Less extreme lockdown better for India: WB | Economic Times

India needs to ward off credit crunch as a strong second wave of Covid-19 has hit the country at a time when there is constrained fiscal space and monetary ammunition, said Carmen Reinhart, chief economist of the World Bank Group. In an interview to ET , she said India would do well to take early action to help businesses and households that face financial stress. Edited excerpts: How do you see economic recovery shaping up given the strong second wave of the Covid-19 pandemic?The global economy tumbled into Covid, not everyone exactly at the same time because first it was China, then it was Europe, then the US, then EMs (emerging markets). But the downturn in economic activity started synchronously. I think the real challenge is that coming out of it, it’s not synchronous.The US right now has a huge amount of optimism with the vaccine rollout, better numbers, big stimulus, so there’s a lot of optimism that recovery is at hand. Concerns about overheating and all that – some of this, I think, is overdone.You have a large segment of the world in which you’re getting important second rounds that includes Europe, Brazil and South America. More recently, in India, we are seeing the current surge surpass the previous one. We are seeing it in Turkey. You’re talking about very significant parts of the global economy that are still in the throes of a second wave and, in some cases, the third wave. So, the case for a synchronous even recovery is just not there.And there’s a point that I’ve been making all along – this Covid pandemic has been a very unequal pandemic within countries and across countries. Within countries, it has hit the most vulnerable sectors, the lower income households, the small and medium enterprises. And across countries it hit emerging markets and developing countries especially hard because they don't have the ammunition capacity that the US has or that some of the advanced economies have to counteract the impacts on the economy of the lockdowns and such. So, it's a very unequal crisis.As recovery gains pace in developed countries such as the US, do you see a risk of repeat of the 2013 taper tantrum?India was hit hard by the taper tantrum in 2013. But I think the risks are different now. First of all, the taper tantrum was, importantly, also about the US monetary policy was about to change and the US interest rates were about to rise. I think the Federal Reserve has made it very clear that they have no intention of changing policy course for the time being and until full employment is restored.You could still have interest rates backing up as they have because of concerns about overheating, whether the US inflation rate is going higher and so on, but not because of a fundamental change in policy. More importantly, to think of the situation India faces now versus 2013, it’s a different kind of risk. I think the far bigger risk that we were talking about is the effects of the new surge.At the time India had a record current account deficit, it was more bubbly in terms of capital inflows in 2013. So I don’t see those risks. I think the big one is the effects of the new wave.How big a risk is it for India because it is already running a large fiscal deficit so there is very little space for the government to do as much?Absolutely, there are several risks. What policy can or cannot do is one of them. But there are also financial fragility risks for India.Like in most countries, India is facing the second wave with more constrained fiscal capacity. It’s also more strained capacity to ease on the monetary policy side because very constructively, central banks around the globe were able to lower interest rates and inject liquidity, provide support to businesses and households when they most needed it. But their capacity stays low for long in the way that the Fed does or in the way that the Bank of Japan does. I don't think that's there for emerging markets. I think emerging markets will face a bigger trade-off soon because of currency pressures – currencies have been depreciating, the rupee has depreciated this year. This in turn does have some filtering through to inflation. There are other inflationary pressures coming in from higher oil prices. So the central bank has also got less ammunition.But the third risk, apart from more limited fiscal space, more limited monetary policy space – I do think this is not unique to India but it is certainly relevant to India – is that countries are facing now, a second round.It is important to remember this did not start as a financial crisis, it did not start with balance sheet problems of banks or anything. But the longer it goes on, the more fragile the situation of businesses, small and medium businesses especially, that are shut down again, that see a reduction in their activity. The longer it goes on, financial strains also emerge for households. And so, what I'm getting at is that I think that a new wave leads to more balance sheet damage and more potentially non-performing loans for banks to contend with and the like. So those are three important risks I think that are very real in the context of this new wave.What are the policy options for countries like India to support the economy at this juncture?Some space is not the same as zero space. Everything right now looks small relative to the scale of packages in the West which is exceptional by any standards, including US historical standards as well. So, everything looks smaller relative to that, but that doesn't mean that there are no tools. Some continued support for the groups that need it the most is essential. It’s essential for a variety of reasons because India, like so many developing and emerging market countries, is now dealing with setbacks also in terms of poverty levels. This pandemic, to reiterate, has been extremely regressive. A look at the ‘World Bank Poverty and Shared Prosperity Report’, the last one, flagged that this is the first time since 1998 that we’ve seen a huge spike in poverty. And that’s very real for the government.The second part is, going back to my earlier comment, is early action in trying to deal with emerging financial stresses. I think a real danger is having the Covid in India, as in many other places we’ve seen, not just monetary and fiscal policy, we’ve also seen forbearance measures in terms of financial institutions allowing households, allowing firms more ease of repayment, some temporary moratoria, restructuring capacity and so on. So, that's been very constructive, but that also at some point will come to an end and I think an important getting ahead of what the government can do is also really take good stock of the state of businesses because the last thing India needs for recovery is to have a credit crunch.A credit crunch is a big problem in any economy for fostering recovery. And how do credit crunches come about? Well, credit crunches often come about because banks have impaired balance sheets, they also engage in evergreening, lending to loans that are non-performing, which basically starts limiting the amount of lending they do to what could be more productive ways of stimulating the economy. So, I think dealing with the balance sheet issues, trying to avoid falling into the zombie loan trap, where the financial industry is also very important for recovery, is very important. Because I’ve studied banking crises, many banking crises, in all confidence for long periods of time, and a common thread is that the quicker in addressing write-offs of bad debts, the quicker the recovery because the faster banks have renewed health in their balance sheets and are capable of maintaining lending. The credit factor is very important for recovery.Do you foresee a need for large-scale government bailouts of the sort seen after the 2008 financial crisis?That was the big onset of the crisis and that crisis in India came after a big credit boom. Remember India was growing about 7%, big credit boom, optimism, a lot of borrowing – that's not where we are right now. So, the scale may not be on a par with what we saw in 2008 but I do think the institutions will need support because, and I've been saying this since March of last year, this did not start because of a boom and because of an excess; it started because of a pandemic. But the longer that the shocks to the economy, the longer that the pandemic lasts, the more damage that is done to the balance sheets of firms and households. And so I do think that, maybe not on the scale of what we saw in 2008-09, but I do think that there is the need for balance sheet repair and I think the government will also have to help the capitalisation process. It's part of restoring normalcy, if you will.Do you think premature tightening of monetary policy due to rising inflation is a big threat to recovery?It doesn’t help but I have a great deal of sympathy with the central banks because they are in a very tough spot. If you don’t tighten and you are in a period of supply constraints – Covid is very disruptive to the supply process as well – because of rising commodity prices, you start seeing a more sustained increase in inflation which can affect expectations. And if you don’t do anything, turning the other way on the inflation question is also not an attractive scenario. Inflation is a tax, and it’s a particularly hard tax on the poor, and the low income are the most vulnerable groups that don’t have the ability to hedge. The higher income groups have alternatives, can hedge. The low income groups, if you look at their consumption basket, it’s importantly food and fuel, and those are the two things that are at the frontline of inflation. Inflation is a tax and it's a very regressive tax. That's why I'm so sympathetic to the dilemma of the central banks – if they don’t do some tightening, you have to worry about the inflation consequences. If they do tightening, you have to worry that this also may be a headwind to recovery. So it's a very tough call.Commodity price rise is feeding into inflation in many import dependent economies like India. Is there a need for a global consensus to keep supplies stable to ensure that this doesn't destabilise the fragile global recovery?I think over the near term I wouldn't count on any international agreement on that front. You have the two largest economies at the moment more or less in sync in terms of recovery. You have the US, you have China. Even though recovery elsewhere is much more muted, the US and China are a big chunk of the global economy and commodity prices and oil prices are always exceptionally volatile. Remember last year we were seeing oil in single digits and I don't see a consensus view emerging to move along the lines of putting a ceiling or any kind of stabilisation. I think living with the price volatility in these markets is going to be the modus operandi, it's going to be the baseline.Some countries have moved to an inward focused policy to encourage local manufacturing and avoid imports. Can such a policy really work?The idea of building domestic resilience in certain areas is very important. It may not be protectionist, it could be about fostering greater tilt on self-reliance in certain areas. That may not imply protectionism. However, when you start getting into more explicit import substitution policy, that's not new, that's an old story. It goes back to the policies 40 years ago and it's hard to say something is fully discredited but they went a long way towards being seen as delivering very little by way of sustained growth and more efficient use of resources. Export-led models did better than import substitution models by a big margin. I think, separating sectors where you would want some sort of resilience, self-reliance, that's one thing. But going all the way to protectionism, to build your own industries to have import substitution, I'd say that that is not a very productive move.Would the World Bank be revisiting its growth projections for India on the back of the second, very strong, Covid-19 wave?To be very honest, my biggest concern at the moment, which I think we share, is the precision of any forecast when you're in the midst of a pandemic, the standard error, I think there's a huge margin for uncertainty. And I think the speed of vaccine rollout is critical. I would rank it as the most critical unknown at the moment. India, like most countries, will face persistent challenges in coming out of Covid, including some of the financial sector issues that I mentioned. But I think that the most imminent one is the vaccine issue. And while the production has been revised up in terms of growth and so on, I think one has to take that with a great deal of uncertainty.I think it's premature, we are still in the early stages. I think what we have is a race between the vaccines and the virus and so it's a little premature to do so.How do you view the debate on lockdown as a strategy to deal with the pandemic?The lockdown question is a very complicated one. So what I'm going to do is a gross generalisation because it's very complicated. I think in countries like India, a very big challenge to the lockdown approach has been the informal sector. We've seen this in different parts of the world and I think, however, that there are ways of addressing, perhaps less extreme forms of lockdown that allow for some flexibility. But vaccines alone have to still be supplemented with health emergency measures, I have no doubt that that is still the case. And I do think the big challenge remains the tension between needing to work for survival and the tension of containing the pandemic. The informal economy has been and continues to be a big challenge for India but I would say vaccines alone, at this stage, don't do it. You still need the other protection mechanisms of social distancing and the like.