To achieve macroeconomic stability during this crisis a large chunk of the credit created both publicly and privately has to be controlled and directed towards the productive sector of the economy
The coronavirus pandemic has brought everyday life to a grinding halt across the world. Even though it is early to fully comprehend the damages caused by this pandemic both on public health and economic fronts, it is feared that this crisis will be of a never-before-seen magnitude and of a cascading nature—one crisis leading to another pushing the world into economic and humanitarian chaos of biblical proportions.
The pandemic has laid bare extreme vulnerabilities and the under-preparedness of governments of developed economies like Italy, Spain and the US. It further exposed their failure to invest in public health infrastructure. However, rather than putting their utmost priority in investing in rapid testing and isolating the infected and imposing stricter rules in ensuring physical distancing to minimize the infection spread, central banks decided to play by the rulebook of the Global Financial Crisis of 2007-08 and hastily announced trillions of dollars of fiscal stimulus.
With the world’s attention now on trying to assess the economic impact and to come up with relief packages worth trillions of dollars a major chunk of which will have to be financed with more debt through central banks shoring up their debt buying spree evermore, the next crisis will be many countries defaulting on their debt leading to possible financial contagion. The world is now as more deeply in debt as it was when the last big crisis hit. On the eve of the 2008 crisis, debt tripled to a historic peak of more than three times the size of the global economy. Over a period of 11 years, debt levels have soared yet again reaching up to USD 260 trillion versus a global GDP of USD 90 trillion. To increase government spending, countries like Italy and Spain that are already saddled with debt will likely have to borrow more thereby the possibility of them defaulting on their debt looks more and more likely.
Another cascading crisis arising out of this pandemic is a humanitarian one as there may be a massive rise in refugees due to a rise in hunger and poverty and an increase in terrorism. And there is a probable downturn in world economy imposed by the oil-rich economies in the Middle East due to steep fall in oil prices as demand continues to weaken and production is still ongoing In developing and emerging economies, due to short term foreign investments going out of these economies and fluctuations in exchange rates, their macro-economic stability is in great peril.
During these unprecedented times, all nations need to join hands in working together to fight this pandemic. Rather than blaming each other and escalating the trade tensions, the leaders of this globalized world need to exhibit exemplary resolve and leadership in working together to minimize the impact of this pandemic.
What should Nepal do?
With the nation under a complete lockdown for three weeks, we are still uncertain about how this virus will impact our country both in terms of wreaking havoc on public health and the damages it will inflict on the overall economy. A serious lack in resources to increase testing and isolating and treating the infected and a clear cut mechanism of contact tracing hasn’t really led us to the full extent of the damages that this virus can cause.
Furthermore, the continuous lockdown has further exacerbated the already weakened economy. Prior to this crisis, we have almost always struggled as an economy due to volatilities in credit creation and with such volatilities with the significant chunk of credit going to the purchase and investment of pre-existing assets such as land. Additionally, with much of our trade-dependent on India and a fixed parity exchange rate with INR, volatile cross border flows of short term capital in India have also led to volatility in exchange rates and trade flows, leading to overall macro-economic instability. Therefore, as we move forward trying to manage this crisis, we have to ensure that we also manage the economic crisis.
The government has taken a very proactive decision to borrow from the IMF, World Bank and other donor agencies to make sure it remains in a position to increase spending as a substantial amount is required to provide direct assistance to the most affected people, businesses and the communities. With a very low debt to GDP ratio, the government has ample fiscal space to borrow and spend as revenue collection is expected to take a very hard toll due to a reduction in imports and disruptions in domestic businesses. Apart from private debt, the government has already announced to raise public debt worth NPR 1.95 trillion as domestic borrowing through issuance of bonds and debentures which will be financed mainly through the public and private savings accumulated over the years. Even though it is not fully clear whether the government would be able to raise almost NPR two trillion through domestic borrowing, this is nevertheless a highly critical and appreciable move from the government at this critical juncture.
In the long term, an increase in government borrowing can put a heavy burden on the government to pay the interests however this can be managed by keeping the market rates low through monetary policy instruments. Yet the challenge for the government will be to address the demands made for the tax cuts and also keep on increasing the spending to manage this crisis.
As of now, the government is already running a huge surplus of almost NPR two trillion. Additionally, to provide more liquidity to the market and to keep the interest rates low, Nepal Rastra Bank has already made cuts in the benchmark rates. However, in order to ensure this liquidity is appropriately utilized and to spur an already weakened demand, government has to come out of their shell and start spending freely and at will to keep the economy moving.
We are predominantly an import driven economy running huge trade and current account deficits every year which dwindles our foreign currency reserves and threatens our external economic stability. This will be further put to test due to a sharp fall in remittances. In order to cope with this imbalance, the government has to put in place a mechanism to restrict the import of items that are considered luxurious and put quotas on other items to minimize the flow of foreign currency going out.
Finally, even during this crisis, to achieve macroeconomic stability through improvement in employment, wages and increase in production, a large chunk of the credit created both publicly and privately has to be controlled and directed towards the productive sectors of the economy such as agriculture, manufacturing, industries, tourism, hospitality, etc. These are the sectors that will be hit hardest by this pandemic but at the same time to restore job creation and consumer demand, the government through NRB has to bring forth the necessary directives and mandates for banks and financial institutions to increase the extension of credit to such productive sectors as much as possible.
This control over domestic credit creation will be ensured further if the government fully enhances the use of electronic payment mechanisms. The electronic payment system not only helps to reduce the overall cost of financial intermediation but also significantly curtails the extent of tax avoidance which is a major issue for a country like ours.
Moreover, through extensive use of the electronic payment system, proper end-use of credits extended to various productive sectors of the economy can be monitored and ensured at all times thus helping the government maintain better control of overall credit creation in the system to achieve overall macro-economic stability.