The problems of yesterday seem minuscule in front of the gigantic coronavirus which has derailed the world's economies bringing it to a sudden halt in addition to killing thousands of people across the world. Who knew, this early in the year our lives will be thrown into disarray, people scared to step out of our home and looking at an imminent threat to humankind.

In this blog, we will be scrutinizing the impact of the Corona pandemic on the Indian economy and certain changes proposed by the Government of India followed by an overview of the FORCE report by the Indian Revenue Services, and what we can do next to recover from the downturn.

The impact of Covid-19 in the economy of India

Who is most impacted by the downturn?

Covid brought the world's economy to a standstill and the ones most affected will be from the unorganized sectors which employ more than 80% of the overall workforce in India. The poor and the low-income earning group will be pushed to poverty due to the stagnant economy causing irreversible damage to the economy. 

Which companies are the most affected?

Micro Small and Medium Enterprises (MSME) contribute more than 45% of the GDP[1] and employ around 25% of India's workforce and will be severely impacted due to restricted cash flows resulting in downsizing and shutting down many of their operations in the next few months unless economic packages are not provided at the right time.

Large enterprises will be able to cope up with the reduced demand in short to medium-term due to their strong financial status. They will not face liquidity issues soon unless the lockdown is extended for a longer time.

Which sectors will be hit the most?

The above chart adequately explains the businesses which will be most affected due to this pandemic.

The severely affected sectors are mostly from the service (airlines, real estate, logistics) and manufacturing sectors which have been under tremendous pressure even before the pandemic. Airlines and hotels will take its own sweet time to bounce back, with people, in general, avoiding all nonessential travel at least for the next few months. We will see a drastic reduction in travel and entertainment with people preferring to stay indoors as much as possible for the next few years. 

There will be a short and medium-term impact on logistics and manufacturing mainly driven by a decrease in demand across the sectors. Manufacturing is dependent on raw materials that are produced by plants/industries across the world. Cutting off supplies for even one of them will result in shutting down the plant, because of its close-knitted relationship. The impact on this sector will depend on how long the lockdown will be in place and under what restrictions across the globe. 

The impact on some IT industries will be noticed later due to the decrease in the overall demand across the sectors. We will see an increase in the usage of online platforms like Netflix, Zoom, Whatsapp, UPI, online financial solutions, etc. 

The least affected will be the agriculture and agri-based industries, Telecommunications, and pharma. The impact on agriculture can be minimized by increasing the demand for the harvest by the opening of all agri-based industries as soon as possible. This will not only give a boost to the economy but also employ almost 30% of India's workforce. The forecast of a good monsoon by the meteorological department provides a ray of hope for the agricultural sector. Other sectors to recover quickly would be the pharma and healthcare as the demand for these sectors is going to increase in the short-term, owing to the essential nature of their products.

In conclusion, we are moving towards an economic recession accompanied by the high unemployment rate, a decrease in demand across sectors, and shutting down of various industries, and hence the economic well-being of the country.

What happened in the Stock Market?

Even though the economic health of a country should not use the stock market as a benchmark, we do see a strong correlation between the economic and stock market growth. The stock market puts forward the sentiment associated with economic policies and their economic impact transparently.

The World Health Organization declared Covid as a pandemic on March 11, 2020, bringing in the largest ever crash in the history of the Indian stock market the next day, which was surpassed 12 days later by yet another fall. Overall, Sensex crashed from its lifetime high of 42k in January to the year to a 5 year low of 26k in March, a fall of over 35%, erasing all the gains made from PM Modi's last term suggesting significant impact to the economy.

Covid-19 induced recession vs 2008 Crisis

Even though the governments across the world were quick in announcing relief measures when compared to the 2008 crisis, the impact of the 2020 recession is going to be long-lasting with a substantial permanent impact on the economy.

In contrast to the 2008 crisis, the entire economy has come to a standstill and is not expected to pick-up anytime soon due to the restrictions on the movement of people and temporary shutting down of businesses. A country's economy prospers when money changes hands and shutting down of businesses hampers the cash flow. 

In 2008, a financial push from the central government was required to overcome the crisis. In contrast, now we need to deal with the health crisis along with the financial crisis at hand which is a double-edged sword. Opening up the economy will further deteriorate the health crisis and a complete lockdown will be beneficial for averting the health crisis but will leave a dent to the economy. Finding the right balance is the need of the hour.

Economic packages announced by GOI

GOI announced a 1.7 lakh crore relief package to help the poor on March 26th two days after the lockdown was notified. It raises two important questions, is it enough to support the second largest populated country in the world? How does it compare to the packages provided by other countries? 

According to various economists around the world[2,3,4], the majority view is that the stimulus is not enough and the government needs to announce a larger package to support the already frail economy.

The stimulus package as a percentage of GDP for the world's top 12 economies (along with few others) is shown in the picture below. India's stimulus is substantially below the packages of other economies (except Russia) implying the need for a stronger package.

RBI has already decreased the repo rate to 4.4% to increase the economic activity and the demand for commodities. Decreasing repo rate increases the economic activity as people and corporates will be willing to take credit (loans) at the lower interest rate and invest the money to generate revenue and profits. The decrease in interest on retail loans like the car, home, personal loans, etc. will increase the cash flow in the economy.

My take on the FORCE report

A group of 50 IRS officers compiled a detailed report called FORCE which recommended solutions to GOI to reduce the impact and recover from the economic downturn due to COVID-19. They suggested some drastic measures like increasing income tax on high-income earners to 40%, reintroducing wealth and inheritance tax, increasing taxes on the MNCs, increasing the tax on NRIs along with other radical changes to increase the revenue of the government for carrying out economic relief of the country.

Increasing the taxes on corporates which are already facing a significant markdown in their revenues and profits, will further reduce the cash in hand for carrying out R&D, new investments, scaling up of operations, etc.

The view encapsulated in the report is of the greater good of the society and a sense of contribution to the poor by paying higher taxes. But this sense of responsibility should not be forced upon the citizens and should be a personal affair in terms of donations. The taxes we pay are for the services we receive from the government like the building of roads, dams, health, defense, etc. and not only for the betterment of the downtrodden and the poor. The report blatantly undermines the reason for paying taxes.

Again, it fails to address the key problem in this crisis, the decrease in overall demand for various commodities.

What will happen if we increase the tax?

Even though it looks like increasing the tax is the solution, it results in an even bigger problem. Increasing the tax decreases the demand for any commodity. We can easily identify the same by looking at an example for a non-essential commodity such as a car. 

Who does not want to own a car? It is not a necessity, but it feels good to have one.

Let's say, 

Salary                                           = 15 Lakhs

Your annual expenses                   = 6.4 lakhs (excluding GST)

GST on annual expenses              = 64k (assuming effective 10% GST) 

Income tax                                    = 1.25 Lakhs. (approx)

Savings                                         = 6.8 Lakhs (15-7-1.25) 

Budget for Car incl. GST             = 6.8 Lakhs (year's savings)

GST of 28% Paid on Car              = 6.8( 1- 1/1.28 ) = 1.48 Lakhs

Overall tax paid to government    = 1.48 + 1.25 + .64 = 3.37 Lakhs

Let's take the case when all the taxes increase by 10%.

Salary                                           = 15 Lakhs

Your annual expenses                  = 6.4 Lakhs

GST on annual expenses             = 70.4 k

Income tax                                   = 1.37 Lakhs.

Savings                                        = 6.52 Lakhs (15-6.4-.704-1.37) 

Budget available for Car             = 6.52 Lakhs (year's savings)

GST of 28 + 2.8% Paid on Car   = 6.52(1- 1/1.308 ) = 1.53 Lakhs

This decrease in your disposable cash and the subsequent increase in the cost of the car make you wonder, whether you need it. Again with GST, the cost of production of the car has also increased due to the increased cost of the raw materials, which has not been taken into account in this case.

Scenario 1: You decide to buy a car with the new budget

If you decide to still go for a car, you will have to decrease your budget by 21k and hence opt for a lower model.

Overall GST paid for Car                              = 1.53 i.e. an increase of 5k

Overall excess tax received by government  = 5k + 6.4k + 12.5k = 24k

This is an increase in taxes at the cost of further reduction in demand for cars in an already stressed sector dealing with falling sales quarter over quarter.

Scenario 2: You decide not to buy a car

In case you decide not to buy a car 

Overall increase for the government = 12k + 6.1k - 153k = -135k = -1.35 lakhs

In this case, the government lost revenue of 1.35 lakhs

Increasing taxes decreases the demand, and we need to find the optimal tax rate which optimizes the overall tax collected by the government. With the already high GST charged on most of the non-essential commodities, increasing it further will put a major dent on the economy and may also lead to permanent damage to it.

What could be the next steps?

Eaze the restrictions

• The government has announced that it is going to open all industries in Green and Orange zones starting May 4th. These zones have been advised to follow all the social distancing norms and should be asked to operate at lower capacities. 
• Red zones should be kept under lockdown until the cases start to reduce. The government should allow critical manufacturing industries with 25% efficiency and social distancing norms as they may be producing raw materials for industries in the green and orange zones. Closing these industries will hamper manufacturing in the green and orange zones.
• Trucks should be allowed to pass-through red zones to increase efficiency and reduce costs.
• Agricultural activities should be allowed in rural areas in all zones without any restrictions
• E-commerce/online delivery with minimal staff should be allowed in urban areas for non-essential commodities

Regulatory changes

• A bigger support package of 5-10% of GDP should be announced in line with the global trend.
• Loans should be provided to corporate and MSME at lower interest rates with a condition that they can not fire employees or slash their pay by more than a certain percentage.
• Government support will be required for startups and prevent them from closure and reduce the liquidation of the owner's equity.
• Wage support will be required for people who lost their jobs due to this pandemic.
• An increase in unemployment and closure of industries will further result in an increase in non-performing assets (NPAs) in both business and personal loan departments increasing stress on the financial institutions. The government (RBI) will have to provide liquidity to banks and NBFCs and write off these loans to reduce the losses due to NPAs.
• Airlines, Hospitality, and Entertainment industries should be provided tax waivers for the next 2-3 years as the effect will be prolonged and the demand is not expected to come back to pre-COVID levels in the next 2-3 years.   

Kicking start the economy

• The government should announce new infrastructure projects like building of roads, flyovers, hospitals, manufacturing industries, etc. will provide alternate employment and will counter the unemployment to some extent.
• Special economic zones need to be created across regions to attract new businesses and will be beneficial in the long term.
• States majorly dependent on tourism will have to attract domestic travelers once the situation stabilizes and is brought under control by providing packaged tours at discounts to resume cash flow in their economies.