Explained: What are zombies and why is the RBI talking about them?
On Wednesday, the Reserve Bank of India used a word popular with fans of Hollywood and Halloween to explain why its monetary policy hasn’t been as effective as it would have liked and why bank credit often doesn’t result in new investment that can boost the economy.
In its monthly bulletin for February, the RBI describes how the so-called zombie firms—dubbed widely as the “living dead”—manage to survive and explores whether monetary policy hinders the process of creative destruction by allocating credit flows to zombie firms during periods of economic slowdown.
So, what exactly are zombies?
Essentially, a zombie is a dead person who has been brought back to life, but who no longer has human qualities. Horror movies and television series often show zombies moving around unconsciously and even attacking or eating human beings.
From the RBI’s point of view, zombies are perpetually loss-making firms that eat away precious monetary and financial resources. Zombie firms, the RBI says, cannot service debt but still manage to borrow more to survive.
Are zombie firms only an Indian phenomenon?
Not really. In fact, it is a global phenomenon that appears to have gained traction especially after the global financial crisis of 2008-2009 that prompted central banks around the world to loosen monetary policy.
The RBI says that, following the unpleasant Japanese experience with the zombies in the 1990s, it has been progressively realised that zombification may be a global phenomenon. Accordingly, research attention has shifted to multiple facets of this challenge – zombies crowd-out growth opportunities of more productive firms and their rising presence in an economy can lower potential growth.
Typically, countries operating with weak banks and weak insolvency regimes allow zombies to thrive.
But how exactly the “living dead” manage to continue living?
Weak banks often lend to zombie firms at higher interest rates. This enables the survival of not only the weak banks in a financial system but also of the zombies themselves.
The RBI says that, globally, there has been an increase in the number of zombie firms, who use more credit and external finance to service debt regularly, enabling them to remain in business.
How does monetary policy help such zombie firms?
Accommodative monetary policy and low-interest rates help zombies to remain in business. So, when a central bank cuts interest rates and injects capital into the financial system so that commercial banks can boost lending that would eventually accelerate economic growth, it also leads to more money for zombies.
The RBI says that the “zombie credit channel” thrives in a weakly capitalised banking system. Accommodative monetary policy in such a system can propel a practice of “loan evergreening” enabling weak banks and weak firms to stay afloat. In such a scenario, weak firms service debt timely using new borrowings from the banks, and the lenders postpone recognition of bad assets to stay above the minimum regulatory capital requirement.
However, during surplus liquidity conditions, credit flows to zombies remain relatively subdued than flows to non-zombies. This implies that pro-growth counter-cyclical monetary policy does not hinder the creative destruction process, the RBI says.
What exactly is the RBI’s problem with zombies surviving? After all, their survival does save jobs, no?
The RBI says that a perception has developed that counter-cyclical policies to boost growth after the global financial crisis may be hindering creative destruction of zombie companies and thereby contributing, inadvertently though, to lower trend investment and productivity growth.
In an atmosphere characterised by growing presence of zombies, stabilisation policies can potentially endanger the medium-term growth trajectory by hampering creative destruction, the RBI says.
The RBI’s main problem with zombies, however, is that such firms’ borrowings from banks often do not give rise to higher real investment activity, unlike non-zombies.
Moreover, such companies are highly leveraged and generate a negative return on assets over successive years. Also, their average cost of funds is more sensitive to monetary policy shocks.
While zombie firms may be able to protect some jobs in the short term, their medium- to long-term survival remains in doubt and doesn’t lead to the creation of any productive assets.
At a broader level, the monetary policy’s effectiveness gets dampened at the margin by zombies who tend to use borrowed resources, including long-term bank loans, less for new investment and more for survival.
So, how serious is the zombie problem in India?
The RBI estimates that zombies to account for about 10% of total debt of the non-financial corporate sector in India. Zombies have also absorbed about 10% of total bank credit extended to all firms in the economy.
On the plus side, credit flows to zombies in India remained weaker than flows to non-zombies during surplus liquidity conditions, which often accompany accommodative phases of monetary policy.
This could largely be due to the salubrious impact of risk-based supervision and the insolvency and bankruptcy regime that may no longer support evergreening of zombies, the RBI says.
This also corroborates that monetary policy in India has not hindered the creative destruction process and, therefore, does not pose any attendant risks to trend growth.
With further improvement in resource allocation through the banking system, however, there is scope for enhancing the effectiveness of counter-cyclical monetary policy, the RBI says.
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