Twin battle and beyond
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Gonny van den Bos and her husband, Jacque van den Bos, are our family friends from Holland. Gonny had sent us a mail a few days ago. This is part of what she wrote: “Now in Holland it’s all about coronavirus. Schools are closed. All bars, restaurants etc are closed. It is very strange. People get nervous and, buy so much so that shops are empty. Especially toilet paper and aspirin are hard to find.”
This is not a case of Holland only, but of the entire Europe and the entire world. The only difference is that disruption to normalcy is different from country to country, depending on how much they are “integrated”.
Holland is a member state of the European Union (EU) of 27 countries and of the single-currency union – the Euro Zone of 18 EU countries. As a result of deep integration, the interactions and transactions are stronger. Goods, services, money and people, can all travel freely across the EU countries.
They trade more among themselves than with the rest of the world. They have sacrificed part of their monetary and fiscal policies for the benefit of the region. They must maintain harmonized macroeconomic standards including interest rates and inflation rates for the sake of unity of the EU. About 450 million people in the EU who hold the EU passport can travel freely among the EU countries and can choose to work in any country. In order to cater to the massive travel demand, the transport network among member states is well developed so that millions of people travel everyday by plane, train, public buses, ships, and private vehicles.
The twin battle
The world has been caught up in a twin battle: One is to fight against the spread of coronavirus with no country yet to declare that it is under control. The other is to fight against its adverse impact on the economy. In this case too, no country has yet declared that the resulting economic recession is averted.
Here is the dilemma: The fight against the former aggravates the latter. All the measures taken to control the spread of coronavirus leads to control interactions and transactions.
One can say that “we would have stopped all flights to Sri Lanka” so that people would not have arrived in the country carrying the virus. In fact, that is what the countries in the world are trying by and large to do – placing limits on travelling. The virus was alien to all the countries except where it originated, but it was carried out all over the world by people who travelled or perhaps, the objects that are transported.
A hotel worker at Shangri-La hotel checking temperatures of all visitors entering the hotel.
The EU countries as well as others are trying to find ways and means of closing the borders that they opened to form the unions. But how could they do that effectively to cut of the transmission of the virus? Due to strong integration, Europe is the epicentre of the pandemic. Even the island nations like Sri Lanka which are not even part of any integrated union, find it hard to cut off their interactions and transactions.
Closing the borders and cutting down travel is not going to solve the problem, when the virus has already entered through the borders. When the people who are infected begin to interact with others – at home, in the shop, on the street, in the workplace and, in any other location, then it is transmitted infecting others. Therefore, it is necessary to cut off all forms of interactions. The infected persons should be in “isolation camps”, while others remain locked up at home.
In fact, that is what the countries in the world are trying to do – preventing interactions and transactions. Countries have imposed restrictions on interactions in various ways, including such actions as declaring holidays, imposing curfew, putting up roadblocks and, deploying the military to manage affairs.
Slowdown in economic machinery
Let’s look at the consequences now. When people don’t travel, demand for the travel industry falls. Planes don’t fly and trains and buses don’t run. Their incomes fall, and employees might go without jobs. Tourists don’t come, and hotels go empty. Hotel incomes fall and employees will have no jobs. Workplaces are closed so that there is no production. Activities are restricted so that consumption falls. When production and consumption fall, trade begins to shrink. In all related activities, incomes fall and jobs are lost.
All these industries demand inputs, which they have to cut down now. The travel industry needs fuel supply, which has to be cut down resulting in a decline in fuel prices. The hotel industry needs food and beverages, but now these inputs have to be cut down. Thus incomes and jobs in the fuel industry and in the food and beverage industry will fall.
People have to limit going to work so that production of goods and services decline and, trade is limited. The value of the company stocks begin to fall as their turnover declines and profits fall. Therefore, investors in company stocks withdraw their investments making the stock market fall even faster.
What these negative multiplier effects show is that every aspect of the economy gets adversely affected resulting in a decline in private incomes and jobs, export earnings and prices, and even the government’s tax revenue. Thus, the slowdown in the economic machinery leads to what we call an economic recession.
Monetary and fiscal stimuli
Governments and central banks devise policies to minimise the fall and stimulate the economic machinery mainly with monetary stimulus and fiscal stimulus. Under the monetary policy stimulus, the central banks cut their policy rates and reduce reserve requirements to make money more abundant and bank credit cheaper.
The expectation is to sustain aggregate demand. The problem is that major economies in the world – the US, EU and Japan, all have already come to the end of the road to go with monetary stimulus. It is mostly the developing countries that have little more space for monetary stimulus.
Under the fiscal stimulus, the governments began to cut taxes and inject subsidies to both the businesses and households to keep their nose above water. The expectation is to minimise negative repercussions on both production and consumption so that income and job losses could be avoided. The problem is, however, that the governments should do this as at present against their declining tax revenue and widening budget deficits, leading to money printing and further borrowing. This means that the fiscal stimulus too cannot go on for too long.
Sri Lanka: A new opportunity
Following the usual monetary policy stimulus, the Central Bank of Sri Lanka too early this week cut down its policy rates by 25 basis points and statutory reserve ratio (SRR) by 1.00 percentage point. The policy rate cut has brought the Standing Deposit Facility Rate (SDFR) down to 6.25 per cent and, the Standing Lending Facility Rate (SLFR) to 7.25 per cent, which is expected to make bank credit cheaper. The reduction in SRR to 4 per cent of rupee deposits is intended to increase bank liquidity making the availability of more credits.
While Sri Lanka has also been tightening its defensive strategies against the spread of the pandemic, the government is faced with a narrow fiscal space for more pro-active fiscal stimulus. Besides in between two elections, the government has already implemented tax cuts and is committed to major spending programmes, further tightening its fiscal space. While the current debt obligations are there on one side, the government is looking for debt moratoria and further borrowing opportunities. With all that, apparently it is a challenge to create room for significant fiscal stimulus in Sri Lanka. In the midst of the battle, there could be opportunities too. It is an opportunity to look beyond the current pandemic issue to make preparations for the next phase of an economic take-off. This requires curing our deep-rooted “economic pandemic” issues. Perhaps, the current inabilities that the country has faced with would give the ability to make corrections and to clear the direction.
(The writer is a Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk).