This crisis is different

Context: COVID induced economic shock is unprecedented as the economy was already under stress before it and thus needs exceptional responses to avoid turning it into a full-blown economic crisis.

Pattern of the response of emerging markets (EMs) to the financial crisis: 

• Restoring confidence in policymaking: which means large increases in interest rates, massive withdrawal of liquidity, and deep cuts in the fiscal deficit. 
• Restarting the economy: by restructuring the tattered (poor) balance sheets of banks, firms, and households.

• This includes debt restructuring and bank recapitalisation aided by privatisation, closures and mergers. 

• Structural reforms: The above measures supplemented by structural reforms in the economy.

Unprecedented nature of Current economic shock:

• Before the crisis, India was already struggling with lower growth, falling incomes, and profits and rising bad debt leading to obstructed flow of credit.
• This is an instance of economic shock turning into a financial crisis if the balance sheets are not repaired.

Needed Response:

• Role of RBI’s monetary policy: 

• To keep markets flush with liquidity and lower interest rates.
• It needs to undertake extensive quantitative easing to keep bond yields from spiking.
• It needs to extend substantial regulatory forbearance to prevent banks from cutting back credit due to worsening credit quality.
• Provide liquidity directly to corporates, instead of through banks supported by government guarantees.

• Fiscal support from the center: The overall fiscal support from the government is limited to only 2% of the GDP, which needs to be increased

• If the revenue shortfall is more than 2 % of GDP, then total spending will need to be cut.

• Income support: to households and firms, providing needed time and space for the recovery.

• This would also repair much of the damage done to the balance sheets of the banks which are primarily at stress during the lockdown.

• Promoting medium-term growth: by allowing the deficit to rise to increase public spending, offsetting the decline in private demand.