Her warning about the pandemic morphing into a financial crisis are in a sense only reasonable projections of what is happening currently. Ms Reinhart’s observations can have some special relevance for India.

Carmen Reinhart is highly respected among economists as an expert on financial crises. She has co-authored an authoritative book on the history of financial crises, along with Kenneth Rogoff, who was at one time chief economist of the International Monetary Fund.

The pandemic has already given rise to a global recession. Output is falling sharply and the global economy has shrunk. Ten years to date, the world had witnessed another crisis, the memories of which are still fresh.

The on-going economic crisis across the world created by the pandemic this time is different in nature from the last global financial crisis. In 2008, the crisis started in the financial sector and later was transmitted to the real economy.

This time, 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. But that might just start manifesting, Reinhart argues. The downturn this time could be even worse and climbing out of it could be all the more tortuous. How and why?

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 have been impaired. They now have balance sheet problems and these could be very difficult to overcome in the short period.

This is because the pandemic and the problems with the real economy have already resulted in building up of large debt overhang. Corporates are struggling with cash flow crisis and resumption of normality itself would call for further infusion of funds. Where will it all come and at what cost?

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 Ms Reinhart has now suggested 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 crisis.

Now, what has happened is the banks have been asked to continue funding the corporates and the governments mandated debt repayment deferment. So, for the 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.

From that point of view, Carmen Reinhart has described the one —that is, debt build-up—as a “quieter crisis” as the proportions of the crisis are hidden and understated at the present moment but could blow up to be a big bang one once the defaults starts on loan maturity.

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.

He had started a concerted action programme for rectifying the bad debts crisis of the Indian banks on a time bound basis. Systems were introduced for tracking loans and raising provisions for bad debts. Many banks were told to be cautious and even disallowed from offering fresh loans. Nonetheless, after five years and at the end of his tenure, the tip of the solutions had not been reached.

The pandemic, striking in the midst of this process, has further queried the pitch.

The second aspect of the present developments is that large scale borrowing by all concerned —governments and corporates— have inevitably jacked up the costs.

Corporates have been borrowing at 8%, 9% and sometimes even 9.5%, and in India the rates are even higher. Consider what should the growth rate have to be to meet interest rates of that kind. In most cases, countries cannot grow at such rates and therefore the debt repayments would remain a major hurdle.

For the time being, fortunately the silver lining is that countries, including emerging ones, could still have market access or access to special institutional funding. But the question is at what price.

So, on a slightly longer time-frame, at about the time when the disease burden is contained and economies start coming back into their normal pace of activity, the financial sector reconciliation problems could start coming to the fore.

For those countries where the banking system is already saddled with substantial bad debt portfolios, 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. (IPA Service)