The Epidemic of 2020: Setting course for a V-shaped recovery

by Vijay Kelkar and Ajay Shah,
in the Business Standard, 7 April 2020.

Epidemics can be terrifying. In 1918, the `Bombay fever' hit India, and killed about 5% of the population. While Covid-19 is surely much milder than this, it is likely to become the biggest epidemic of the following 102 years. Shocks like this are a test of state capacity. The Indian state, at all the three levels of government, has to rise to new levels of capability in devising and executing policy initiatives. In responding to this pandemic, the problems of health, macroeconomics and finance are intricately interwoven. In this article, we synthesise a view of the road ahead for policy, combining knowledge from the three disciplines.

The immediate impact of the lockdown

The market economy involves remarkably complex interconnections between various industries; every "essential" output requires myriad "non-essential" inputs. For example, making face masks or ventilators requires a complex array of engineering inputs. Production in many factories, producing both "essential" and "non-essential" things, may get disrupted in coming days. In coming days, inventories will get depleted, supply chains will be broken, and then production will be disrupted. About a quarter of the large firms may find it hard to deal with a month without revenue.

The supply chain of food is particularly important. The availability of certain `essential' goods (e.g. vegetables or milk) could be a problem at certain locations. There is the danger of regressing into the 1960s and 1970s in terms of attacks upon `profiteering' and `hoarding'.

In this environment, many workers and firms will pull back on expenditures, thus giving a demand shock to the economy.

The supply chain disruption and the demand shock will interact and give a decline in GDP. This shock to income will harm the health of the people, as has been extensively demonstrated by research on macroeconomic and financial crises.

Play for the full 2020 and 2021

We should not view Covid-19 as a three week problem. After the lockdown ends, there will still be a large number of infected persons in India. Just as the Lehman default of September 2008 cast a shadow upon 2009 and 2010, this problem is going to be with us through 2020 and 2021.

Everyone -- policy makers, firms, health care producers, individuals -- needs to develop the rhythm of a new normal where there is greater social distancing, where many are getting sick, where there is considerable difficulty in the macroeconomy and the financial system. Exceptional behaviour will generate fatigue, and is not sustainable. All of us need to find a new normal, a sustainable approach to livelihood and lifestyle. We cannot just hold our breath; we cannot just do fire fighting.

The most important question that we should be asking today in terms of the economy is: How to set the stage for a V shaped recovery? We should think about every policy action today from the viewpoint of whether this feeds into an L shaped future versus a V shaped future on the horizon of calendar 2020 and 2021.

Finding the right balance

The optimal degree of social distancing comes from a tradeoff between the health impacts of Covid-19 versus the health and welfare impact of social distancing.

We see a role for a sustained reduction of activities where there is a high public health hazard and relatively low importance to livelihoods. Examples of these include places of worship, pubs, the Republic Day parade, etc. The next two years look bad for the remarkable festivals of India, ranging from the Pushkar fair and Durga puja, to the Jaipur Literature Festival and the Kochi-Muziris Biennale. The precise design of social distancing will have to be local, reflecting a deep insight into the health impact of activities, the present threat assessment, and the economic impact. These decisions should draw on intellectual capacity all across India, but get made in a decentralised way.

Covid-19 is a relatively mild disease for the young. The case fatality rate of Covid-19 is low for persons below the age of 50. Once a person recovers fully from the disease, we may hope that immunity is obtained for a while (perhaps one to three years). The elderly, who have not yet contracted the disease, need to be protected from the risk of infection.

This suggests a strategy for getting back to normalcy in the economy. We need to get the young back to work, and perhaps emphasise the immune persons for the riskiest roles. Caution in participating in the economy should be concentrated in the at-risk population, i.e. the elderly. We also need to worry about young people taking the disease back to elderly persons that they live with.

In the overall Indian population, using data for May-Aug 2019, 81% are below age 50. In the labour force, 75% are below age 50. We can thus make a lot of progress, going from a complete lockdown to a framework where persons above age 50 exercise caution, while the remainder get the economy rolling again. In the class of women in the age group from 16 to 50, at present, 8.8% are working: there is ample spare capacity which can come into the workforce. The Indian situation diverges considerably from most advanced countries, and we should reflect upon our situation from first principles.

Public health is the need of the hour

The old fashioned public health machinery of trace - test - isolate - treat is required on scale. Public health workers have to trace all contacts of infected persons. Large scale testing has to be done. Persons who test positive have to be isolated, as they communicate the disease even though 95% of them will bounce back with few symptoms. The remaining 5% of the infected persons require treatment, and again, the bulk of these will recover fully. We in India start with low state capacity in public health. Within a few weeks, we have to establish a great increase in the quantities and the quality of this work.

The marginal gain from an extreme lockdown is greater when there is a large scale infection, which is not where India is today. The best argument in favour of this lockdown lies in the idea that these three weeks are being used to put health policy into motion, to get to quantity and quality in tracing - testing - isolating - treating. The timelines that we face, in improving state capacity for public health in India, are daunting. As the head of the Italian Protezione Civile (the Italian equivalent of NDMA) put it, The virus is faster than our bureaucracy.

In this public health problem, there is important variation across states. Some states are faring better (Kerala, Tamil Nadu, Maharashtra, West Bengal). We should aspire to get these states up to the quality of outcomes seen in (say) South Korea. There is a need to urgently improve state capacity in the North (where one advantage is a younger population).

The key requirement on this path is engaging with the private sector. Most of the testing capacity, ICU capacity and ventilators in India are found in private organisations. PPP contracts are required, through which public funding is linked up to private production of testing and treating. Purchasing should be done through contracting mechanisms which buy real options from private firms, i.e. create incentives for firms to scale up capacity, even if a future surge of purchase does not arise.

If we are lucky, the epidemic will spread slowly in the temperature and sunlight of the summer, which will buy time till the autumn. This time should be used to build capabilities in tracing - treating - isolating - treating. If we are lucky, scientific progress will come about by then on a vaccine, a cure or a prophylactic. We should be fully ready to harness the Indian drugs industry to manufacture these on scale, and have the health system capability to implement these all over the country.

1% coercion and 99% persuasion

The Indian state commands low trust in the eyes of the citizenry. This is not new. In 1897, the lieutenant governor of Bengal remarked that many of the natives would rather die of the plague than allow themselves to be segregated or removed.

When public health works well, it relies on 1% coercion and 99% persuasion. If a more coercive approach is used, civil servants lose the trust of the populace. Once the state gets into an antagonistic stance, this harms all public health activities. Social distancing, testing, isolation, immunisation, prophylactics, gathering data: all these require the trust of the public.

For achieving this trust, policy work in public health needs to achieve democratic legitimacy. This is done through expertise, transparency, consultation, a culture of service rather than coercion, of getting 99% of the required change through persuasion.

In the international literature, there is a well established fact: Liberal democracies fare better when faced with epidemics (link, link). As an example, we see how technocratic system building coupled with strong state coercion in China failed. As an example, individuals in India are reticent in their health records going to the state, given the lack of protection against the use of this data by the state. Our best weaponry to fight the virus is individual agency, production and release of sound information, intellectual debate, discussion, criticism, and checks and balances.

Trust in the state, and social solidarity, are great strengths when facing an epidemic. One of the political economy factors that will positively help the growth outcome would be to ensure high levels of social harmony and national solidarity.

The Epidemic Diseases Act, 1897, is a colonial law which lacks checks and balances. We should eschew the toolkit of our colonial masters. We should renew our vows to the foundations of civil liberties, to the basic structure of the Constitution of India.

Exceptional times call for harnessing markets

The first instinct of the Indian state is to resort to command-and-control: the toolkit of bans, price controls, barriers to cross-border activities, orders to private persons. The embarassment that the authorities feel when engaged in illiberal activities is diminished when faced with a terrorist attack or an epidemic. There is the temptation of engaging in central planning, of government directing myriad activities in the economy, trying to solve the coordination failures which have suddenly arisen.

Even in previous decades, when the Indian economy was much smaller and simpler, and when the institutional and intellectual infrastructure for central planning was much stronger, such command and control generally failed. In the present situation, the economy is much more complex, and it is impossible for the government to create the organisational capability that can see the economy, solve optimisations, and direct private persons on how to organise production.

An increase in the price of masks is the way in which a market economy sends out a call to arms, asking a lot of private persons to contemplate surging the production of masks. If the coercive power of the state is used to impose price controls, we lose this supply response. Policy makers will become more effective by going with the grain of the price system -- e.g putting out tenders for 20 firms to deliver a million masks each -- rather than fighting the basic instincts of rational human beings. These firms will solve problems of raw materials, logistics and production, in ways that the government cannot.

While the complex self-organising system, of the market economy, has been disrupted in some aspects, the best path lies in letting the self-interest of firms figure out how to heal supply chains and business relationships. The private sector will organically negotiate its way, in the quest for profit, to solve the problems that it sees on the field. The self-organising system is the best at obtaining information, arriving at mutually beneficial bargains, and organising production.

The need of the hour in health care is harnessing the self-interest of the private sector in testing and health care. The private sector is the only path to large increases in output, and to real options for a surge scenario. Commandeering the private sector, or forcing price limits, will backfire. A more respectful approach, which invites the private sector to voluntarily enter into contracts, will work better. This requires policy makers to design sound contracts and put them out for bidding by self-interested firms.

The problems of macroeconomic and financial policy

  1. The macro/finance situation is daunting. Covid-19 and the lockdown are upon us. The world economy has shrunk. It could get worse; e.g. there could be a large scale return of Indian workers abroad, or a fresh bout of stress in Indian finance.
  2. The overarching theme of the macroeconomic and financial policy response should be: To set the stage for a V shaped recovery and not an L shaped one. This requires doing responsible economic policy. There are always people saying Now that this huge crisis is here, we have to throw out the rule book, and do all kinds of expedient things. Such expedient actions will, however, come back to haunt us when the virus is out of the way.
  3. There is low room for maneuver in India on macro policy, as we start from a large effective fiscal deficit and a feeble monetary policy transmission. For a contrasting example, Germany started out from a long history of prudent fiscal policy; this gave the space for a 10 per cent of GDP fiscal expansion in response to Covid-19. The fiscal institutions of India are not organised to normally run primary surpluses, and borrow from voluntary lenders, so as to support a large deficit when faced with a crisis. Similarly, in response to the decline in forecasted inflation, RBI should cut rates, but this will have a low impact upon the economy given the problems of financial economic policy. We should thus set low aspirations for what macro policy can do.
  4. Some balance-sheet based lenders (banks and NBFCs) are healthy, and this is a time for countercyclical movement in their leverage. But many lenders are not healthy, and will face greater stress in the downturn.
  5. The private sector is worried about the extent to which policy makers will do the right thing. In the tension between rules and discretion, the Indian state has often exhibited a low priority for rules. Going further down this route will increase policy uncertainty and harm the recovery. When we put state actions about the epidemic -- from macro policy to rules about social distancing -- on a predictable and rule of law foundation, this reduces uncertainty and fosters private investment.
  6. There is a lot to learn from the macroeconomic and financial policy responses that India adopted to the 2008 crisis. We see calls to close down or restrict the working of financial markets and speculative trading [example, example]. As with 2008, the right path lies in not interfering with the working of markets.
    When actions by a regulator reduce the liquidity of a financial market, this makes the market more vulnerable to large price changes when faced with small orders. This gives greater volatility. In an uncertain time, economic agents require confidence in the availability of deep and liquid markets (should they require to trade) and confidence in the observed price (that it comes out of a deep and liquid market). If anything, at an exceptional time like this, what is needed is an array of financial economic policy reforms which foster the liquidity of the market.
  7. Monetary policy has been nicely tied down to deliver a 4% CPI inflation target. This is a source of stability. The MPC should stay the course: forecast inflation, and deliver on the 4% inflation target. There may be a surge in inflation in the next month or two, but monetary policy works on horizons like 12-18 months, and should see through the short-run supply dislocation. If the government reneges on the rules-based framework of the MPC and the inflation target, there will be an upsurge of uncertainty, and it may take a decade for private persons to trust monetary policy again.
  8. As with 2008, exchange rate flexibility is a key tool for adjustment. When there is a local shock, the market exchange rate depreciates, and this bolsters the tradeables sector. The good work of macro policy in mature market economies worldwide will generate a positive impact upon the Indian tradeables sector, as long as India eschews exchange rate management.
  9. This is a good time to liberalise capital controls, and to remove barriers faced by non-profits, so as to foster the inflow of financial and philanthropic capital. There is a need to analyse barriers to operating in India, as seen from outside, and address all the constraints. As an example, in addition to the overt capital controls operated by RBI and MOF, there are implicit capital controls operated by agencies such as the Income Tax Department. The task of liberalisation is to address the full landscape. Such liberalisation will help address capital constraints, improve the policy process, and help some affected persons.
  10. What can fiscal policy do?
    1. We start from a daunting fiscal deficit before the epidemic. Automatic stabilisers will be in action (e.g. when profits go down, corporate income tax collections will go down) so the fiscal deficit will expand automatically. There is little room for discretionary actions that enlarge the fiscal deficit.
    2. Expanded resourcing into public health is a good use of fiscal resources (if the expenditure process is able to translate money into outcomes). As an example, a testing voucher of Rs.2000 per person and 0.5 million tests per day comes to a cost of Rs.1 billion per day.
    3. There are many cash transfer programs which can be utilised to send money to poor people.
    4. The fiscal space for health and subsidy expenditures should be created by reducing expenditures on inefficient subsidy programs, e.g. the fertiliser subsidy.
    5. There is fiscal space for state governments as they are below the deficit ceilings associated with fiscal responsibility rules.
  11. There is one interesting possibility which kills many birds with one stone: a linked reform of the GST and of petroleum pricing. The opportunity for this emerges because oil is at $26 per barrel:
    1. There is the long standing problem of moving the GST into a single low rate with a universal base.
    2. There is the long standing problem of removing government involvement in the pricing of petroleum products.
    3. There is an immediate need to get public money to the households of India, particularly the more vulnerable population. For these households, direct and indirect expenditure on petroleum products is a large part of their consumption basket.
    4. These three objectives can be achieved by merging petroleum products and coal into the GST and changing the GST into a low single rate. Alongside this, an excise on petroleum products and coal is required, which is a carbon tax. Government involvement in the price of petroleum products should simultaneously be discontinued.

    This reform gets many things right: In the short run, it enlarges the fiscal deficit while getting money into the hands of the more vulnerable households of India, who would see a direct decline in the price of kerosene or LPG or other petroleum products, and an indirect decline in the prices of all goods owing to reduced costs of transportation. At the same time, it is a long-delayed structural reform (single rate GST, low rate, enlarged base for GST) that marks a step towards building India into a mature market economy. It enhances private confidence and contributes to a V shaped recovery.

The fresh urgency of research

The whole world is searching for tests, vaccines, cures and prophylactics. There is a shortage, worldwide, of medical supplies such as personal protective equipment, and ventilators. This is a huge opportunity for Indian skill-intensive manufacturing to engage in frugal innovation, and serve the world. India has been at the global frontier in vaccines before. Some of the innovation in Covid-19 testing that we see today has come out of CSIR's initiatives, of working with the private sector. Large contracts by the state can help create economies of scale and push open standards, as was done by the UIDAI in its early years.

An intellectual community is required in India, that is able to parse global knowledge (in science, biomedical engineering, health policy, macroeconomics and finance), and adapt it for the unique features of Indian conditions. In addition, there are numerous research questions that are of paramount importance to India, which might not be a priority for researchers and funders elsewhere.

  1. How does SARS-Cov-2 transmit in the Indian heat, light and humidity?
  2. What is the role of the built environment? If doors and windows were opened, and table fans setup to increase air flow, would it help?
  3. How do the SARS-Cov-2 strains present in India fare, when faced with the genetic characteristics and the knowledge of the immune system in India?
  4. There is some early evidence that Covid-19 can ride on solid particulate matter in the air (caveat). This could create a lethal transmission mechanism in North India, when the winter comes. There is an urgent need to develop the evidence on this question, and (if required) plan the least-coercion pathways to ensure that air quality in North India will do better than usual in late 2020.
  5. What are the optimal protocols for health care of Covid-19 patients, that are feasible for scaling up under Indian conditions? How to obtain dramatic cost reductions in all aspects of public health and health care connected with Covid-19?
  6. There is a lot of work going on in the global epidemiology community, and can be brought to the Indian data. However, there are important concerns about the imprecision of the Indian data. How can priors about the measurement process be brought into the modelling process? How can Covid-19 be measured through surveys and panel data?
  7. How do we replace the Epidemic Diseases Act, 1897, by something that is grounded in modern Indian constitutionalism, with checks and balances?
  8. Why does the public health recipe of trace - test - isolate - treat work poorly in India? What is the institutional change required in order to obtain better performance in all these elements?
  9. How can health policy gear up for a possible surge in health care requirements?
  10. How can government overcome the public financial management problems of contracting in order to harness private sector capabilities in testing and in health care? This will require modified mechanisms of procurement, contract management and payments.
  11. What should macroeconomic and financial policy do in 2020 and 2021?

The Indian research community, and its philanthropic funding streams, need to pursue such questions, which are of vital importance for India but will not attract commensurate prioritisation abroad.


Covid-19 is a tragedy. Whether it becomes a catastrophe is up to us. Low state capacity shapes and circumscribes our optimal path.

We should not feel the peer pressure of matching the policy actions of first world countries. What is wise and optimal for them is often incorrect for us. The fact that the US is sending out a cheque to each person, of 2% of the US per capita GDP, does not mean that the Indian government should commensurately send a payment of Rs.3000 to each citizen.

We must look at the Indian setting, understand the gaps of information and state capacity, and bring commensurate caution in the use of state power. Analogies with war, shooting from the hip, `shouting from the hip', throwing out the principles of sound public policy in a liberal democracy: these are the ways in which we will enlarge the problem. Many times, when faced with low state capacity and low information, and faced with complex social systems that we only dimly understand, the best path is one of masterly inaction.

We should look beyond the heat of the moment into the medium term. In some months, the deaths per day will subside. This is not a war; we will come out of this with our physical and institutional infrastructure intact. Health, macroeconomic and financial policy must do the things today that set the stage for a V shaped recovery. This calls for thoughtful decisions through 2020 and 2021, where the desired outcome is one where private investment in 2025 is superior to the value seen in 2011 in real terms.

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