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Global Economic Downturn brought by Corona Virus What India & Indonesia should do?

By Shiv Dave (shivdave@televisory.com)

 

Going by the stock market plunges around the world, it seems apparent that the world is in for a major economic crisis not seen since 1987 and perhaps matching 1930s. The worries for similarities are, never before has there been an organized effort to stop traveling, meetings, shopping (discretionary) than taking place as I write this blog. While corporates will strive to survive, the eventual casualties will be small businesses and employees at large – the weaker economic link, yet the most important parts of the society.

Differing recipes have been applied in the past at different places. During the Asian financial crisis of 1997-1999, banks closed down, interest rates jumped, job losses soared, before some of the affected Asian economies recovered. Indonesia was one of the most affected countries back then. However, during the 2008 global financial crisis, the western governments injected more money into the system to protect jobs and to provide confidence to the market. The developed world has now a standard recipe for its financial and market woes, inject more liquidity into the economies, cut down rates, for an extended period. of time. The United states had a near zero interest rate policy for nearly 7 years post 2008 financial crisis and is back to that level within 4 years of its first rate hike. Europe and Japan are into negative interest rate zones while continuing (or readying) to inject further liquidity into their markets.

                      Image Source: weforum.org

Basically, Asian economies that suffered during 1997-99 period were provided bitter pills of painful path to recovery. Whereas, the developed world has chosen less painful path for themselves. One of the key reasons for this differing treatment is that developed countries have better ability to handle their financial difficulties than others. I do not quite agree with that. India and Indonesia are large enough to manage their economic difficulties as any large sovereign will strive to do.

Based on the above, my suggestions below for the two economies that I have known closely (which also bear significant similarities) are as follows –

1. Capitalize banks before it is too late – The governments should assume drastic stress that banking sector is going to bear (and bearing as I write this piece). Rather than having to deal with any systemic banking crisis, a wise pre-emptive action should be to infuse capital into the banking sector. This will be easy to do for state owned banks. The Private sector banks should be encouraged to raise money through its investors or tap into government assistance through temporary liquidity assistance, a funding that should rank at par with Tier 1 capital. A preventive action by the government will also keep the overnight inter-bank lending market calm;

2. Encourage banks to lend prudently – Banks tend to pull back liquidity in markets like this. This creates chain of reactions that throttles liquidity in the economic system. Many good corporates can go bankrupt due to lack of liquidity. A timely availability of liquidity will only help stabilize the economy at large. Banks should be encouraged to lend and assist good corporates ride over the crisis (which may entail restructuring in some cases). Further banks should be advised to consider new liquidity based on prudent credit assessments;

3. Deficit Financing – the Governments like India and Indonesia will need to pause the fiscal prudence quantitatively, not principally, and embark upon massive infrastructure project and invite investments into these sectors to shore up demands and provide employment opportunities. Infrastructure development is needed in both countries and there is no better time than to embark upon large initiative now. Both countries are reliant (with varying degrees) on imported oil and lower oil prices and commodity market should help them keep costs of these initiatives low and manage inflation within limits;

4. Slash income taxes – Governments have often put money in the hands of corporates but rarely in the hands of individuals. The benefits of slashing corporate taxes reach to common man, and eventually provide impetus to demand at large, slowly. However, if income tax for salaried employees is slashed or reduced to zero, it will almost immediately result into jump in consumer spending in consumer durables, housing, automobiles and other sectors. Lowering of taxes for small and medium scale sector should be considered as well. Reduction in taxes for these will be more than compensated by increase in spending (resulting in higher GST or VAT and corporate income taxes) and the multiplier effect it will unleash. The demand growth that this initiative will bring will help increase employment as well;

5. Incentives for employment – The Governments should consider, at least for a period of 3 years to allow tax deductibility on employee cost amounting to twice the cost incurred on employees to encourage them retaining their employees and minimizing retrenchments. This will not only be a good social cause, but also a wise economic decision to shore up demands (providing similar benefits enumerated under #4 above);

6. Keep interest rates low – It’s important to keep the interest rates low to help keep inflation low and allow affordability of the borrowings. If the governments follow the suggestions of recapitalizing banks, this will automatically help keep the interest rates lower;

7. Liberal Exchange rate – With the Western world (US, Europe) and Japan at near zero interest rate, their currencies are currently strong only due to ‘safe heaven’ perception. It may be wiser to let the currencies (INR and IDR) float so that it benefits exporters. Weaker local currency will make imports expensive, but that is a calculated risk one will have to take. The low commodity prices currently help this and as things normalize, the currencies will strengthen eventually.

Both India and Indonesia enjoy a healthy demographics and therefore the impact of some of the above monetary and fiscal benefits will be higher than seen in Europe and Japan, as both the regions have higher proportion of older population.

Lastly, the above recipe will create non-performing (or less performing) loans, but these can be addressed in medium term as economic conditions improve. 

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