We need a fiscal push for infrastructure modernization on the massive scale it took to rebuild Europe after World War II
As the Covid-19 pandemic wreaks havoc around the world, from China to Europe to the US, the economic disruption that it has brought is being felt. The most reliable high-frequency economic numbers are from the US, where the historically high unemployment claims of 3.28 million reported last week are indicative of the magnitude of its impact. The hardest hit were the accommodation and food services sectors, followed by healthcare, entertainment, recreation and manufacturing. Chinese car sales fell 86% in February. US gross domestic product (GDP) growth forecasts for the second calendar quarter are sharply negative, with Goldman Sachs and Morgan Stanley forecasting 24% and 30% output declines (on a quarter-on-quarter seasonally-adjusted annual rate basis). Global growth estimates for 2020 have been revised to under 2% and are likely to head towards zero as the year wears on.
The historical parallel for the 2008 Global Financial Crisis (GFC) and this pandemic-induced global recession is the Great Depression, which began in 1929 and was followed by World War II, which began in 1939. In terms of disruptive effects, however, this pandemic is akin to those of World War II, though we hope these last only a few months. Both the GFC and Great Depression were caused by economic and market events, while World War II and this recession have been caused by non-economic events that have a significant economic impact. The hope is that post-pandemic growth and reconstruction will offer a path forward in the same way that war mobilization, post-war investment in reconstruction and post-war global institutions created growth and prosperity around the world.
The Marshall Plan (MP), named after then US Secretary of State George Marshall, was an American initiative conceived for a post-war recovery in Europe. It was intended to repair war-torn systems, rebuild infrastructure, modernize industry and increase productivity. It also had a political motive of preventing the spread of communism. An even more ambitious reconstruction plan was enacted in Japan from 1945 to 1952 by US General Douglas MacArthur, who took charge of the Supreme Command of Allied powers.
In India, as the public health crisis enters its ninth week and the total lockdown its second, the economic impact is only just beginning. What we know from past crises is that India will need to mobilize its response with speed and heft. Unlike the GFC, India enters this crisis with anaemic growth, a wounded banking system and static investment and employment. It entered 2008 after several years of near-9% GDP growth, a revenue-surplus budget, high productivity and a strong currency. The disproportionate impact of this disruption is likely to fall on India’s informal sector and underserved communities. Given a poor real estate market and the sharp fall in equity markets, the wealth effect on India’s equity holders is also significant.
The initial responses from both the ministry of finance (MoF) and Reserve Bank of India (RBI) have rightly focused on providing liquidity and easing the impact on payments immediately due. The MoF’s ₹1.7 trillion ($22.7 billion) relief package includes direct cash transfers as well as in-kind food distribution, and insurance for healthcare workers on the front-line. RBI has slashed interest rates and allowed deferral of instalment payments.
Beyond these immediate relief measures, the focus will have to shift to repair and reconstruction. The most important sector for both monetary and fiscal transmission is the banking sector. The MoF has been rather slow in effecting changes in this sector. It must now move quickly and bring in a programme that is broadly similar to the Troubled Asset Relief Program (TARP) of the US about a decade ago. TARP was authorized as a $700 billion plan to purchase or insure “toxic assets" of the banking system so that banks could return to the task of lending to businesses and in that way become agents of reconstruction. India’s banking sector is estimated to need about $100 billion in equity. A TARP-like infusion would kick-start the banking system into lending again. Of course, India’s TARP will need to be tailored to the unique structure of the country’s banking system and require governance changes as well. Once credit returns to the system, broad reconstruction can proceed apace.
Another massive stimulus plan will be required to kick-start the real economy. Infrastructure modernization could be the focus of such a “Marshall Plan for India". The scale of the required stimulus is about 5-7% of GDP, or $150-$200 billion. One way to organize funds is to create a government-guaranteed special purpose vehicle (SPV) that is equity-funded by sovereign and pension funds around the world (specifically West Asian and Canadian) and leveraged by (low interest rate) development capital from Japan. An additional tranche of (high interest rate) loans can come from the Indian diaspora. The funders will no doubt require assurances of governance and preferential return, but it would catapult India forward.
A 10%-of-GDP stimulus will need to be managed carefully, since it will have inflationary consequences. The rupee is likely to be a victim and sink to 90 or worse on the dollar, but we can use our substantial foreign exchange reserves to cushion such a fall. The alternative is a pestilence-induced anaemic economy that will set us back decades.