Devil is in the Demand

In times of great trouble, more often than not, I have found that returning to nature & her laws can provide man with the requisite guidance to navigate choppy waters and ferocious winds. We are completing nearly two months of a differently regulated lock-down and we once again stand at an interesting junction that demands us to redefine our priorities and re-balance between immediate risk to lives vs. economic hardships (a longer term, more drawn out, more slow and equivalent in pain/loss if not more). As we step into a post-COVID world, Government of India is coming up with a slew of interventions & stimuli to reboot our economy. The announcements are being done in tranches and the broad theme of these moves has clearly emerged which I shall elaborate later. While some of us are upbeat, some are not glad with the announcements. During the course of this write-up, taking the Rs. 20 lac crore economic package as a context, I'd be pondering upon the role of the government, economic demand generation concerns, possible stable solution and few of the many questions that the outbreak of the #ChineseWuhanCoronavirus has possibly catalyzed. I am hoping that my loud pondering will assist the reader in exploring the events happening around and likewise aid my own thought process & development as well.

For free-market proponents like me, the phrase "Government has no business being in business." has great importance for at the core of the statement is honouring the core principle of economics - optimal allocation of resources, efficient leveraging of available inputs and effective delivery of outcomes that maximize value for stakeholders. When any government is freed up of micro-management of businesses, it can focus on its core job, i.e. management & securing the country. Under the free-market theory, a government retains only minimal businesses with itself while fully opening up all others for private players to compete in a healthy manner.

To that effect, the broad theme of the four tranches of #AtmanirbharBhaarat seems to be congruent with this thought. The moves seem to represent points on the continuum that is moving towards true free markets. There are no extravagant dole-outs but supportive measures such as cheaper credit, interest subvention, moratoriums and government guarantees - the last of which was a major demand of the Indian Banking Association and its introduction should reassure extension of credit to MSMEs. Then we see the that decades old request is finally here - to reform Agri through amendments in Essential Commodities Act and APMC management (multiple states are modifying the APMC Act under the state list that complements these moves at the centre). Agri-ancillaries like bee-keeping are also on the radar. Today, we have path-breaking changes in the field of defence (74% FDI through automatic route approval and updating of weapons list for import; I remain skeptical on the former though till the fine print and execution details come through) and coal (government monopoly to end). In all this though, there are strong voices expressing the need for relief, not reform. The most common demand that seems to be picking steam is direct transfer of cash into the bank accounts of most citizens of India in the hope that these cash transfers will enable demand and lead to economic activity.

It is worth noting that targeted direct transfers are already taking place and core ration requirements are already being taken care of (and that was since the very first lockdown announcement). Direct cash transfers for the needy as a rare policy tool, well-managed and minimalistic in nature is understandable (and that remains a completely different topic of discussion) but seeking cash transfers for stimulating demand is a very tricky wish to seek that needs careful evaluation. Even if we leave aside dangerous socialist red flags in this demand, viability comes under question. To understand the same, it is vital to know how a government balances its books. Broadly speaking, taxes (direct or indirect) form the chunk of government revenues which are then utilized towards government expenditure ranging from a variety of schemes for the public, running businesses and securing our borders. The revenue-expenditure mismatch is termed the fiscal deficit (generally expressed as a percentage of GDP) and is funded through government borrowing. Rationally so, deficit will worsen if either revenues fall or expenditures rise or both. In that context, we should note that April PMI unsurprisingly came in at 5.4 for services and 27.4 for manufacturing (a number below 50 indicates contraction and these are significantly affected numbers). Even if the lock-down restrictions are loosened, it will take a few months before our metropolitan areas see any recognizable economic activity given the spread of COVID and population density. Our rural economy should reboot first with cities like Mumbai & Delhi being the last in the queue even at current levels of infection. That said, several economic agencies like Moody's are stating that India, like the world, will witness a sharp reduction in GDP growth rate in FY21 though we might be lucky enough to not see an actual contraction in our GDP. All in all, this implies that the tax revenues for the government are sure to take a strong hit this fiscal and with rising expenditures due to COVID, fiscal deficit is for sure going to balloon alarmingly into uncomfortable territory (pre-stimulus numbers are expected at ~7-8% of GDP while post-stimulus numbers can take it to ~10%+). In such a context, any direct cash transfer for boosting demand will entail further stress on the fiscal deficit and additionally lead to inflationary pressures as fiscal deficit gets monetized. Monetization of fiscal deficit implies the government raising money by selling government bonds directly to the RBI with the latter completing the purchases by printing more currency. Printing of more currency leads to an increased money supply in the economy which when not backed with proportionate rise in the total goods & services produced leads to inflation as more money is chasing lesser goods & services. Till 1997, India used to automatically monetize fiscal deficit and that policy was stopped due to the very risk of inflation which appears in lag in an economy. Higher inflation directly implies lower value of the domestic currency leading to costlier purchases; as value of the currency drops, imports start getting even costlier and the wheels come off post that! An indicator like inflation in lag might not leave the powers that be enough time to respond leading to catastrophic events that can potentially sink an economy (Venezuela and Zimbabwe are prime examples). Notably, proponents of the "print more money" school of thought present the cases of US (~10x our GDP) and Japan (~1.6x our GDP) who have both printed money consistently for over a decade to inject into the economic system through a mechanism called as Quantitative Easing (QE). However, it has to be noted than Japan has witnessed annual deflation multiple times and low inflation for the remaining instances - a prerequisite for "print more money" to have a chance at working. Additionally, the Japanese tendency to spend less provides the QE tool some leeway to not sink the nation. Further still, Japan has a debt-to-GDP ratio of ~250% which is very very concerning! As far as the US goes, the US has never had to worry about inflation given the US$ denominated world trade (especially with the two biggest commodities - gold and crude). As long as global trade is invoiced in US$ and the US$ is perceived to be the safe haven, demand for US$ will never drop significantly - with demand intact, so is the value. While US will be long insulated from its QE policies, India can't have the same luxury; nor can it run the risk of challenging fate through high fiscal deficit and high debt-to-GDP ratio inviting the economic risks Japan is sitting on, especially since we are a developing country with relatively low per capita incomes.

With this overview, I am sure we can surely accept that a government too has limitations in how it can operate and to what extent it can intervene. If a government is taken for granted and is expected to run the country whole & sole while the citizens are purely there to reap its rewards, the system will fail - one day or the other - as every socialist experiment has proven beyond doubt. What we have needed is an equity form of governance, rather than debt. (I had written about this is a previous blog titled Indian Government: Your, Mine or Ours?). What I see, prominently so since the last couple of years and more so in the four tranches announced in the 20 lac crore economic package, is equity governance in action. With equity governance and a steadfast refusal to not spur demand externally through widespread cash transfers, we run the risk of short term pain, but our long term horizon stays more bright. Nevertheless, the problem of demand is yet to be addressed and that is where we can look into nature's laws to find its answer. Most animals live quite a peaceful life - their supply-demand chains work efficiently with a predator hunting only when hungry (I had written a blog on this related topic in 2010 - Nature: The One Colossal Classroom). So, rather than copying other models of artificially stimulating demand, can we not consider demand to be more organic and thereby, less toxic - as nature wants it to be? Imagine running on a treadmill and you start accelerating too fast for comfort; what will happen? Your muscles will start getting over-exerted, heart rate will start shooting up and you'll be on the verge of slipping & falling down, right? Similarly so, rather than chasing mindless growth fueled by artificially created demand, can we take a step back and reassess the optimal speed that we as an economy would like to function at? If the economy needs to function at an optimal speed, its constituents - all of us need to figure out the same for ourselves. This is all philosophy though; what is the practical economic solution to the question "how to spur demand and thereby the economy?" - the answer to this is where it has always been, let free market economics figure it out! As with every crisis before COVID-19 (and this one is not even a financial crisis, per say), man has adapted; the ebb and flow of events will result into some sectors subsumed into the wider economy and few others will reemerge! Private players and corporations working under free markets will reassess and realign their operations to cater to the changing reality and all that the government should do is to keep them in the game till they figure out the new ground realities - and that is exactly what the Government of India seems to be doing! It is allowing the new organic demand to take shape rather than providing an external agent to do a shoddy unsustainable job! With our experience of the past few months, we might see more innovation into building organic demand within the domain of needs, rather than wants - that should indicate a higher sustainability for our economic systems! It will also mean lesser stress on the government to provision for every citizen demand and mean even governments can hope to strike some semblance of a balance between its citizens and its country's natural ecosystems. As far as the economics goes, we can look into logistical network innovation considering a delivery reliant economic model with the risk of COVID infection expected to continue for some time. We can explore the possibilities of frequent WFH or even integrated manufacturing set-ups built as colonies - that will optimize our land bank freeing up room for more economic activity. There is a lot that can be thought about and that is currently beyond the scope of this blog. Thus, I'll move to the conclusion:

Assume you have a 100 GB data pack to be used for a month and you front-load consumption into the first two weeks leaving 0 GB data for the next two weeks - well, you either recharge again or live a data-less life for two weeks. Nature does not provide the luxury of "recharging" again and hence the need to embrace the fact that we need to not front-load our economic demands - any kind of them! The demand, made on all resources - self or social - has to be rationally distributed and importantly, organic! Otherwise, we might just end up demanding the devil himself! COVID-19 has given man an amazing opportunity to re-calibrate his existence more in-tune with nature - if we miss this opportunity as well, we'll have a tough time ahead. COVID-19 is asking mankind some primal questions:

1. Where does man see himself in this natural set-up?
2. What role man has envisioned for himself?
3. What is growth? Is it purely economical? Is there a social, psychological, emotional and environmental angle as well?
4. Where does the buck stop? When does natural balance get threatened? How much of nature has nature "allocated" to man? With whom is man supposed to share nature?
5. Is man willing to consider social costs and the expensive externalities?

Nature has enough for man's need, not for his greed - the earlier we accept it and align our economies to this fact, the more a chance we have to live in peace! Until mankind learns that lesson, I guess we'll all have to bear our share of pain, inevitably so!

Jai Hind!