Can we stop the clock?

To minimise economic damage during the lockdown, focus on cash flows, promise of growth

“I have seen power blackouts as enemy bombers flew overhead, have stood in long queues to collect kerosene, and have lived through food shortages, but have never experienced anything like this before,” said my mother a few days back. Unfortunately, from the perspective of economic forecasting and the financial markets, neither have most —if not all — of the current crop of observers, including this author. Prior global viral pandemics were either too localised (SARS in 2003), or were too far back to have analytical value even if they triggered lockdowns: The 1968 Hong Kong flu was half a century ago, and the deadly 1918 Spanish flu a century ago. Policy toolkits differed too (the US Federal Reserve’s monetary intervention over the past two weeks has been unprecedented, as have been the record-breaking fiscal stimuli being announced by governments across the world), as also the economic interconnectedness of the world (much higher now).

One must therefore resort to first principles. Assume that we shut down all non-essential activities across the world for two months, and people who do not have to be out and about must stay at home. The definition of “essential” of course varies from person to person and between countries, but for the sake of modelling ease, let us limit it to food and basic groceries, utilities (electricity, water, sanitation, garbage collection), essential health care, telecommunications (including social media, satellite TV and video-on-demand), fuels (cooking gas) and finance (this includes banks, insurance and securities markets). After these two months, everything comes back to normal. 

What would be the lasting impact on economic output and the financial markets? Should everything not return to normal on the day of the restart? This is where the ability to stop the clock comes into question.

Illustration: Binay Sinha

 

For these two months, the providers of essential goods and services keep earning, even if at a slightly reduced pace. Surprising as it may seem, we estimate that two-thirds of India’s workers fall in this category: This would be lower in other economies as a large part of India’s workforce is in agriculture, which is mostly unaffected, and nearly half of all retail stores mainly sell food and basic groceries. Even if the variety declines, people eat: Demand for cereals, vegetables and fruits may remain largely unchanged, but that of meat may fall. Optional surgeries get postponed as people stay away from hospitals for fear of infections, and fuel demand falls as people stop moving around, though not to zero. For individuals involved in these businesses, given that their expenses would also be lower during this period, their survival would not be in question.

It is the consumption of non-essential goods and services that take a hit. Construction stops (though one suspects that rural house construction, which accounts for a large number of workers, may be hard to police), as do factories producing everything from textiles and shoes to consumer appliances, furniture and vehicles and their components. Private schools and tuitions shut down, even though for the privileged video-conferencing and online tools may substitute. People cannot take autos, trains, inter-city buses or flights. No one takes a family vacation, goes to movies or eats out. To this, one must add exporters of goods and services, where the decline in demand is due to clampdowns on travel, but also the lockdowns in other countries. 

The challenge for these enterprises, and to a lesser extent for those providing essential goods and services, is the fixed cost, i.e., the cost that accumulates irrespective of the quantum of output. These mainly consist of salaries, interest payments, rents and utility bills (we ignore depreciation as it does not mean cash outflows). All of these are transfers: Someone pays, someone receives. If the clock on these could be stopped for the lockdown period, system-level damage could be minimised, and a relatively normal resumption may become possible. The only problem that may remain would be the problem of daily-wage earners for whom the rebuilding of savings after this two-month lull would take a while: Something that may be handled fiscally.

But this may be hard to engineer. Take rents, for example: In an ideal world landlords would understand that instead of forcing a tenant into closure (or evicting individuals), and then seeing zero occupancy for months, negotiating easier terms is best for everyone. But rents, like house prices, are very sticky on the downside. 

Salaries involve a different optimisation: A destruction of institutional memory and in some cases the whole enterprise (most enterprises in India have less than 10 people) by reduction of workforce, versus a cut in wages like what the state governments of Maharashtra and Telangana are doing: Temporarily cutting salaries (by up to 75 per cent) and pensions to reduce their cash flow stress. These cuts are being calibrated by income level (lowest cuts for the lowest paid) so that all households can access basic necessities. If some private firms can afford to pay even the reduced wages, they may choose to do so, but this may also need an early promise of stronger future growth in the form of a large growth stimulus that keeps their hopes intact.

Interest payments, which total about Rs 10 trillion a year in the banking system (and likely another four to five trillion in the non-bank financial system) are man-made, but hard to deal with at a system level. The Reserve Bank of India providing the option to postpone interest payments, and the Securities and Exchange Board of India relaxing guidelines for default recognition by rating agencies are important steps, but these costs keep accruing. The borrower and lender may renegotiate the duration of the loan to delay the cash flows further, but this may not be an option for many loans, like in microfinance. If these costs are to be waived, how will lenders service their own liabilities? Banks cannot deny interest accruals on savings accounts or fixed deposits, after all.

This framework suggests that even if it would be ideal to stop the clock, it may not be possible to do so. To reduce the economic damage caused by destruction of enterprises, which can then take several months if not quarters to regenerate (this can compound if lockdowns get extended), the twin strategies of enabling enterprises to access sufficient cash during the lockdown, and a promise of stronger future growth may be necessary.

The writer is co-head of Asia Pacific strategy and India strategist for Credit Suisse