Improve infra to become part of global supply chains: IMF's Ranil Salgado

The economic impact of Covid-19 is expected to be substantial, but recovery should take hold once the virus has been contained, says Salgado

Reserve Bank of India’s (RBI) foreign exchange reserves are enough to serve as a buffer amid a Covid-19 slowdown, but the country needs to walk a long way before it can take advantage of attracting some of the global supply chains that is expected to move out of China after the pandemic, says Ranil Salgado, India Mission Chief at the International Monetary Fund in an interview with Anup Roy and Indivjal Dhasmana:   

With Covid-19 causing a global recession, will India still be the bright spot in the world that IMF generally describes the country as?

We strongly support India’s response to the pandemic, including the proactive decision to pursue a nationwide lockdown to stem the spread of the virus and to save lives, along with fiscal, monetary, and financial policy steps taken to support the economy. 

The economic impact of Covid-19 is expected to be substantial, but recovery should take hold once the virus has been contained. A gradual recovery is expected in FY2021/22 (7.4 per cent growth), supported by monetary easing and some targeted fiscal measures, as well as favourable terms of trade from lower oil prices.

What should be the ideal fiscal, monetary and financial response to the Covid-19 pandemic for India? Any advice for India on the extent to which it should widen fiscal deficit? Should it go for deficit monetisation with the RBI?

The immediate priority is to take all steps needed to address the health needs of the country, including by boosting healthcare spending. It could also include extending the lockdown as needed. In addition, we believe further measures could be taken on fiscal, monetary, and financial sector policies in the near term.

In the near term on fiscal policy, additional support is needed, including on healthcare and for small and medium-sized firms and vulnerable households, beyond the fiscal stimulus package already announced. This could require rationalisation of some non-priority expenditures. After the Covid-19 shock recedes, though, substantial new measures will be needed over the medium term to bring the deficit and debt back towards the central government’s medium-term targets (3.0 per cent and 40 per cent as a share of GDP). Committing now to credible and clearly defined medium-term measures, along with increasing fiscal transparency, could help the government finance some of its short-term needs by increasing investor confidence and lowering borrowing costs.

The RBI’s policy rate actions along with the regulatory measures to boost liquidity would provide some relief to borrowers and financial institutions. Monetary policy should maintain a strong easing bias to mitigate any sharp Covid-19-related slowdown and support the recovery, given the sharp slowdown in domestic and global activities, moderating inflation amid a wide negative output gap, and lower commodity prices.

What is your assessment of the economic impact of the lockdown imposed by India? What would be the potential impact on jobs and private investments due to Covid-19? One point to note is that the capacity utilisation had fallen to 69 per cent in December, even before the Covid outbreak. 

IMF staff projects that growth in fiscal year 2020/21 will slow to 1.9 per cent, reflecting both the domestic Covid-19 impact from the unprecedented national lockdown and weak external demand. The balance of risks is tilted to the downside, given the uncertainty surrounding the pandemic.

On the demand side, growth is affected by weak external demand from major trading partners, a reduction in tourism, and global financial shocks leading to tighter domestic financial conditions, with an offset from declining oil prices and fiscal, monetary, and financial policy steps taken. In addition, growth is weighed down by weak domestic demand from containment measures including the national lockdown. 

On the supply side, services (especially hotels, restaurants and transportation), manufacturing, and construction sectors are severely affected by Covid-19.

Both employment and private investment (especially in the sectors mentioned above) are expected to be adversely affected by the national lockdown. 

What would be the likely impact of the pandemic on the banking system? Can we expect large defaults and widespread bankruptcies, coupled with huge distressed assets sales?

The lockdown is critical in containing the spread of the virus, but it is also having a significant impact on households (especially low-income) and corporates through the loss of income and slowdown in economic activity. The loan moratorium will provide relief to borrowers whose cashflow has come under stress due to the pandemic, but could also constrain liquidity in the financial system. It is too early to assess the potential longer-term impact, but the debt repayment capacity of borrowers may weaken and risks to banks’ asset quality could arise if the economic fallout of the pandemic gets protracted. In this regard, we take note of the progress prior to the outbreak in addressing banks’ balance sheet weaknesses and improving their capital positions. 

Is the foreign exchange reserve of RBI enough to provide an adequate backstop if the financial slowdown? What if the slowdown persists for a longer period, say beyond the second half of this calendar year?

India’s foreign exchange (FX) reserve levels are assessed to be adequate for precautionary purposes, according to various criteria. The official FX reserves are at around $475 billion (16 per cent of GDP). Short-term debt plus the projected current account deficit for 2020/21 is about 25 per cent of the official FX reserves. India’s exchange rate flexibility and sizeable FX reserves should serve as buffers. 

India’s real effective exchange rate has remained relatively stable vis-a-vis other emerging markets currencies. Does that indicate that volatility in USD-INR exchange rate is in the offing? 

Intensification of the external risks including a sharper-than-expected and a more prolonged global slowdown and heightened risk aversion could lead to further capital outflows and FX market pressures in emerging markets, including India. However, India has strong foreign exchange reserves buffers, and exchange rate flexibility should continue to play the role of a shock absorber while avoiding excessive volatilities.

What could be the impact of the pandemic in borrowing cost, both for the government and the private sector?

The pandemic has significantly increased economic uncertainty and risk aversion around the world. Higher uncertainty and demand for liquidity have led to tighter global financial conditions and could lead to some increase in borrowing costs. That said, monetary policy easing accompanied by various liquidity interventions made by the RBI is likely to moderate that increase. 

FPIs have been liquidating their investments from India. What kind of measures would be necessary to bring them back? The government has already given them more play in some government securities. Will they be interested in coming back in a risk-off environment?

The global intensification of the Covid-19 shock and the confluence of a growth shock, an oil price shock, and a sharp spike in global risk aversion has led to broad-based capital outflows from the emerging markets, including India. A key role in managing the risks and encouraging inflows needs to be played by macroeconomic policies, sound financial supervision and regulation, and, over the medium term, durable structural reforms that can lift India’s potential growth and competitiveness. Looking ahead and beyond the Covid-19 shock, macroeconomic policies should continue to aim at enhancing monetary policy credibility, fiscal prudence, and exchange rate flexibility. 

India’s household savings rate has been falling for some time. Can Covid-19 change the pattern or the economy would be weak enough to not allow household savings for quite a few years?

The economic toll from the pandemic is likely to be large, especially affecting the most vulnerable groups in society. Large, timely, and targeted fiscal and financial sector measures are essential to shield vulnerable households and firms and to support the build-up of household savings and the economic recovery going forward. The fiscal stimulus package introduced in India (on March 26) is one step in the right direction. The package has appropriately included in-kind (food; cooking gas) and cash transfers to lower-income households; insurance coverage for workers in the healthcare sector; and wage support to low-wage workers. Additional financial support is needed in the near term, including on healthcare and for small and medium-sized firms and vulnerable households, beyond the fiscal stimulus measures already announced.

Do you expect the Covid-19 outbreak to move some productions away from China? How should India approach this to further its “Make in India” initiative?

The Covid-19 outbreak is now global. To benefit from the secular trends in global supply chains (GVCs), looking beyond the Covid-19 outbreak, creating an ecosystem for VGC participation along with deeper backward linkages is critical. Reducing tariffs and non-tariff barriers, while minimizing trade policy uncertainty, would help. Furthermore, energy, logistics, port facilities, and customs will need to be aligned to attract foreign companies to locate in India.

It is the states which are implementing various packages on the ground. But their financial condition is not that strong. Do you think the Centre should come out with a package to help them out?

In the face of the Covid-19 pandemic, which is likely to have profound human and economic consequences, there is an urgent need for both central and state government action, including prioritizing spending on healthcare, while also providing income support to those most vulnerable, and supporting micro-, small- and medium-sized enterprises (MSMEs). 

The measures taken to date by both central and state governments — such as the provision of food and cooking gas to vulnerable households, as well as cash transfers to poorer households — go in the right direction and are a good start. We see scope for additional spending in these areas, beyond what has already been announced, and at both the center and state levels, as well as a need to enact policies which support MSMEs who have been hit by the (appropriate) social distancing measures and nationwide lockdown.