Managerial Economics Assessment-2: Model Solution
Managerial Economics Assessment-2: Model Solution
Managerial Economics Assessment-2: Model Solution
Assessment-2
Model Solution
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About the Case
COVID-19 is having an unprecedented impact on public health and is likely to have significant
economic consequences too. As the announcement of lockdown was unexpected and sudden,
a lot of ventures, especially the manufacturing and continuous process firms, were forced to
halt. The manufacturing GDP share of the country was already declining every year from 15.58%
in 2015 to 13.64 in 2019, this lockdown has even affected the sector severely. The GDP of the
nation has been declining pre-pandemic as well. An emerging market economy like India which
has lower household incomes and less mature capital markets is structurally different from an
advanced economy. However, they offer potential long-term gains for investors. India’s
contraction due to COVID-19 is steep than global average. A combination of rising inflation and
declining output would eventually lead to a stagflation trap which will likely result in demand
shock. During the peak of lockdown, the unemployment in India had reached a high of approx.
23.52 per cent as per CMIE reports.
In May 2020 a stimulus package was announced by India's finance minister which is the fifth-
and-final instalment of the 10%-of-GDP economic support plan. The immediate fiscal support
under the “Aatma Nirbhar Bharat Abhiyan” announced by the Government of India (GoI) is
estimated at a modest 10% of the substantial total package of Rs. 21.0 trillion. With the further
extension of the lockdown, and the expectation of substantial delays in getting the full supply
chain operational, especially given the likelihood of enduring labour mismatches following the
return of migrant workers to their home states, and the subsequent economic recovery in India
to be shallower and more delayed than our earlier assessment.
To support the Indian economy in the aftermath of the Covid-19 pandemic, the GoI had
announced the “Aatma Nirbhar Bharat Abhiyan” or “Self-Reliant India Movement” on May 12,
2020, with an intended package of Rs. 20.0 trillion. The measures detailed subsequently amount
to a higher Rs. 20.97 trillion (refer Exhibit 1), which is equivalent to ~10% of the nominal GDP of
India for FY2020 (as per the 2nd Advance Estimate released by the CSO). The package includes
the monetary measures already announced by the Reserve Bank of India (RBI; Rs. 8.02 trillion)
as well as the initial announcements made by the Centre (Rs. 1.93 trillion), which include the relief
package announced under the Pradhan Mantri Garib Kalyan Yojana (PMGKY), revenue foregone
due to tax concessions since March 22, 2020, and the emergency response and health system
preparedness package.
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Break-up of the stimulus package items Amount in Rs.
Trillion
Sub-Total 11.03
Earlier measures announced i.e. under PMGKY, health sector, revenue 1.93
loss due to tax concessions
Sub-Total 9.94
IMPACT OF COVID
Cost of traditional factors of production (land, labour, capital) went haywire in early part of
decade due to imbalances in growth model which has stalled the growth engine. However, we
are now in a better situation with falling land prices and cost of capital, stable labour costs and
lower corporate taxes. While India’s ranking has improved in terms of ease of doing business,
several impediments are still there in land acquisition, flexibility of labour, rate transmission and
availability of capital which will have to be ironed out soon if India were to be able to capitalize
on this opportunity.
With multiple extensions of the lockdown creating uncertainty regarding the resumption of
gainful employment and income generation opportunities, many migrants have chosen to avail
of the special trains being run by the Indian Railways to return to their villages in their home
states. With a considerable portion of their savings likely to have been used up over the last two
months, apprehensive that the migrant workers may choose to delay their return to the cities
and towns until after the festive season is over, which could affect the pace of normalization in
various economic activities, including manufacturing and construction.
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Talking about the imports/exports trade market, the demand from the exteriors were at a
standstill. Complete travel bans across various countries as well as deadlock of businesses made
the trade sector at risk. Goods movement blocked the trade finance and as the consumption
kept reducing, there was significant impact expected in the forthcoming. Many MSMEs in India
were dependent on materials to be imported from China. 30% of products/materials for
chemical, automobile industries were sourced by China. India also exports diamond and
petrochemicals to China. The entire supply chain with China as well as other countries like US,
Germany, middle east countries etc. were disrupted due to closure of borders.
Impact on individual sectors due to lockdown relaxation Sector Lockdown relaxation impact
1. BFSI
Improvement in collections as some movement of people allowed; also,
improvement in disbursements to standalone shops as well as vehicle and CD
financing. Asset quality may improve gradually as economic activity picks up. For
NBFCs, benefits for vehicle, gold financiers and MFIs.
2. Capital Goods/Infra/CD
Migrant worker availability the biggest concern. Impact higher in South India.
Industrial automation companies like Siemens and ABB to benefit from industrial
activities being permitted in Red zones. Consumer Durables may see some
resumption of sales from standalone shops. Seasonal products like ACs would
struggle due to limited time to recoup summer sales as well as installation
requirements. Consumer Electronics like TVs, laptops, mobiles, etc. should benefit
more than ACs.
3. Consumer/Retail
Positive for all consumer staples stocks on account of warehousing being allowed
even in Red zones and for rural dependent stocks like HUVR, CLGT and Dabur on
account of no restriction for MNREGA activities. Marginally positive for UNSP and
UBBL as alcohol retail shops allowed to open subject to approval by state
authorities.
4. Autos
Opening of standalone shops to benefit auto dealerships. Work in industrial
establishments with access control has been permitted, benefitting auto
manufacturing. However, permission to operate both dealerships and plants are
subject to the approval from state governments. Restarting operations might take
some more time.
5. Oil and Gas
Expect faster normalization of demand in diesel v/s petrol as trucking accounts for
60-70% of diesel consumption. Revival in demand should prove advantageous to
OMCs – it should raise utilization levels and OMCs should benefit from high
marketing margins of INR18- 20/liter on auto fuels.
6. Utilities
Revival in industrial activity would lead to increase in PLFs. India's power demand
decreased 24% YoY in Apr’20 with coal-based generation declining 32% YoY.
7. Pharma
Hospitals should benefit as OPD and medical clinics are allowed in Red, Green and
Orange zones. Supply chain and logistic issues should get resolved further and help
improve availability of medicines.
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8. Telcos
Opening of standalone shops should benefit from physical recharges. Telecom
providers may not have to extend incoming validity for low ARPU providers.
Revenues could grow ~2-3%.
9. Retail
Opening of standalone shops is a positive sign. Large retail shops are, however, not
allowed to open in malls. Retailers may weigh rental and fixed costs v/s footfall
recovery in malls before deciding to open stores (even after government’s
permission to open). We see limited store openings in this partial lifting of the
lockdown.
The seven steps announced focused on a variety of topics - MGNREGA (India's rural employment
guarantee programme), ease-of-doing- business, PSE rationalization and state government
resources. The rise in MGNREGA outlays was expected and necessitated by migrant labour
returning to their villages. Easing the insolvency rules - raising minimum threshold, suspending
fresh insolvency proceedings for a year and promising a special scheme for MSMEs - are likely
to provide a breather to stressed firms. Other than this, a new PSE strategy with a wave of
privatization, was announced. The devil, however, will be in the execution, given that several past
disinvestment drives have had limited success. Finally, there was a rise in the borrowing limits for
state governments, but with several conditionality’s attached to it. States can now borrow 5% of
GSDP (versus 3% earlier), but only the first 0.5% of the increase will be unconditional. This
follows from a host of announcements yesterday (the fourth instalment), which focused on
implementing schemes, several of which had been outlined in the past. The highlights were
implementing the coal commercial mining scheme, raising defense FDI limits (from 49% to 74%),
privatizing some power distribution companies, and auctioning out more airports.
The 10% package covers many sectors, and touches upon some much needed reforms. For the
short run, the following schemes seem to be most effective - rise in MGNREGA outlays, free food
grains for the needy, loan guarantees for MSMEs and NBFCs, and breather from the IBC process.
If implemented well, the following can prove powerful over the medium term - passing laws to
revitalize agriculture marketing, implementing commercial `mining policy, and privatizing PSEs.
• Immediate government cash out-go versus rise in future public sector liabilities: Much of
the 10% program is to be funded by RBI liquidity a rise in future liabilities (on the back of
the loan guarantee programmes), and borrowings of other public enterprises (e.g.
NABARD for agriculture outlays).
However, a large part of the attention has been towards medium-term supply side measures
(revitalizing agriculture marketing, stabilizing coal availability, etc.). Taking the two together, the
idea here may be to raise the medium-term growth potential, which will help fund future
liabilities, and lower public debt. Expectation of higher medium-term potential growth may even
help raise short-term risk capital, and ease funding constraints. However, much will depend on
speedy implementation of these reforms, and in that sense, the work for the authorities has just
begun.
AGGREGATE DEMAND:
It sums up the amount of goods and services people buy over a specific period of time
such as a month, quarter or year.
According to the law of demand, we know that as price falls people buy
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Impact of COVID-19 on aggregate demand
Let’s now understand how the different components of AD are impacted by the relief package.
The unemployment rate had fallen to a high of 23.52% which will eventually lead to reduced
purchasing power of consumers. Along with this, the consumers savings and their spending will
fall as the price level of products increases. This will lead to additional demand for money which
will in turn lead to higher interest rates. Due to higher interest rates business would reduce
borrowing for investment purposes, thus reducing both consumption and investment spending.
Productivity growth depends on firm’s investment, which depends on aggregate demand. The
government tried to partly compensate this fall in aggregate demand by announcing a fiscal
policy measure. Due to higher unemployment risk most of the consumers/public have opted to
save the money given by the government through stimulus package in their bank accounts
rather than spending it which will depress the equilibrium interest rate. This would eventually
lead to lower economic growth and higher uncertainty. However, aggregate bank deposits have
increased since April 2020 compared to the previous year, which can be a driving factor in
reducing the equilibrium real interest rate. In short, the measures taken by the government to
support the firm’s and stabilizing incomes would work only in the short run. If there is an
increased supply of government funds in the form of packages, there might be an upward effect.
The negatively sloped AD curve indicates that with increase in prices the real money balance
(M/P) and the purchasing power falls which leads to reduced demand for output.
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Impact of Govt Policies on GDP:
Consumption
Investment
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consumer spending work in the primary
and investment and secondary
sector.
REDUCTION IN Consumption level More money will
TDS RATES BY Consumption of consumer be in circulation as
25% Government increase a result of
spending Government increased spending
and taxation earnings through However
taxation method will government
decrease might not earn much
REDUCTION OF Consumption Increased Increased income
EPF Investment consumption by level of employees
CONTRIBUTION employees Decreased money
to eb set aside as
cash reserve ratios
through companies
LIQUIDITY Increased spending Income level of
INFUSION FOR Investments done by companies companies and
POWER Exports in equipment, industrial sector
DISTRIBUTION machinery and other might increase and
COMPANIES Consumption fixed assets to more employment
enhance their opportunities can
money earning also be provided
ability and by
production those sectors
OTHER POLICIES Consumption Aims at increasing Aims at increasing
Investment consumption by the income level of
Government encouraging people the marginalized
spending to secure loans from and middle-income
banks without group.
collateral security
and invest in their
business to generate
income and circulate
money
inside the country
The impact of the 10%-of-GDP package on the fiscal deficit is small. Adding across all the items,
estimate it at 1%-of-GDP.
Adding up (tax and non-tax) revenue shortfall and the fiscal cost of the package, the central
government fiscal deficit will likely come in at 6%- of-GDP in FY21 (versus 3.5% budgeted). The
state fiscal deficit is forecasted at 4%-of-GDP, taking general government fiscal deficit to 10% of
GDP.
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Conclusion: -
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