What is 'the original sin'?

Economic Survey 2021 terms 7 years of forbearance 'the original sin' — Here's why

Chief Economic Advisor Krishnamurthy Subramanian addresses a press conference on Economic Survey 2020-21, in New Delhi, Friday, Jan. 29, 2021. Credit: PTI Photo

Forbearance, a term which means restraint and tolerance. Financially speaking, forbearance means the provisional moratorium over loan repayments between the lender and the borrower, caused by a demonstrated economic hassle on the latter's side.

The Economic Survey 2021, released on Friday, dubbed the Reserve Bank of India's sever-year forbearance period 'the original sin' and that the Centre must get rid of the forbearance window, provided by banks to borrowers, as soon as the economy starts to revive.

The Survey said that the forbearance window provided due to Covid-19 induced economic challenges is only an "emergency medicine" and not a "staple diet".

Survey stated that such policies had desired short-term economic effects and the GDP growth recovered from a low of 3.1 per cent in FY2009 to 8.5 per cent within two years.

Growth in bank credit, which had fallen from 22.3 per cent in FY2008 to 16.9 per cent in FY2010, recovered quickly to 21.5 per cent in FY2011.

"The time was therefore ripe to withdraw the forbearance; after all the emergency medicine had worked in restoring the health of the economy. However, the central bank decided to continue with the same the forbearance continued for five more years till 2015, even when its withdrawal was recommended – a clear case of emergency medicine that was chosen to be made into a staple diet," it said.

Financial regulators across the globe adopted the regulatory forbearance measures to tide over the economic challenges posed by Covid-19 and India was no expectation, said the Economic Survey 2020-21 presented on Jan 29 ahead of the Union Budget.

Emergency measures such as forbearance prevent spillover of the failures in the financial sector to the real sector, thereby avoiding a deepening of the crisis, according to the survey tabled in Parliament by Finance Minister Nirmala Sitharaman.

"Therefore, as emergency medicine, forbearance occupies a legitimate place in a policymaker's toolkit...forbearance represents an emergency medicine that should be discontinued at the first opportunity when the economy exhibits recovery. It is not a staple diet that gets continued for years," said the Economic Survey 2020-21.

Noting that the current regulatory forbearance on bank loans has been necessitated by the Covid-19 pandemic, the survey said during the global financial crisis, forbearance helped borrowers' tide over temporary hardship caused due to the crisis and helped prevent a large contagion.

However, the forbearance continued long after the economic recovery, resulting in unintended and detrimental consequences for banks, firms, and the economy.

In the current Covid-ravaged scenario, that there is a relaxed provisioning requirement, banks have exploited the forbearance window to restructure loans even for unviable entities, thereby window dressing their books, it said.

"Undercapitalization distorted banks’ incentives and fostered risky lending practices, including lending to zombies. Firms benefitting from the banks' largesse also invested in unviable projects. In a regime of injudicious credit supply and lax monitoring, a borrowing firm's management's ability to obtain credit strengthened its influence within the firm, leading to deterioration in firm governance," it added.

 

(With inputs from PTI)