The mounting cost of Covid-19

New Covid-19 cases continue to rise at a worrying pace. India recorded 314,835 new cases on Thursday, the highest ever for any country in a 24-hour period. It’s not very clear at what point would the new cases begin to stabilise before they start coming down. This wave will significantly increase the final cost of the pandemic, both in terms of lives and livelihoods lost. It is likely that the spread has increased because of new virus strains, but India could have done better in handling the situation. Clearly, it declared a premature victory, which was visible in large political rallies, religious events, protests, and crowded markets across the country.

Perhaps the hope was that India will not witness another wave. This was also apparent in a comparatively slower roll-out of the vaccination programme. Unlike some of the other countries, India did not place large orders for vaccines, which would have given manufacturers certainty and funds to increase the scale of production. The pricing of vaccines didn’t help matters either. But this is likely to change. The government has decided to open up the procurement and administration of vaccines. Now state governments and the private sector would be able to procure independently. The visibility of orders and better pricing should incentivise manufactures to increase production. However, increasing the scale of vaccination to a meaningful level will take time. Therefore, the focus till then should be on augmenting medical infrastructure to save as many lives as possible.

Several state governments have imposed restriction on mobility to contain the spread of the virus. The rapid increase in the number of new Covid-19 cases and restrictions on activity are affecting economic recovery. Nomura's India Business Resumption Index, for example, has slipped to 83.8 from 98.1 a few weeks ago. The gain in economic activity since November 2020 seems to have already been wiped out. It is possible that the actual output in the current quarter would be lower than the last two quarters. This could significantly delay the full economic recovery and make policy management even more complicated.

India’s public debt and budget deficits are already on the higher side, and a sharp slide in economic activity will only make things worse. The current year’s Budget estimates for the Union government are based on an assumption of 14.4 per cent nominal gross domestic product (GDP) growth. But the potential sequential contraction in economic activity could increase risks. The fiscal deficit could rise from the projected 6.8 per cent of GDP on account of lower than expected revenue and higher expenditure. States are at the forefront in handling the pandemic and will also need more resources. Yet another increase in government borrowing might become inevitable. Although deficit expansion may be unavoidable, it will still have longer-term consequences.

The bond market is anyway struggling to finance the general government deficit and is demanding higher compensation. Another increase in government borrowing on an existing large base would further complicate market realities. The Reserve Bank of India (RBI) is trying hard to keep “bond vigilantes” in check. But the risk is that it might end up doing too much. The RBI has started a new programme called the “G-sec acquisition programme”, mainly to manage market interest rates. It will now commit upfront to buy a certain amount of government securities from the market. The market did react positively for some time but soon reverted to reality. The market is more worried about the supply of bonds and the inflation outlook. The inflation rate in March inched up to 5.5 per cent. Disruption in supply chains can push it up further as happened in 2020. Higher global commodity prices are also a risk.

In terms of policy management, it’s important to recognise that the central bank’s excessive focus on yield management by flooding the system with liquidity could lead to sustained higher inflation in the medium term. As the International Monetary Fund in its latest World Economic Outlook, noted: “...if monetary policy is used primarily to keep government borrowing costs low (or is widely perceived as doing so) at the expense of ensuring price stability, inflation expectations and inflation could, in principle, increase rapidly.” The RBI should avoid such an outcome. This would also undermine its own hard-won feat of attaining price stability over the last few years.

Higher public debt and budget deficits, along with higher inflation, will also affect the currency and increase financial stability risks. Rapid economic recovery in the US has anyway started pulling capital out of emerging market economies. The Indian rupee has depreciated by about 3 per cent this month. Although India has a large foreign exchange reserve, it should not prompt policymakers to take excessive risks. Further, with rising Covid cases and restriction on activity, India may also not be able to capitalise on global economic and trade recovery. The economic outlook will only improve once the Covid caseload begins to decline. Thankfully, the cloud of uncertainty has a silver lining. Unlike last year, it’s possible to conclusively contain the pandemic. Therefore, the policy priority should be to curb the damage till a critical mass is vaccinated.