A key structural issue behind the slowdown, and now the contraction, in the Indian economy is the crisis-ridden financial sector. The challenge has only become bigger over the past decade. As pointed out by former chief economic adviser, Arvind Subramanian, what was initially a twin-balance sheet crisis — encompassing banks and infrastructure companies — became a four-balance sheet crisis, including non-banking financial companies and real estate firms. The pandemic’s shock has made matters worse. According to the report of the KV Kamath Committee, set up by the Reserve Bank of India (RBI) to look into the restructuring of loans after the Covid-19 shock, almost 70% of banking sector debt has been affected by the shock of the pandemic.
In this backdrop, the Centre’s credit guarantee scheme for micro, small and medium enterprises and RBI’s moratorium on payment of existing loans were crucial relief measures. Both these measures, however, cannot go on forever. Banks will eventually need to recover their capital. The longer this takes, the larger will be their forgone income and accumulated losses. But if the economy does not recover soon — and most experts do not believe this is unlikely to happen — businesses might not be in a position to start paying back these loans if the moratorium is revoked immediately. A rush to invoke bankruptcy proceedings against defaulters could lead to destruction of firms and, therefore, productive capacity of the economy.
This policy dilemma is currently playing out in the Supreme Court. The apex court has asked banks to not declare accounts as non-performing assets until a final order is passed. The court will resume hearing on the issue on September 28. The entire issue looks like a zero-sum game at the moment; either banks or debtors will emerge victorious. However, the larger economy will continue to suffer, irrespective of which party bears the burden right now. The only meaningful resolution is to expedite an economic recovery. This will rejuvenate revenue flow and facilitate timely payment of debts. This newspaper has consistently argued that a fiscal stimulus is essential to give a boost to the economy. At the same time, RBI and banks need to make sure that due diligence is exercised while separating genuine borrowers who hold promise in the future from those who will perish in keeping with the market’s logic of creative destruction. 4