The COVID-19 pandemic has thrown up unprecedented macro-economic challenges for the world in general and for India in particular. Countries around the world have been dealt with two major shocks- the first and the obvious is the health shock and the second is the economic shock. Although the health shock carries greater urgency at present, it is a relatively short-term one that will abate sooner than the economic shock and its repercussions. The economic shock induced by the pandemic is dually loaded with a shrinking of demand (which includes fall in consumption, investment and exports) and a collapse of supply chains that keep an economy running. The gravity of the economic crisis is precipitated by measures such as social distancing, suspension of non- essential activities and nationwide lockdown- which although necessary to contain the spread of the virus, spell disaster for economic health.

Pre-COVID roots of economic slowdown

The conditions of slowdown that had gripped the Indian economy well before the pandemic set in make it a unique case in point as opposed to other countries majorly affected by the pandemic such as Italy, US, UK, China and Brazil. In the 2019-20 FY, GDP was at a dismal 4.7% and unemployment was at a 45 year high. Private sector investment and consumption were rapidly plummeting. This predicament had roots in three major factors. The first was the overdependence of the GDP on a large informal sector (90% of the workforce). Reeling from blows dealt previously by demonetization and GST, any crisis experienced by this sector translated to system-wide shocks at all levels of the Indian economy. The second factor was the balance sheet crises that gripped banks and private firms alike. While the banking sector grappled with the NPA crisis, private firms found themselves overleveraged to the extent that they could not repay their loans. The third factor was the twin action of high fiscal deficit of the government and the unsuccessful transmission of monetary policy.

Implications of Economic Slowdown: Risk Aversion

Risk aversion in the Indian financial sector was a child of uncertainties that the banking sector in India faced. Banks (unequipped to deal with the trials and tribulations of the NPA crisis coupled with a global pandemic) were reluctant to disburse credit and chose instead to park their money with the RBI. This was despite a cut-back on reverse repo rates and liquidity cushions offered. While credit flowed in a dangerously skewed manner to retail loans as well as the agricultural and allied sector, credit flows to the services and private sector dropped to meagre 23.9% and 3.1% respectively by February 2020 itself.

Risk aversion also permeated the debt market. Jolted by the worsening sentiment in NBFC sector that the unexpected collapse of reputed firms like IL&FS triggered, banks became prone to hold G-Securities even beyond the SLR limits. Even when they did invest in non-SLR bonds, it was in big private sector firms they considered ‘safe’ rather than the MSMEs that really needed this investment.

Policy Measures: Analysed

The RBI has sought to arrest this economic shock (albeit quite unsuccessfully) through various monetary policy measures. It cut the reverse repo rate to a low of 3.75%, it has tried to boost liquidity in the system through Targeted Long Term Repo Operations, it increased the moratorium on loans to 3 months and increased NPA recognition from 90 days of loan default to 180 days. However, the RBI policies have failed to persuade banks to lend more and have counterproductively been bent on injecting more liquidity into an already liquidity flushed system. This is being done without heed to the root cause of the issue i.e. risk aversion of the financial sector.

Policy recommendations and the way forward

In order to sustainably navigate the unique requirements of economic revival during the COVID- 19 crisis, there is a need to return governments and banks to the roles that they perform best during periods of crisis i.e. government as the risk-taker and banks as capital allocators. The government needs to relieve the banks of the burden of assessing and assuming risks so that they can freely focus on capital and credit allocation. Dr. Rajeswari Sengupta suggests that this might take the form of a credit guarantee fund operated by the government to cover the risks of the banking sector when it extends loans. Macroeconomic policy interventions ought to be sensitive to the unique requirements of various sectors rather than promote ‘one size fits all’ policies. For instance, in the informal sector there is an urgent need to leverage and utilise informal credit channels and micro- finance institutions.

While there is a call for the government to scale up its monetary policy response, such a response should tread cautiously so as to not sacrifice the integrity and credibility of existing frameworks and institutions in favour of cosmetic and short-term fixes. Thus policies such as quantitative easing (e.g. - helicopter money) should be adopted with an exit plan in place, mindful of its long-term fallouts in triggering inflation. The road for economic revival in the current Indian context is hardly an easy one. Yet there is hope to be found in context-sensitive, targeted and comprehensive policy interventions.