MNI POLICY: Draghi and Rajan Say Kill Off Zombie Firms

Governments should ease weaker companies into bankruptcy rather than continuing blanket support that will impair a strong economic rebound from the pandemic, Mario Draghi and Raghuram Rajan, the former eurozone and Indian central bank leaders, said in a report Monday.

Adjusting bankruptcy laws to avoid clogging up the legal system and looking at "bad banks" to keep regular credit flowing could help the process along, according to a report they wrote for the Group of 30, a Washington-based think tank. While Rajan told reporters at a briefing that banks appear well capitalized so far, Draghi said the last thing the world economy needs is lenders with balance sheets becoming overwhelmed by nonperforming loans.

"The wrong answer is to turn a blind eye to all this, we know from the experience of Japan after their bubble burst that the sooner you fix the problem, the more you get back to strong, sustained growth, and if you don't fix it, it just gets bigger," Rajan said.

Nonfinancial corporate debt has climbed from 73% of GDP at of the start of 2007 to 91% at the end of last year, and moved closer to 100% this year, the G30 report said. S&P Global Ratings on Dec. 3 said that next year will trigger further credit downgrades and defaults, especially as governments and central banks move to scale back support.

"Central bank balance sheets will grow this year, paralleling increases in public debt. There are limits to the role that monetary policy can play on an ongoing basis," the report said.

Governments should avoid tacking on other social objectives to corporate support packages, unless they are aligned with accelerating the rebound, the report said. Equity backstops for firms or nationalizations should be rare, though there's no clear rule that can apply across countries with different attitudes towards state control and economic management.

"The main issue is how do you design these programs, how well you spend this money. Because ultimately, growth will depend on that in many countries, only on that," Draghi said at a briefing for reporters.

Draghi and Rajan's report did say there could be more latitude shown to small- and medium-sized firms that can account for a major share of jobs in some countries, which would impose unwelcome social costs.