Coronavirus and macroeconomic interventions

https://nation.com.pk/22-Mar-2020/coronavirus-and-macroeconomic-interventions-
Published on Sunday 22 March 2020

The world economy has turned upside down in the last few months after the coronavirus outbreak in China. Globally, stock markets have collapsed. Factories are shut down, airports are deserted, offices have stopped their operations and shops are closed to try to contain the virus. Social distancing, self-isolation and a few other practices are being adhered to. As a result, UNCTAD estimates $2 trillion loss in world incomes.

Employees have started worrying about their jobs. Investors have started becoming concerned about their money invested in companies. Everyone has been experiencing the sharpest economic decline since the great depression. China’s GDP probably shrank by 10-20% in January and February compared with a year earlier. A similar drop is expected in other countries as well, especially European countries and Iran. Massive government interventions are required to lessen the shock to economy.

The outbreak in China forced factories to stop production, which reduces the demand for oil, raw material, intermediate goods as well as the supply for intermediate and final goods to the world from China. European countries face a similar situation. Hence, we see an overall downturn in the global economy. Developing countries, especially outward-oriented countries will be affected the most.

In the last ten days, the Pakistani stock market has been losing 1500 points daily. Investors are reluctant to invest as well as selling their shares to reduce the overall losses. The reduction was associated with the decline in interest rate first, reduction in oil price second and coronavirus proved to be the last nail in the coffin. Billions of rupees invested in different shares are reduced by one third and in some case half of the value according to three weeks ago.

On the other hand, the manufacturing sector, especially exporters, are facing difficulties due to the decline in the demand for imports from Pakistan and other developing countries. Numerous consignments of the textile sector are stranded on sea because, in the wake of the pandemic, no state wants to bring them inside the country unless everything goes to normal. Exporters are also facing problems in capital management in this scenario. Moreover, small businesses, especially freelance entrepreneurs, are struggling as supply chains dry up, leaving them without products or essential materials.

Pakistan has been facing high fiscal deficit. The decline in economic activity would reduce tax revenues, hence higher fiscal deficit. However, given the current scenario we can propose a few interventions which mitigate the overall negative impact on the economy. However, these interventions necessarily need coherent support through smaller interventions.

Several sectors would face a low volume of business. Hence, they will lay off their employees especially contractual workers who are among the vulnerable class. Consequently, we might see poverty increase. Nonetheless, a million-dollar question is whether we can reduce the impact of increase in poverty. The answer would be to increase social protection.

The government needs to increase its budget if it wants to increase social protection. However, civil society as well as the private sector (following corporate philanthropy) must step up and contribute significantly in identifying the vulnerable (people in need) and monetary contribution.

Unemployment insurance and nutrition assistance would be beneficial especially in transition to meet basic needs through the crisis and after. This policy would have a big multiplier effect on the overall economy because cash-strapped people are the most likely to spend additional money, which comes back immediately into the economy. A positive outcome of the pandemic is the reduction in oil prices. It will lessen the burden on the overall oil bill which is around one-third of our overall import payments. Thus, our current account deficit will be reduced.

Another positive outcome of the decline in oil prices is reduction in overall inflation.

Due to lower economic activity overall, the private sector would not want credit. Subsequently, it is expected that inflation will remain lower in the next six months to one year. Therefore, now is a good time to reduce the interest rate.

If the State Bank of Pakistan (SBP) lowers the discount rate, the private sector would urge to take credit. Nonetheless, this also depends on how much SBP reduces the discount rate and the timespan of decreasing the interest rate.

My recommendation would be to reduce discount rate to 6 or 7 percent from 12.5 percent in the next monetary policy statement or by next week in special circumstances. There is a fear of having higher inflation but in the current scenario when we know that economic activity is continuously declining, it is the best time for quantitative easing to pick up aggregate demand.

Reduction in interest would reduce the cost of government borrowing. Therefore, they can social protection to mitigate the consequences of COVID-19 on job loss that may push them to poverty and increases inequality. Lower interest rate would urge small and medium enterprises to ensure they can continue to stay in business and meet payrolls.

Another important policy intervention for the exporters is to give incentive of zero interest rate on the LC with banks. This would reduce their cost of delaying consignments by importers. The government must impose a condition not to lay off their workers in the wake of their declining economic activity.

Tax cuts (corporate income tax and personal income tax) for one year or two years stimulate the demand that reduces the downturn of economic activity and helps in early pick-up after the lockdown is over.

For a longer-term impact, it is a good time for the government to organise the unorganised sector. It must also make special regulations for the registered sector which are working informally, and document the entire regular sector which is registered, organised and have electricity and gas connections.

The downturn of the economy gives space to the government to improve the institutions as well as rationalise the tax rates and other numerous vital interventions which will have longer term positive impacts on the economy.