Central Banking During A Crisis

Viral V. Acharya, C.V. Starr Professor of Economics at New York University’s Stern School of Business and a former deputy governor of the Reserve Bank of India, speaks with Global Finance about the fallout of the coronavirus epidemic.

Global Finance: Will the financial sector be able to provide enough liquidity to keep businesses from collapsing?

Viral Acharya: There has been a huge wave of drawdowns of prearranged credit lines by large and small firms in this fog of economic uncertainty. The drawdowns are involuntary for the banking system, as the terms have been prearranged. Not all corporations accessing cash are necessarily in need of liquidity. Some just want to hoard the liquidity. My concern is: Can banks still afford to serve as financial intermediaries efficiently for households and small businesses?

If small businesses do not have the same access to credit as large corporations, the system must ensure them a soft landing. Large corporations have a larger market value, but small businesses provide a much bigger percentage of jobs to the economy. Small businesses cannot access bond markets. How do we design things right for small businesses?

GF: What do you think of the Paycheck Protection Program, the US Small Business Administration plan to help small businesses?

Acharya: Unfortunately, the program, issued in two tranches of $349 billion and $320 billion, is not targeting the sectors most in need. Construction, agriculture and restaurants—these jobs cannot be done from home. It is a free-for-all. Everyone in small business is applying for these loans. Given the program’s limited size, even for a country as rich and well trusted in bond markets as the US, it would have made good sense to direct the money to where the bang for the buck would have been highest—sectors in which working from home is not easy.

GF: What is the risk of deflation?

Acharya: The risk of deflation is quite severe, because the economic shock is very large—much bigger than the global financial crisis. The shock is not accelerating primarily through the financial sector. It is a direct, real hit to the cash flow itself of the economy, with things shutting down.

I worry about three things: the fog of uncertainty as to how long the very large shock to the real economy will last; the likely staggered revival to their precorona zone of different countries; and stretched corporate balance sheets, in terms of borrowings. While households and banks had deleveraged over the past 10 years, corporates and governments took on more debt.

The size of public sector balance sheets in developed economies will increase even more. These will be important deflationary forces. To repay these huge quantities of debt, governments will have to raise taxes down the line. Deflation is therefore a significant risk that has to be put on the table.

GF: Are governments in emerging markets providing enough business and social support?

Acharya: Many of these governments have not run their fiscal situation very well, running up huge off-balance-sheet-liabilities. When they have to spend on a true humanitarian crisis, they don’t have a fiscal buffer for spending without facing sovereign downgrades. Some countries already have been downgraded by a notch or more. And several others are on the verge of negative outlooks or further downgrades.

If governments undertake direct expenditures, it would add to the bottom line in official statistics and increase their measured liabilities. They are more likely to use credit guarantees through banks to their bottom line. This way, they can postpone recognition of their fiscal support. Many people are disappointed with the fiscal relief measures of emerging markets. But governments’ fiscal space has been used up in connected lending, populist agendas and inefficient subsidies. They are worried that if public indebtedness rocks their bond markets and external sectors, they could have financial instability problems on their hands. Hence, fiscal compression—as in reorienting expenditures from inefficient ones to immediate needs—and rebuilding credible commitment to fiscal consolidation in the post-pandemic era, are both the needs of the hour.