What is the issue?
- There is a looming threat of global recession and impending domestic demand destruction due to COVID-19 health emergency.
- Faced with significant uncertainty over the depth and duration of the negative shock, policymaking should be extremely quick and innovative.
How the policy focus should be?
- Due to COVID-19 spread, the policy focus has been to avert the health emergency otherwise; the economic emergency would be inevitable.
- But, looking ahead, it is important to keep a fiscal and monetary policy template ready to reduce any implementation delays.
What principles could be a framework to guide policy?
- Minimising hysteresis - Supporting easy reversibility.
- Subsidiarity - Supporting local action by official and civil society.
- Sustainability - Retaining the ability to provide a graded response to ensure political and economic confidence.
Why the FRBM Act needs to be suspended?
- The government has already utilised the elbow room offered by the FRBM Act under exceptional circumstances in FY20 and FY21 budgets.
- This leaves limited conventional fiscal space for any stimulus.
- But there could be a case for temporarily suspending the FRBM Act, as was done during the global financial crisis of 2008.
- Given the recent trends, the FRBM Act-mandated maximum target of a fiscal deficit of 3.8% of GDP might have already been breached for FY20.
- As growth concerns outweigh worries about future macro-stability risks now, any fiscal stimulus should not be deterred by FRBM considerations.
- The fiscal package should be proactive, quickly implementable, sizeable, targeted and reversible.
What are some spending ideas?
- Earmarking an enhanced budget for healthcare would definitely be the top priority.
- Income support to people whose livelihood has been impacted (these will primarily include daily wage earners).
- Direct cash transfer to this group is ideal, but might suffer from proper identification challenges.
- Packages for deeply affected sectors like travel, tourism and MSMEs could have three components - temporary postponement of taxes, cheaper loans, and explicit financial grants.
- Frontloading public spending to counter balance the near-term headwinds.
- The government can suspend capital gains tax temporarily to incentivise flows back into the equity market in the short term.
How a fiscal package could be funded?
- Windfall from oil prices - The government should be optimising the windfall from the sharp drop in oil prices.
- The central and state governments should not raise the taxes on petroleum products disproportionately, so that the benefits could be passed on to the consumers.
- Moreover, there should be further fiscal gains from lower kerosene and LPG subsidy.
- Health emergency bond - The government could consider issuing a tax-free health emergency bond to tap more resources.
- In a volatile equity market environment, these bonds could receive good response.
- Direct RBI monetisation of deficit - This is allowed by the FRBM Act under special circumstances including the “national calamity”.
- This could be met through a combination of direct monetisation and OMO support to check interest rates from rising.
What would be the monetary response?
- Central bankers are trying to counter the two channels of transmission of the virus shock,
- Financial stability risk arising out of large market dislocations,
- Growth risk from estimated disruption in economic activity.
- Adequate buffers need to be created, so that the turmoil in equity market/macro economy does not spread to credit markets.
- RBI has been infusing both dollar, and rupee liquidity to ensure that the financial systems do not freeze up.
- On top of it, there is scope for an immediate 25-50 bps rate cut as a first step to support growth.
- RBI may indirectly intervene in the corporate bond, CP market as the credit spreads have widened quite substantially.
- It might provide regulatory forbearance for retail customers, and certain specific sectors.
Source: The Indian Express, Financial Express.
