the temporary disruption whose primary impact may well be over in the next 4-6 months.

Temporary income support to people forced to sit idle or having serious cash flow problems as a result of business disruption is another major action area. Many countries are devising specific relief packages to alleviate the temporary loss of income by initiatives like allowing deferment on payment of taxes, interest and loans, rents, and electricity bills, especially for small businesses, and protecting at least 80% of wages of furloughed workers. This is easier to finance by the government since this dislocation would be for a few months, rather than for many years, as in the case of a prolonged recession. Also, it would be less costly than allowing the firms to go bankrupt and start all over again.

However, it is far more difficult to administer a program to protect the incomes of people like daily wage workers, roadside vendors, cab drivers and homeless people as most of them are unregistered workers.

It is of utmost importance to minimize the disturbance to supply chains as far as possible to maintain cross-border transportation of goods while restricting the migration of people.

This needs international coordination of policies, which is not an easy task as the difficulties in intra-EU movement of goods following the virus outbreak show. The International Monetary Fund will have an important role in ensuring that the monetary and fiscal policies of different member countries do not run at cross purposes, in addition to arranging temporary adjustment assistance to needy countries. Philanthropic organizations can provide a big helping hand in this humanitarian crisis.

If China’s industrial sector quickly recovers (as major industrial areas like Shanghai are not much affected, unlike Wuhan), it will hopefully help the rest of the global economy by resuming supplies of inputs and final products at low prices again.

Finally, if (and it is a big if) India can bridge the crisis through appropriate advance measures at relatively low cost while the Chinese GDP suffers a couple of percentage points loss, India may even get back the ‘fastest-growing big economy’ tag for a few quarters.

By Mr. Alok Ray
Former Professor of Economics, IIM Calcutta, India, and
Cornell University, USA