Extension of Moratorium: A way forward for India?

In the month of March, 2020 the Central Bank of India granted permission to all commercial banks, cooperative banks, all India Financial Institutions and NBFCs to allow moratorium. The time period for the same was three months and was further extended by three more months till 31st August 2020. Now, if reports are to be believed the Government of India is pondering upon the possibility of further extending this moratorium period. This poses two questions, firstly, whether the extension of moratorium is a solution and secondly, what impact will it have on the economy in the long run.

Extension of Moratorium: A Solution ?

The moratorium, though prima facie proved beneficial for the borrowers who were struggling to make ends meet because their jobs and businesses were affected by COVID, also acted as a facilitator to those corporate debtors who were in a position to pay the creditors yet chose not to, taking advantage of moratorium. The further extension of moratorium, if permitted, could inculcate a lethargic attitude in the minds of creditors (which still can be there as the fresh insolvency proceedings are barred for a year).

Apart from the moratorium being allowed by RBI, the Government of India has also put a break on initiation of fresh insolvency proceedings for one year which can be detrimental to the lenders who were hoping for a fast and streamlined insolvency proceedings to happen so that they can receive their money back. But, one time debt restructuring by RBI as allowed recently, as in pursuance to June 7, 2019 circular, can help the creditors in these times when fresh IBC proceedings are stalled in structuring a loan in a manner that matches the borrowers capability to pay. RBI has also formed a committee headed by KV Kamath, who has been Chief of New Development Bank of BRICS in the past. The committee will chalk out the way in which restructuring will be implemented. It is also pertinent to understand why RBI has such a cautious outlook towards One time Debt Restructuring. The answer to the same is plain and simple, because of its past experiences. Prior to April, 2015 the banks and its promoters used to work in close nexus to exploit this scheme. The Reserve Bank had also allowed the one time debt restructuring scheme for MSME without putting them under non performing assets category, which means that bank has to provide just five percent of the loan value to cover the risk of default which was increased to fifteen percent by new rules notified by RBI in April, 2015.

So, for the first question one can say that an extension of a moratorium may not be the ideal solution for dealing with COVID’s impact on the economy considering that the financial sector is already suffering from a liquidity crunch and bad loans are also expected to pile up next year.

Moratorium when lifted, the result

If one has to understand the impact or effect of a certain decision, the person must look at what happened when similar decisions were taken anywhere else. This comparative approach towards a problem helps in finding answers to various complex questions. In the instant case, a comparative analysis between Germany and India is done.

Germany also introduced a similar rule to counter the financial emergency posed before the country as a result of COVID 19. The order stated that the companies which were severely affected by the pandemic need not file for insolvency. The news as reported by financial times states that this decision has resulted in creation of thousands of zombie companies (a term denoted to a company that cannot cover its debt servicing cost from profits, in a long term) which will snap the economy in future. Now, what this has resulted in is that companies whose revenue model was already flawed and insolvency proceedings were about to be initiated against them irrespective of COVID 19 effect, have been protected by the government which is not benefiting anyone and rather they are wasting public money spent on them by the government. This is further acting as a disrupter of ‘creative destruction’. It is a term used by Schumpeter that states: the process in which old industries are destroyed from within and thus they pave way for new ones.

The situation in Germany as mentioned above is similar to that of India. India too has allowed a moratorium for six months (it was earlier announced for three months which was further extended by three months) and halted fresh insolvency proceedings for one year. (You can read more about Impact of COVID - 19 on proceedings under IBC here) Many argue that there are chances if one draws parallel with Germany that in India too one may find Zombie Companies in future, once moratorium period is uplifted and more details are out.

Author’s Perspective

Insolvency Bankruptcy Code, 2016 (hereinafter referred as Code) was enacted in the year 2016 to serve as one stop destination for insolvency and bankruptcy proceedings. Also, the Code was brought to reduce the time which is spent in resolving an insolvency. But, that was the time when an effective market was there as compared to the current situation where it is a broken one. Therefore, moratorium permission as granted by RBI was although necessary at the moment to ease the burden of debtors, it cannot be deemed as a permanent solution. The financial sector cannot be made a mere spectator in relation to the decisions taken on their behalf by the government under public pressure. In India too there are several businesses that ought to have gone to insolvency but are taking undue advantages of the moratorium. The author believes that the decisions taken by the government by applying a compassionate attitude are usually hard to be taken back but deferring the same does not lead to any solution. As the case is in Germany where the government is looking forward to extending the moratorium till March next year because of several reasons such as the country going to election next year, it does not benefit the economy in reality and it is just postponing the inevitable. The author hopes that the government in India does not extend the moratorium further because it will severely affect an already suffering financial sector because of the aforementioned reasons. This may also lead to a domino effect where several healthy competitors may also be affected due to ailing companies and clients who are not in position to pay their dues.