Why It’s Time To Ignore The ‘Viral’ Prescription And Take A Macro View Of The Economy

Why It’s Time To Ignore The ‘Viral’ Prescription And Take A Macro View Of The Economy

by Karan Bhasin - Friday, August 28, 2020 05:42 PM IST
Why It’s Time To Ignore The ‘Viral’ Prescription And Take A Macro View Of The EconomyIBC will emerge as an invincible tool against future defaults
  • Combining short term policy interventions with reforms, and improving governance in the banking sector would be the way forward.

Recently, Reserve Bank of India’s (RBI’s) former deputy governor gave a series of interviews outlining concerns regarding the current state of the Indian economy.

The statements made by the former deputy governor are important given his role during the last couple of years when India moved towards a formal inflation targeting framework.

One of the key issues highlighted by Dr Viral Acharya is the suspension of insolvency and bankruptcy proceedings by one year. He argues that the same will restrict the ability of firms to restructure their debt delaying the process of clean-up of balance-sheets.

This will become important as the pandemic will increase the prospects of bankruptcies which will put pressure on the banking system.

There is no denying that we may witness higher defaults as economic activity contracts in the current financial year. With over a quarter under the lockdown, economic activity was restricted for most sectors and this is bound to put strain on India’s private sector.

The key concern is of existing bankruptcies, which are unlikely to be resolved during the pandemic, adding to greater debt burden making their resolution difficult.

The point is well taken, but it does not warrant the re-initiation of insolvency proceedings for the simple reason that even if we were to reinitiate the same, it would be virtually impossible to find suitable buyer for the asset.

The single-minded focus on financial system and pursuing credit discipline is a fair point, but from policy perspective, it comes in conflict with the objective of preventing the pandemic from scarring economic growth over a longer period of time.

Moreover, the underlying cause of an increased stress on India’s financial system has to do with the public health emergency which has resulted in a lockdown disrupting economic activity across sectors.

It is, therefore, important to take a comprehensive macroeconomic view of the situation rather than focusing on simply different sectors. A macro view becomes important given the interlinkages between different sectors, especially the one between financial sector and the real economy.

The growth slowdown in 2018 was primarily driven by the problems in the financial sector which originated due to the two untimely rate hikes in 2018 followed by problems in India’s non-bank financial company (NBFC) sector.

This is precisely why we need to look at ways to restore the health of India’s financial sector which is likely to witness further stress due to increased bankruptcies.

The key issue while dealing with pandemic is to avoid any long-term economic impacts of the same. This makes it important to prevent bankruptcies and shutdown of firms which can have catastrophic implications as they are a permanent reduction in income and jobs which will impact India’s long-term growth potential. This is the objective with which any policy must be formulated.

The move to suspend Insolvency and Bankruptcy Code (IBC) is important provided banks are allowed to restructure existing loans and provide some relief during the pandemic with the intention of preventing bad assets to deteriorate further due to accumulation of debt.

However, merely allowing for a one-time restructuring of all bad assets may not be sufficient to meet the objective.

The idea of a bad bank has been discussed far too many times by now. However, despite several debates around it, government has been reluctant to set it up.

The problem in the balance-sheets of banks, NBFCs and other systemically important firms needs to be addressed on a priority.

A bad bank would take on these assets on its balance-sheet and de-stress the entire financial system. This would work as a one-time operation to restore the health of India’s financial system.

There are various policy options available in front of the government when it comes to dealing with the financial sector stress. The key will however be to align the policy instrument with the overall growth objectives of the economy.

The best way to ensure the same would be to combine the short term policy interventions with reforms as proposed in the P J Nayak Committee and improve governance issues in the banking sector.

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