The coronavirus pandemic has rendered the nation’s world over through a rough economic patch. Even the most stable of economies have been rattled by the virus which induced a total economic shutdown as trade and the consumer market took a backseat during the lockdowns. Even though the world has started limping back to economic normalcy with the unlock phase, yet many experts opine that the global financial crisis is far from over. Carmen Reinhart, chief economist of the World Bank fears that the financial crisis may just be starting and her comments cannot be taken lightly as she has deep insights into the working of the financial system. Additionally, Reinhart’s observations can have some special relevance for India.
The pandemic has already given rise to a global recession with output falling sharply and the global economy shrinking. The world witnessed a similar crisis ten years ago in 2008, which started in the financial sector and later was transmitted to the real economy. This time, however, the real economy has been deeply scarred and its consequences have not so far got reflected in the performance of the major financial sector players. The real economy players have invariably been plagued by wide scale disruptions in their normal functioning. With lower output and lower off-take, their functioning has been impaired. A similar problem has overwhelmed countries, as faced with the sudden disruptions the national governments had to resort to huge debts to keep themselves floating. The World Bank itself has deferred loan repayments and moratorium on interest by six months and Reinhart now suggests rolling over the debt repayment by another six months. So, both the sovereign governments as well as the corporates have all been saddled with debt obligations and twin deficits —fiscal deficits and balance sheet crises.
Now, what has happened is the banks have been asked to continue funding the corporates and the government’s mandated debt repayment deferment. So, at present, the imbalance in the corporates have been accommodated and transferred to banks and financial institutions. Nevertheless, whenever the debt repayments fall due a large part of the debt portfolio would never be repaid. So that would be a turning point in the financial cycle. Reinhart describes this as debt build-up which is again a “quieter crisis” as the proportions of the crisis are hidden and understated. From this point of view, the aftermath of the pandemic could be even more troublesome for India. We had a huge bulge in bad debts of the commercial banks’ loan portfolio well before the pandemic struck. Former RBI governor, Raghuraman Rajan, himself a financial sector expert, had pointed out these vulnerabilities of the Indian financial right at the start of his tenure. The large scale borrowing by governments and corporates have inevitably jacked up the costs. For countries where the banking system is already saddled with substantial bad debt portfolios like that of India, the problem of banking sector viability could become jeopardised. It will be imperative to amount some global financial sector rehabilitation programme and provision of long-term funding for easing the adjustment process. But the outlines for such a rehabilitation programme should be put in place well before that.