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According to a report by economists from the country’s central bank.
These companies are usually highly leveraged and generate negative returns on assets over the years. Their cost of funds is more sensitive to monetary policy shocks because they borrow more for survival than for new investments, according to a Feb. 16 article by executives from the Economic and Policy Research Department of the Reserve Bank of India, or RBI.
Although there is no evidence that easing monetary policy during economic downturns helps these companies by falsely awarding them credit, “[zombie companies] seem to have dampened the effectiveness of monetary policy at the margins as they use borrowed resources more for survival than to undertake new investments,” he said. The comments in the document do not necessarily represent the views of the central bank, according to the report.
India’s share of corporate zombie debt was the highest in at least 20 years in 2016, before plummeting the following year. It rose again in 2018 and has stabilized since then, according to the report.
Zombie companies tend to thwart the process of “creative destruction”, which requires a dynamic reallocation of resources from weak and vulnerable companies to strong companies with high growth potential. Coined by economist Joseph Schumpeter, “creative destruction” refers to the relentless mechanism of product and process innovation by which new units of production replace obsolete ones.
The RBI, along with other major central banks, has pursued an aggressive easing policy as the COVID-19 pandemic has weighed on the global economy since 2020. India’s central bank is now preparing to normalize its monetary policy , ending its bond buying program, while keeping benchmark rates low. The US Federal Reserve is widely expected to start raising rates as early as March to stem inflationary pressures, while its Chinese counterpart has continued to ease, seeking to better support the economy’s recovery. Accommodative monetary policy around the world has raised fears that cheap credit is being used for unproductive purposes.
Zombie firms in India operate with significantly higher leverage, measured by total debt to assets, although they have managed to borrow funds at comparable costs to healthier firms, the report says. . Despite their greater leverage, zombie firms’ share of total non-financial business sector sales has declined in recent years, he added.
Indian banks have managed to slow credit flows to financially weaker firms, thanks to risk-based supervision and the insolvency and bankruptcy regime that may no longer support the continued renewal of zombie firms, the report notes. .
“With further improvement in resource allocation through the banking system, however, there is room to improve the effectiveness of countercyclical monetary policy,” he added.