COVID – 19: Health shocks getting converted into financial crisis

-by Nishant Tiwari & Alankrita Singh

The COVID-19 outbreak is causing epochal changes in our lives. A few months ago, the life we are living today would have been unthinkable for most. In just a span of few weeks, attention has changed dramatically. Governments around the world are trying to stem the tide with ever-stronger measures. Economic growth in a modern economy depends on an efficient financial sector that combines internal savings and mobilizes capital for productive projects. The coronavirus pandemic (COVID-19) has brought with it a new set of challenges for the Indian economy, which can have a potential long-term impact on the stock markets.

No previous infectious disease outbreak has impacted the stock market as strongly as the COVID-19 pandemic. Right now, the sentiment in stock markets around the world is gloomy and this is reflected in frequent shocks in the stock markets in all parts of the world. Financial markets in India are currently experiencing strong volatility as a result of the consequences on world markets. The drop is in line with global benchmarks, as the domestic market generally tracks the world’s top indices and high volatility is likely to continue in the near future. The article would analyze the potential impact of COVID-19 on the stock market and some temporary yet effective solutions such as a ban on short-selling and relaxation of Fiscal Responsibility and Budget Management Act, 2003.

POTENTIAL IMPACT OF COVID – 19 ON STOCK MARKETS

The outbreak of the novel coronavirus will go down in history as an important example of neglected risk. In light of the massive impacts of the coronavirus on public, physical and psychological health; the economic and financial impacts may seem secondary. However, the economic effects will potentially be of the first order. This is reflected in frequent shocks in the stock markets in all parts of the world. Furthermore, seeing the current situation at some point, deaths from starvation will far exceed than deaths by the novel coronavirus.

There are primarily three stakeholders in an economy:

  • The Households
  • The Businesses
  • The Government.

Households have labour and capital that they send to companies. Then, companies using this labour and capital produce goods and services. In this process, companies pay money to households that again create demand for goods and services. In between, a portion of the wealth is shared with governments in the form of taxes that again spend this money on welfare plans. This flow of money keeps the economy running around the world. Now, the entry of COVID-19 has brought the existential crisis for the households that were forced to stay indoors and practice social distancing.

As a result, the production of goods and services has stopped, which has disrupted commercial activity. In addition, over time this will create low demand as households will run out of money, which in turn will reduce revenue for the government as households and businesses will be unable to contribute anything in the form of taxes to the government.

Furthermore, there is also a fear that the world economy could fall into depression, if liquidity taps are opened by the world’s central banks to provide rescue measures before finding a medical solution, as the crisis seems to be on the middle path without a close solution. In fear of such an expectation, market speculators are expected to do massive short-selling with a view to profit in the event of a falling stock price.

RELIEF MEASURES THAT CAN BE ADOPTED TO REDUCE THE IMPACT OF COVID – 19

It is the need of the hour to adopt relief measures which can be used to reduce the potential long term impact of COVID-19 on the stock market. Relaxation of Fiscal Responsibility and Budget Management (FRBM) Act, 2003 and ban on short-selling can be effective measures to cure the current problem. These measures are effective in the following ways:

Relaxation of Fiscal Responsibility and Budget Management (FRBM) Act, 2003

The Act was enacted in 2003, with the objective of holding the central government responsible for guaranteeing inter-generational equity in fiscal management and long macroeconomic stability. The law also requires states to keep their fiscal deficit at 3% of the state’s gross domestic product (SGDP). On the other hand, the law also contains the escape clause that is established in Section 4(2) of the Act. According to the aforementioned section, the Center may exceed the annual fiscal deficit target by citing reasons including national security, war, national calamity, the collapse of agriculture, structural reforms and a decrease in real production growth of a quarter by at least three percentage points below the average of the previous four quarters.

Since states, today not only need to continue their COVID-19 mitigation measures but would also have to cover other expenses for routine affairs related to the implementation of socio-economic programs and also post-pandemic recovery. Therefore, states would want more leeway to borrow due to a shortage of funds, as they have suffered a loss of revenue from declining tax collections due to the lockdown. Given the ongoing pandemic could be viewed as a national calamity, which, along with the ongoing lockdown to combat it, is in likelihood to cause a serious contradiction in economic output. Therefore, the fiscal deficit targets of the centre and the state must be suspended in such a time as it would allow both the Union and the state governments to carry out the increases in expenses that are so badly needed to meet extraordinary circumstances.

In addition, the pandemic has spread to the Indian economy at a time when it was already vulnerable, as it was hit by the double whammy of a recession in household spending and private investment plus a credit crisis. The International Monetary Fund (IMF) forecast that growth in Asia’s third-largest economy would slow to 1.9% in the fiscal year 2020-21, the slowest pace in three decades. Therefore, it has become necessary to relax the provisions of the FRBM Act, so that states can borrow money to finance the fight against COVID-19. Without a doubt, the exemption from the FRBM Act may not be unconditional. States will also have to commit to far-reaching reforms in areas such as labour regulations, agricultural marketing, urban development, and energy distribution.

Ban on Short-Selling

Short-selling is basically when the shares are sold by the non-owner seller at the time of the exchange. In such practice, financial traders hold bets on specific stocks that expect a drop in price. Therefore, on 20 March 2020 SEBI toughened the short-selling from 23 March, 2020; though the ban cannot be the permanent solution to improve market conditions. However, it would be an effective step to control the ongoing threat in the capital markets, as it plays a vital role in the drop of the stock index, which leads to an abnormal drop in share prices in such a pandemic.

Thus, the ban would help restore stability in the struggling financial market as the Indian stock market has seen a large short-selling in future index segments such as Sensex, Nifty and Bank Nifty. Furthermore, foreign portfolio investors have tested a huge deficit in India, resulting in a relentless decline in the stock market.

CONCLUSION

It would be foolish to expect a rapid economic rebound from the current COVID-19 effect. Although the financial crisis is inevitable, considering the general efforts of central banks and tax authorities to soften the blow, a deep economic depression could be avoided. The problem in the current scenario is that until we know how quickly and completely the public health challenge will be resolved, economists cannot predict the end of this crisis. Exchange in 2020 is expected to drop sharply in all regions of the world and basically in all sectors but world trade could recover quickly after that. However, it would depend on how quickly the pandemic is controlled and the policy options governments have taken to support their economies.

Effective measure like a ban on short-selling can be considered, as it will be then that we expect normalcy returning to business and the economy. Another measure can be a relaxation of FRBM Act. Only then the stock market will begin to move in a positive direction and as seen in the past, the recovery would be faster than expected.

Views are personal.

Image credits: The Economic Times

ABOUT THE AUTHOR

Nishant Tiwari and Alankrita Singh are currently pursuing B.A. LLB (Hons.) from National University of Study and Research in Law, Ranchi

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