The term i.e. the reverse of leveraging ( the process of borrowing to fund asset acquisition in order to increase gains and losses) is applicable both at micro-economic or macro-economic level. At the micro-level, individuals and companies reduce their debt or % of the debt in the balance sheet while at the macroeconomic level, the process effects debt reduction across multiple sectors simultaneously. The extent of deleveraging in the economy is ascertained using the debt to the GDP ratio in the national account. The process is eventually important and at the same time crucial for the economy to grow.
How the process of deleveraging is implemented?
Individuals and corporates deleverage or reduce their debt liability from either cash generated through operations or by sell-off of assets including subsidiary companies, bonds, shares, real estate etc.
Why the process is essential?
Too much of debt impairs the overall economy as it does a household. Though, debt is an integral part that fuels the development and growth of the economy, excess debt during the down trend results in incapability to service debt. The incapability impacts financial institutions substantially who had financed these indebted companies. This then push entities to take the debt-restructuring route and in the process they attempt to reduce debt proportion on their balance sheet.
Undoubtedly, leveraging that proves to be an effective tool on the positive side yields far destructive results in case of a reverse trend. So, the process of deleveraging is taken on to reduce the risk and simultaneously push the focus on business operation. So, as to spearhead investment cycle and push growth. Nonetheless, with deleveraging potential to make upside gains is given up.
Deleveraging in Indian context
With slowdown impact, companies across the board had been hit hard and are finding difficulty in debt-servicing. However, the excess debt and ever-increasing NPAs, crisis at the corporate level is unlikely to result in financial debacle in the Indian economy any time soon.