Lockdown, Printing Notes & Demand

reserve bank of india rbi

When the lockdown is lifted, a package of interest waiver and deferring of loan repayment for businesses will be needed for them to restart. The RBI and the government will need to rethink their strategy since money by itself is not a resource.

The lockdown is slowly being lifted. Still, most businesses, except those producing essentials, are not able to get to work at full capacity. The sharp and unprecedented decline in the Purchasing Managers’ Index, both for manufacturing (to 27.4) and services (to 5.4), confirms the worst fears. The result is large-scale unemployment as CMIE data suggests, especially among unorganised workers who have no security of tenure, low incomes and little savings. No wonder they are migrating in hordes back to the villages under trying circumstances.

Many businesses are on the verge of collapse either because they work with little working capital which has got exhausted or because they were already stressed before the lockdown due to the Indian economy slowing down before the pandemic hit the world in February. Incomes of many of the small and cottage sector entities have stopped, so they would have consumed their little savings that they used as capital. The package announced by the government in the last few days is inadequate to deal with the extent of the crisis and the priorities are all wrong.


Businesses definitely need relief. If they collapse now, it would be difficult to revive them later and that would cause   long-lasting damage to growth, employment and demand. Skilled workers have either migrated or are now doing so as the lockdown is eased due to the prevailing atmosphere of fear. So there would be shortage of labour, making it difficult for many businesses to restart.

But the bigger problem is lack of demand. At present, the economy is working at less than 30% of capacity and the loss of incomes every month is about Rs 13 lakh crore compared to last year. Consumer confidence after such a huge calamity is bound to be low. So even if businesses can produce, many of them would not be able to sell their entire output and inventories would pile up. Therefore, they would work much below capacity and that would lead to postponement of new investment. This would set into motion a vicious cycle of continued decline.


Government intervention is crucial as markets are in turmoil and cannot provide the solution needed. The first priority has to be to boost the health infrastructure so that if Covid-19 flares up, lives can be saved and societal breakdown prevented. For the success of the lockdown, workers and especially those who have lost work had to be provided the essentials of life wherever they are. But this was not done and the poor were forced to move around and the disease is spreading with the number of people declared positive rising rapidly. A large number of poor in urban areas who live in congested conditions needed to be decongested immediately for the lockdown to at all succeed. Schools, halls and tented colonies in open grounds can be used for this purpose. Finally, businesses have to be given the minimum support needed to prevent collapse. This is a survival package.

If 50% of the citizens are given half the World Bank’s extreme poverty line support ($1.9 per person per day) for one year, about Rs 18 lakh crore would have to be distributed like “helicopter money”. But given the weakness of our system of money transfer, it would be better to supply the essentials of life through an extended PDS. Even if the money currently given to the poor (like subsidies) is used for this package, Rs 15 lakh crore more would be needed.

Direct tax collection will fall drastically because both business incomes and salary and wage incomes will fall sharply during and after the lockdown. Indirect taxes are collected mostly from inessentials whose production have stopped or will remain curtailed after the lockdown is lifted. Essentials that will continue to be produced either pay no tax or a low rate of tax. Hence, GST collections will drop sharply at present not even 15% of it is being collected.

With government revenue falling drastically, the already high fiscal deficit would shoot up. To keep it in check while funding additional essential expenditures related to the pandemic, the government would have to cut back on salaries, public investment and defence. When at least half the workers lose their incomes, the remaining cannot expect to get the income that they got before the pandemic hit the country.


How would the huge deficit be financed? The economy would have little savings since basic consumption has to continue while incomes would fall due to stoppage of production. Those out of work will have to dissave to continue consumption. Only the few who would continue to work during and after the lockdown will save. Businesses that are closed will be dissaving—running down their reserves. With so much dissaving, there would be little of saving to finance the deficit. How about borrowing from the wealthy and the RBI?

The wealthy get their current income from their ownership of property. But with business incomes down and rents falling, their incomes will decline substantially. Consequently, asset prices will drop, leading to a sharp decline in their wealth. Share markets have already declined substantially since the start of the pandemic. Real estate prices were already stagnant and now will come down further as businesses fail and properties get vacated. Financial assets like mutual funds will mostly decline as asset prices decline. Only bonds with fixed coupons will rise in price as interest rates in the economy decline.

The result will be that revenue from income tax and corporation tax (or wealth tax) will decline sharply. Raising the tax rates at this stage will be futile. Monetising the temples gold or getting foreign funding will also not serve the purpose. These ideas would have worked in the pre-pandemic situation but not in the new circumstances where output is restricted. There is a new normal requiring fresh ideas.


So the government would have to borrow from the RBI. Namely, monetise the deficit, a practice which was formally ended in 1997. Banks can also lend to the government since they have excess liquidity which they are at present parking with the RBI. But this will also decline as dissaving continues. The RBI’s monetisation of the deficit can be theoretically large but it would be effective only to the extent of the reduced resource base of the economy due to the sharp decline in GDP.

The borrowings can finance the survival package mentioned above and little else. When the lockdown is lifted in stages, support would be required by those businesses that restart since they would have incurred losses for quite some time. For other closed businesses, the government will have to waive the interest payment and defer loan repayments that fall due. Lest this creates a crisis for the financial sector, the RBI and the government would have to provide them funds. Would prices rise due to the massive printing of notes? Actually, due to lack of demand, aggregate prices should fall and there could be deflation rather than inflation.

In brief, due to the lockdown, the resource base of the economy has dramatically shrunk. There is a need to think completely differently about the economy and society. Even printing notes by the RBI to fund the large deficit looming before the government will only be able to sustain a survival package and nothing more—the truth is money by itself is not a resource.

When the lockdown is lifted, a package of interest waiver and deferring of loan repayment for businesses will be needed for them to restart. The RBI and the government will need to rethink their strategy since money by itself is not a resource.

Originally published on May 23, 2020, in indialegallive.com, online magazine


By Prof Arun Kumar is Malcolm Adiseshiah Chair Professor, Institute of Social Sciences , earlier in JNU.

He is  author of several books including…

 Indian Economy since Independence: Persisting Colonial Disruption.

Understanding the Black Economy and Black Money in India: An Enquiry into Causes, Consequences and Remedies




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