Thank you, Mr. Salunkhe, for inviting me to this webinar and good afternoon to all the distinguished speakers and viewers who have joined this webinar through different platforms.
I was here in India in early March attending a conference and sharing my views on the global perspective on India’s growth slowdown; its consistency with decelerating international growth and how India’s slowdown compared to other emerging market and developing economies - or EMDEs. And today, only three months later we are dealing with a much more severe blow to the global economy caused by the coronavirus (COVID-19) pandemic.
I will focus my remarks mainly in three areas: (i) how COVID-19 is impacting the global economy; (ii) the impact of the virus on India; and (iii) the SME implications in India.
Impact of COVID-19 on Global Economy:
Growing from an international health emergency in January 2020 to a global pandemic by mid-March 2020, there are more than 6.7 million confirmed cases and nearly 400 thousand confirmed deaths across 216 countries by now. While outbreaks in most advanced economies appear to be past the peak, the pandemic is rapidly spreading across many EMDEs, including low-income countries, where health care systems have limited capacity. The rapidity of the coronavirus’ spread has severely challenged even the world’s top health systems, while associated lockdowns and travel restrictions have upended normal life for most of the world’s population. The COVID-19 crisis is spurring deep changes in behaviors, preferences and societal trends that are likely to transform the post-COVID-19 world.
Those EMDEs that have weak health systems; those that rely heavily on global trade, tourism, or remittances from abroad; and those that depend on commodity exports will be particularly hard-hit. Beyond its short-term impact, deep recessions triggered by the pandemic are likely to leave lasting scars through multiple channels, including lower investment; erosion of human capital of the unemployed; and a retreat from global trade and supply linkages. These effects may well lower potential growth and labor productivity in the longer term.
The COVID-19 pandemic has triggered what is likely to be the deepest global recession since World War II. In a base case scenario, the global economy could shrink by 5.2 percent in 2020 before rebounding in 2021; in the downside scenario of prolonged shutdowns, world output could contract by almost 8 percent in 2020 (roughly equivalent to the combined GDP of France, Italy, and Spain). The recession in advanced economies is hitting EMDEs hard, and the World Bank now projects negative growth for over 150 countries in 2020. Faced with reversal of capital flows EMDEs are likely to contract for the first time in sixty years. The emerging food crisis could also intensify, and food insecurity could spread much more widely across the developing world.
Emerging Global Jobs Crisis.
Billions of jobs are under threat worldwide, and half of world’s workers could lose their jobs because of the pandemic according to the ILO. Nearly 80 percent of the world’s informal economy workers have faced COVID-19 lockdowns and slowdowns in wholesale and retail sectors, food and hospitality, tourism, transport and manufacturing. Notably, with 740 million women globally in informal employment and a majority employed in services, women are particularly hard hit by the crisis. Among the estimated 2 billion workers in the informal economy globally, incomes fell by an estimated 60 percent in the first month of the crisis. As the informal sector accounts for up to 90 percent of workers in some emerging economies, the implications of lost wages will cascade from households to communities to entire societies. Remittance flows, which are the economic lifeline for many low-income families and a key source of revenues for many developing economies, are expected to fall by one-fifth in 2020.
Aggravating long-term challenges.
Recessions associated with the pandemic will likely have an even larger impact on long-term growth prospects because of pre-existing vulnerabilities, fading demographic dividends, structural bottlenecks, and permanent changes in behavior patterns, including consumption habits, and human capital formation. In most years during the past decade, EMDE growth fell short of its long-term average. This was reflected in repeated downgrades to long-term growth projections for EMDEs. The pandemic is expected to exacerbate the multi-decade trend slowdown in potential output and productivity growth.
Urgent Need to Step up Support for EMDEs.
Packages of policy support have been far greater in advanced economies than in EMDEs. The unprecedented reversal of capital flows – now flowing from south to north – is helping finance the exceptional fiscal packages in the advanced economies but leaving EMDEs exposed. Financing gaps for developing countries arising from the COVID-19 crisis will likely be exceptionally high and persist over the medium term. Financing gaps for low income countries could be in the range of US$25-100 billion per year and for the middle-income countries the equivalent range is US$75-300 billion annually. While the immediate priorities of policymakers are to address the health crisis and moderate the short-term economic losses, the likely long-term consequences of the pandemic highlight the need to forcefully undertake comprehensive reform programs to improve the fundamental drivers of economic growth.
A successful crisis response at the country level will depend critically on macroeconomic stability and a strong fiscal framework – including debt management and debt transparency.
The World Bank Group is taking broad, fast action to help developing countries strengthen their pandemic response, increase disease surveillance, improve public health interventions, and help the private sector continue to operate and sustain jobs. Over 15 months, the World Bank Group will be providing up to $160 billion in financing tailored to the health, economic and social shocks countries are facing, including $50 billion of IDA resources on grant and highly concessional terms. As of June 1, the Bank had approved $5.9 billion for emergency health support to 104 developing countries – home to 70 percent of the world’s population. Early responses by IFC and MIGA complement each other as well as the early action by the World Bank.
With that backdrop, let me now zoom into the specific impacts of the COVID-19 pandemic and crisis on India.
The COVID-19 epidemic has created a daunting challenge for India. The COVID-19 outbreak is expected to significantly hurt the Indian economy, at a time when growth was already slowing. Its impact on the real economy will exacerbate earlier fragilities, including low credit to industry with the banking sector burdened by a legacy of non-performing assets and non-banking financial companies – or NBFCs – by stressed asset quality and tight liquidity. Consequently, the RBI has taken multiple steps to not only ease overall liquidity via open market operations, but also to relax regulatory requirements, including a 3-month moratorium on outstanding loans.
The World Bank’s latest forecasting cycle - concluded on May 21, 2020 – projects negative growth of -3.2 percent in FY20/21, with risks tilted on the downside. Given the very significant uncertainties pertaining to the possible epidemic related developments (in India and in the rest of the world) it is impossible to assess the severity of the impacts. Nevertheless, in FY21/22, growth is expected to come back, but slowly, reflecting the possible long-lasting effects of the crisis.
Public sector banks – or PSBs – are expected to play a proactive role in reviving credit growth. Their share in incremental lending has already grown in recent months. While PSBs accounted for 39.7 percent of all new rupee loans sanctioned by scheduled commercial banks in August 2019, that share increased to 52.8 per cent in February 2020. After several of them were merged in April 1, 2020, PSBs now have higher regulatory and growth capital, and they are also perceived as safe haven by depositors.
Recent economic data for India suggests that some recovery in May as activity reopens. Data for May shows a recovery in electricity consumption and mobility almost to levels before lockdown as workplaces in many states resume: the central government has eased restrictions and is giving more discretion to the states to impose selective restrictions. However, India’s services PMI remained very lackluster in May lifting to just 12.6 from the record-low of 5.4 in April (a level below 50 shows declining orders from the previous month).
The external sector remains weak, although India is not highly linked to global value chains
South Asia has a relatively low global value chain participation rate compared to other regions. Manufacturing, other than pharmaceuticals and personal protective equipment, remains subdued in India according to data as of April, as demand for machinery, electronics and autos collapsed globally in March. Many global value chains have been affected, and their ability to survive will depend on whether protectionist sentiment in advanced economies and the US-China conflict do not intensify further.
South Asia’s main export industries such as textiles and garments as well as BPO/IT services have suffered. For garments, many of the buyers (retail companies as well as fast-fashion companies in Europe) have gone under due to collapsing demand for retail fashion; while call centers in principle can still function as many employees begin to return to work. The longer-term question is whether demand in advanced economies for call-center services will resume to pre-COVID levels.
Remittances have fallen by 20 percent in all of South Asia and are expected to continue doing so, which is a concern for the whole of South Asia given their importance as a share of GDP.
Both domestic and foreign tourism which had been growing well prior to COVID and had provided livelihoods for a large, mostly urban section of workers, has collapsed in India as also in other South Asian countries.
The government fiscal and monetary policies have responded quickly.
The Government of India has announced stimulus measures and guarantees to a range of sectors equal to an estimated 10 percent of GDP, around 1 percent of which has been effectively spent till May. Food prices have stabilized, and food distribution is now mostly working despite some initial bottlenecks.
The depth and length of the economic impact of the COVID-19 pandemic will crucially depend on the extent to which the initial shock is amplified through India’s weak financial system. Banks will need to increase lending again to fund the recovery.
Let me now share a few insights on SMEs given their critical role in the Indian economy.
First, why the emphasis on MSMEs? Various estimates suggest around 150-180 million people are employed by 75-80 million MSMEs today. Additionally, MSMEs are estimated to contribute to 30 percent of India’s GDP and 40 percent of exports and accounted for 30 percent of India’s non-farm labor force in 2015-2016. Socially and economically, they are a critical source of non-farm employment which needs to keep growing to absorb millions of new job market entrants. Therefore, the recently announced modification by the government in the definition of MSMEs is a welcome structural change – it will not only increase the coverage and extend benefits to many more units, it will also encourage MSMEs to grow and create the much-needed jobs.
MSMEs urgently need access to liquidity. The COVID-19 impact on MSMEs comes primarily through a collapse in demand and a resultant sharp fall in revenues. This has created a cash flow problem and liquidity constraints. Funding sources for MSMEs have become scarce: while the overall credit growth had been slow during FY19-20, MSME credit growth had been hit even worse, falling to below 2 percent even before the crisis. Access to liquidity has been severely impacted – in the form of lack of working capital and delayed collection of receivables – and it’s a huge challenge to continue paying workers’ salaries, cover fixed costs incurred during closure, pay rent and suppliers for inputs; and all this during a period of time when demand has fallen off and MSMEs are not earning adequate revenues. Many units are working at less than half their capacity and it may take months before demand comes back to pre COVID levels.
But why is desired liquidity not reaching MSMEs? Despite early and decisive measures taken by the RBI to infuse liquidity into the market, the liquidity has not made its way to MSMEs to a desired extent.
First, the risks of lending to MSMEs in the current environment are high and banks are naturally conservative.
Second, NBFCs and SFBs are less risk-averse than banks and important financiers of MSMEs, but they themselves are facing severe liquidity issues which is hurting their ability to lend to MSMEs. Only the highly rated NBFCs have the ability to access funding from capital markets. With uneven implementation of the loan moratorium for NBFCs, they face severe mismatches in asset-liability management. NBFCs play an important role in MSME credit as they utilize innovative underwriting models and alternative data to serve thin-file MSMEs which would not have been considered credit-worthy by banks.
Third, long delays in honoring outstanding payments owed to MSMEs, especially from public sector enterprises, are yet another source of liquidity constraint. Platforms such as Trade Receivables Discounting System allow MSMEs to discount invoices which helps them to better manage their working capital needs. Strengthening such platforms will lead to reduced turnaround time and improved MSME liquidity.
Fourth, while the new loan support schemes announced by the Government of India are welcome, additional interest burden may prove to be a deterrent in the current situation. Flexibility in terms of debt restructuring may be the need of the hour.
Global examples that India can benefit from. Public DFIs serving as quasi-lenders of last resort to NBFCs (e.g., Landesbanken in Germany) can serve as highly relevant examples for India due to its large NBFC sector without a dedicated lender-of-last-resort window. The torrent of COVID-19 response measures from around the world, Advanced Economies and EMDEs alike, provides multiple examples of instruments and approaches to review and consider.
- In terms of access to finance schemes for MSMEs that leverage public sector creditworthiness, credit guarantee schemes from Germany, Switzerland, or Spain are very relevant. DFIs such as Kreditanstalt für Wiederaufbau in Germany or Instituto de Credito Oficial in Spain have stepped in forcefully in extending their governments’ support to local MSMEs.
- The United States offers examples of a paycheck protection and other MSME programs as well as a joint U.S. Treasury-Federal Reserve Bank Special Purpose Vehicle for financing domestic firms.
- Multiple central banks have provided various forms of liquidity support/quantitative easing to their markets towards (i) maintaining liquidity of the otherwise cash-strapped market participants, (ii) maintaining stable interest rates and values of debt securities in primary and secondary markets, and (iii) preventing disorderly debt deflation.
The World Bank is supporting India and the South Asia region (as well as other parts of the world) to face the economic and health crisis related to COVID-19. In particular a proposed operation for India is focused on releasing some of the financing constraints to MSMEs. The operation is based on the Government of India’s overall strategy to fight COVID-19 and the program will support measures that: (i) reduce risks of lending to MSMEs for both banks and NBFCs; (ii) address the funding constraints facing NBFCs and SFBs so that they remain important intermediaries which serve the MSME segment; and (iii) leverages fintech/Digital Financial Services to accelerate lending to MSMEs and importantly to tackle payment delays to MSMEs by large buyers.
The COVID-19 outbreak has magnified pre-existing risks to the outlook. The government is undertaking measures to contain the health and economic fallout, and the RBI has begun providing calibrated support in the form of policy rate cuts and regulatory forbearance. If a large-scale domestic contagion scenario is avoided, early policy measures payoff, and restrictions to the mobility of goods and people can be lifted judiciously, an upside scenario could materialize in FY21.