Building liquidity infrastructure and solution and protecting incomes required in the short-term; rebuilding trust in the long-term.
We looked at some of the possible impacts of social distancing in the previous article. As various supply chains get disrupted due to sudden convulsions of demand and supply, the impact will be as much social as economic. The public health systems across the world are gearing up to cope with the challenges of the virus. We detail some of the steps that policy makers, industries and companies can take to tackle the uncertainties arising from this unprecedented way of living.
The fundamental premise of social distancing is that individuals keep distance from one another. The premise of human economic activity in the modern world is based on the division of labour which intricately links up the economy to social interactions. Any lack of social interaction can create significant break-ups in the economic links. This flows through not just via the supply of goods and services but also credit and trust. If a counter-party has limited comfort on the ability of the other to deliver, such distrust can disrupt the system significantly: this is not dissimilar to how the markets “gummed up” post the Great Financial Crisis.
Hence, the policy response has to focus on keeping the system working till it stabilizes.
When comparing Covid-19 with earlier episodes (demonetization, GFC, the Spanish flu outbreak, etc.), what is unclear is the time dimension to attach to the current challenge. In hindsight, we know that each of the above issues lasted between a few weeks to a year and beyond. As we walk into this challenge, we have no good handle on how long this can last. This puts an additional unknown to the business strategy and public policy mix.
Businesses will see impact across the board: (1) revenues could stall or fall led by both pricing declines and volume compressions, (2) costs could remain elevated as businesses attempt to fill in the gaps with last-minute arrangements, (3) working capital cycle could come undone, (4) liquidity and credit may be difficult to find as the various ratios that comfort a banker (growth, margins, working capital days, etc.) could all be trending poorly. Coupled with lesser productive employees who try out the new office-at-home, this could lead to material challenges across P&L, balance sheet and cash flow. Small changes in the external environment can rapidly convert a healthy company into a sick one. It might be impossible to predict in which sectors such challenges may emerge next and with what ferocity – a constant vigil and rapidly periodic assessment is required.
Different business ecosystems will have vastly different inherent abilities to withstand revenue shock. Businesses with high-capex and low-margins which rely on significant asset-sweating (say airlines) may not be able to hold on for a long-period of low or no revenues before starting to defer their payments. Alternatively, businesses with low asset-turnovers but high margins (say service industries) may be able to sustain for longer. Since this type of a spread and lock-down in unprecedented, it is not analytically clear which supply chains are most at risk. Comparisons with the 1-3 month disruption at the time of demonetization or a 3-6 month period of disruption in India during the Great Financial Crisis could offer some leads. However, if this lasts longer, we may see very different economic actors left behind.
Liquidity infrastructure: In such times, creating liquidity lines are important – such credit lines will be useful as the supply chain convulses creating sudden, unanticipated requirements for funds. However, the need for liquidity will face the concern of financiers on the ability to repay. A societal solution (fiscal or regulatory) for liquidity will need to be found. It could take various forms like deferring or partially condoning taxes, a line of credit from the government (a Kisan Credit Card equivalent for all citizens linked via UPI for easy fund-flow), increased drawdown limits or term extensions for loans, etc. Liquidity challenges could lead to solvency issues across businesses and industries – avoiding such a precipitation will require building the liquidity infrastructure. Fiscal and regulatory authorities will need to consider forbearance provisions in the regulations.
Liquidity solutions: Liquidity creation is not just a cost-of-funds issue. Reducing interest rates will help but cannot necessarily help bring cash where it is required. As doubts on the viability of companies take hold, what will be more important for them is the access to cash than the price. While monetary and fiscal policy authorities can help bring down the systemic costs of funds, building the pipeline of liquidity will require the banking and financing system to step up. Not surprisingly, they too will be as concerned about the quality of credit and its sustainability: offering liquidity to troubled sectors will hence require specific forbearance dispensations from the authorities. Every sector may require its own unique solutions ranging from offering holding capacity (agri), creating liquidity within the supply chain (auto), to financing end buys (real estate), etc.
If the social distancing were to last longer than a few weeks, the biggest challenge will be faced by the informal and unorganized workforce. Anyone whose economic activity is variable in nature could find oneself redundant. This will happen both at a sectoral level where consumption is either denied or deferred, and at the individual level where small enterprises face the brunt. Income support will be crucial especially in sectors that are front and centre, like aviation, hospitality, retail, etc. As people stay indoors, the informal segment dependent on serving others, like taxi-drivers, small shops with perishables, etc. will find that customers are suddenly no where to be found.
It is easier giving income supports to formal sectors – by say offering a tax cut or some other form of fiscal incentive (like deferring taxes, relaxing timelines for payment, etc.) Companies could be incentivised to give a line of credit to their employees by allowing them to advance salaries or borrow against their retiral benefits. Allowing partial or substantial withdrawal from the retiral accounts (with requirement to replenish it within say a year or so) can also be offered.
Reaching the informal segment will be difficult. It is here that India will have to reimagine the Direct Benefit Transfer pipeline that it has built. Depending on the severity of the outbreak and on how long it lasts, it will be important to put in place a system where the central or state governments are able to reach out quickly for income support.
Asset and commodity prices across the world have fallen. Central bankers in all large economies have reduced the price of money significantly by driving out-of-policy rate cuts, or promised to do so. This puts savers and pensioners on a sticky wicket – at a time when asset prices are falling, they are also seeing their regular incomes fall. India, which has seen monetary transmission, being impacted by the high rates of returns that the government offers on its small savings schemes, will need to find a way to protect savers incomes. Again, targeted support may be required, especially for the elderly who are especially at risk with the outbreak.
Rebuilding confidence and trust
Once the social distancing phase is over, rebuilding confidence and restoring trust will be key. Most of this will naturally start to happen but some of it can be triggered by greasing the economic activity via large capital spends or social works programme by the government. In these times of tackling the challenge head-on, this may seem a distant requirement. However, with luck and perseverance, we will have “flattened the curve” in a few weeks. It is critical to survive this phase!
The author is Head, Strategy and New Initiatives, Axis Bank. Views are personal.
Originally published in The Financial Express.