Indian Bankruptcy Reform: Where We Are And Where We Go Next.
Background:-
Bubble and burst are platonic partners.They are akin to any other pair of platonic coupling , such as – high-low, dark-dawn,success-failure etc.There is only two facets of any risk , especially in case of entrepreneurial risk – Few will succeed and many will fail.This happened in the 1990s dotcom boom.India is staring at two probables of success and failure of entrepreneurship and especially given it’s recent push for more entrepreneurship ,we will soon have our own version of bubble and burst.
There is nothing bullish or bearish about it- it is just , plain reality and proper channel to deal with it is thus essential.
As India unleashes its entrepreneurial capabilities in its run up to waking the sleeping giant , we are soon going to have our own bitter-sweet experience of bubble and burst.Few will certainly succeed , many will fail – No one knows for sure , who is who though , but then again that is the beauty of risk – Nobody is ever sure.Failure usually strikes at the very unfortunate moments and when companies go bust , they tend to disrupt normal lives and the world of its employees are shaken – recall the Satyam aftermath.
So , as reality of failure stares at us, it is quite-essential that, India should build a certain institutional mechanism to deal with it , not only to give a proper winding up mechanism but also to deal with the domino effect that ensues failure.In this prospect, a perfect Bankruptcy bill is the need of the hour and a critical analysis is thus called for.
Analysis:-
All business plans are speculative views of the future. Some will inevitably go wrong, either because of failures of conception or of execution. As India lacks the requisite institutional arrangements, at present, when a firm goes into default, the management, capital and labor get stuck in an interminable mess. With a sound bankruptcy process, we would be able to rapidly resolve the situation, and everyone would move on.
In India, the lack of a sound bankruptcy process implies a flawed legal foundation of limited liability companies. The classic definition of limited liability is a bargain: Equity is in charge of the company as long as all dues to Debt are met. When the firm defaults on its debt obligations, control over the assets of the firm shifts from Equity to Debt. This is not how India understands limited liability today. We tend to think that a company belongs to its founding family no matter what happens by way of firm default.
From Bits and pieces of Bankruptcy to a full fledged Bankruptcy code:-
One component needed for bankruptcy reforms was built by the Financial Sector Legislative Reforms Commission (FSLRC), led by Justice Srikrishna from 2011 to 2013. The `resolution corporation’ in the draft `Indian Financial Code’ is a specialised bankruptcy process for two kinds of financial firms: those that make intense promises to consumers, and those that are systemically important.
This component has been slowly moving towards implementation, after MOF first setup a `Task Force’ on the subject, and then made an announcement the budget speech of February 2016. But the bankruptcy process for all other firms was a project waiting to be done. Some work on these lines went into the Companies Act, 2013, but it only partly dealt with the mechanisms of restructuring and winding up.
The Budget Speech in July 2014 had one sentence in Paragraph 106:
Entrepreneur friendly legal bankruptcy (sic) framework will also be developed for SMEs to enable easy exit.
This sentence could have been done in an incremental way. Instead, it was taken on a more ambitious scale at the Ministry of Finance (MOF) with a policy project that would go beyond just an SME bankruptcy framework for India. I
In late 2014, MOF setup the Bankruptcy Legislative Reforms Committee or the BLRC, led by TK. Viswanathan, with the objective of building a full-fledged bankruptcy code.
The work of the BLRC was placed in the FSLRC division of the Department of Economic Affairs (DEA), so as to harness the institutional memory about the working of FSLRC. The BLRC submitted a two volume report on 4 November 2015. The report is similar to the output of the FSLRC: the economic rationale and design features of a new legislative framework to resolve insolvency and bankruptcy.
After the IBC was tabled, the Joint Parliamentary Committee on Insolvency and Bankruptcy Code, 2015 (JPC) was set up on the same day to analyse the draft bill in detail. The JPC submitted its report which included a new draft of the law. This is the draft Insolvency and Bankruptcy Code (IBC) that has since been passed by both houses of Parliament.
The essence of the BLRC proposal is a formal procedure, termed the `insolvency resolution process’ (IRP) which starts when a firm or an individual defaults on any credit contract. Any creditor is empowered to initiate an IRP: a financial firm or an operational creditor whether it is a non-financial firm or an employee. An insolvency professional (IP) called the `resolution professional’ (RP) manages the working of the IRP, and is responsible for compliance with the law.
Once the IRP commences, power shifts from shareholders/managers to the Committee of Creditors. This includes the power to take over management of the firm, the ability to change management, to bring in fresh financing, to ask for all information required in order to invite bids for commercial contracts, including from the existing creditors and debtor, to keep the enterprise going. Decisions are made by voting in the Committee of Creditors.
The process of resolving insolvency is similar for firms and for individuals. In the case of individuals, however, the final resolution plan must have the consent of the debtor. There are additional innovations in the process of individual insolvency in the IBC that will increase individual default resolution efficiency in India. One is the concept of the Fresh Start, which gives a debt write-off for individuals who are below certain thresholds of wealth and income at the time of default.
The reading of the law reveals seven areas of concern:
1. Precision of language.
2. The working of the regulator.
3. Information utilities.
4. Insolvency profession Provisions.
5. Forbearance.
6. Judicial infrastructure and
7. Transition issues.
That Parliament has passed the law is a major step forward. However, in and of itself, this does not yield success in the sense of getting to the desired economic outcomes. While some elements of the process that led up to this law were well done, in many respects, there were shortcomings compared with the 11 principles of sound process design for drafting of laws. The IBC, 2016, is an important milestone, an important way station in the long journey of Indian bankruptcy reform. But it does not, in and of itself, deliver an improved bankruptcy process for India. Now, seven areas of work are required.
Conclusion
The BLRC process, and the law enacted by Parliament, are major milestones in India’s economic reform. However, they are the beginning of the journey to bankruptcy reform and not the destination.
What would constitute tangible proof of success in Indian bankruptcy reform? Two events and four key data series define the report card for this.
Event 1. When a default of a Rs.10 billion firm takes place, it swiftly goes into the bankruptcy process, which leads to a transaction where the firm is sold as a going concern to a new strategic buyer or a private equity fund, and a good recovery rate is obtained by the lenders.
Event 2. When a default by a Rs.10 billion firm takes place, the firm gets smoothly put into liquidation within a short time, and a good recovery rate is obtained by the lenders.
Four key measures. Successful bankruptcy reform should mean an increase in four measures through time:
- The leverage of firms (holding business risk constant),
- The share of borrowing from the financial system in the total debt of firms.
- The share of non-bank borrowing in borrowing from the financial system.
- The share of unsecured borrowing in total debt.
On all four metrics, things in India have become worse over the 1990-2013 period. But a strong team, with focus and competence, is needed to work on these issues, and this could yield success in a few years.
Welcome the success but have the courage to hug the failure.And on the later Bankruptcy rests its weight- the swifter , smooth and better managed exit without dominoes is the key for the bill to succeed. It had to succeed in managing failures-that’s the irony.
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Petrol in India is cheaper than in countries like Hong Kong, Germany and the UK but costlier than in China, Brazil, Japan, the US, Russia, Pakistan and Sri Lanka, a Bank of Baroda Economics Research report showed.
Rising fuel prices in India have led to considerable debate on which government, state or central, should be lowering their taxes to keep prices under control.
The rise in fuel prices is mainly due to the global price of crude oil (raw material for making petrol and diesel) going up. Further, a stronger dollar has added to the cost of crude oil.
Amongst comparable countries (per capita wise), prices in India are higher than those in Vietnam, Kenya, Ukraine, Bangladesh, Nepal, Pakistan, Sri Lanka, and Venezuela. Countries that are major oil producers have much lower prices.
In the report, the Philippines has a comparable petrol price but has a per capita income higher than India by over 50 per cent.
Countries which have a lower per capita income like Kenya, Bangladesh, Nepal, Pakistan, and Venezuela have much lower prices of petrol and hence are impacted less than India.
“Therefore there is still a strong case for the government to consider lowering the taxes on fuel to protect the interest of the people,” the report argued.
India is the world’s third-biggest oil consuming and importing nation. It imports 85 per cent of its oil needs and so prices retail fuel at import parity rates.
With the global surge in energy prices, the cost of producing petrol, diesel and other petroleum products also went up for oil companies in India.
They raised petrol and diesel prices by Rs 10 a litre in just over a fortnight beginning March 22 but hit a pause button soon after as the move faced criticism and the opposition parties asked the government to cut taxes instead.
India imports most of its oil from a group of countries called the ‘OPEC +’ (i.e, Iran, Iraq, Saudi Arabia, Venezuela, Kuwait, United Arab Emirates, Russia, etc), which produces 40% of the world’s crude oil.
As they have the power to dictate fuel supply and prices, their decision of limiting the global supply reduces supply in India, thus raising prices
The government charges about 167% tax (excise) on petrol and 129% on diesel as compared to US (20%), UK (62%), Italy and Germany (65%).
The abominable excise duty is 2/3rd of the cost, and the base price, dealer commission and freight form the rest.
Here is an approximate break-up (in Rs):
a)Base Price | 39 |
b)Freight | 0.34 |
c) Price Charged to Dealers = (a+b) | 39.34 |
d) Excise Duty | 40.17 |
e) Dealer Commission | 4.68 |
f) VAT | 25.35 |
g) Retail Selling Price | 109.54 |
Looked closely, much of the cost of petrol and diesel is due to higher tax rate by govt, specifically excise duty.
So the question is why government is not reducing the prices ?
India, being a developing country, it does require gigantic amount of funding for its infrastructure projects as well as welfare schemes.
However, we as a society is yet to be tax-compliant. Many people evade the direct tax and that’s the reason why govt’s hands are tied. Govt. needs the money to fund various programs and at the same time it is not generating enough revenue from direct taxes.
That’s the reason why, govt is bumping up its revenue through higher indirect taxes such as GST or excise duty as in the case of petrol and diesel.
Direct taxes are progressive as it taxes according to an individuals’ income however indirect tax such as excise duty or GST are regressive in the sense that the poorest of the poor and richest of the rich have to pay the same amount.
Does not matter, if you are an auto-driver or owner of a Mercedes, end of the day both pay the same price for petrol/diesel-that’s why it is regressive in nature.
But unlike direct tax where tax evasion is rampant, indirect tax can not be evaded due to their very nature and as long as huge no of Indians keep evading direct taxes, indirect tax such as excise duty will be difficult for the govt to reduce, because it may reduce the revenue and hamper may programs of the govt.
Globally, around 80% of wastewater flows back into the ecosystem without being treated or reused, according to the United Nations.
This can pose a significant environmental and health threat.
In the absence of cost-effective, sustainable, disruptive water management solutions, about 70% of sewage is discharged untreated into India’s water bodies.
A staggering 21% of diseases are caused by contaminated water in India, according to the World Bank, and one in five children die before their fifth birthday because of poor sanitation and hygiene conditions, according to Startup India.
As we confront these public health challenges emerging out of environmental concerns, expanding the scope of public health/environmental engineering science becomes pivotal.
For India to achieve its sustainable development goals of clean water and sanitation and to address the growing demands for water consumption and preservation of both surface water bodies and groundwater resources, it is essential to find and implement innovative ways of treating wastewater.
It is in this context why the specialised cadre of public health engineers, also known as sanitation engineers or environmental engineers, is best suited to provide the growing urban and rural water supply and to manage solid waste and wastewater.
Traditionally, engineering and public health have been understood as different fields.
Currently in India, civil engineering incorporates a course or two on environmental engineering for students to learn about wastewater management as a part of their pre-service and in-service training.
Most often, civil engineers do not have adequate skills to address public health problems. And public health professionals do not have adequate engineering skills.
India aims to supply 55 litres of water per person per day by 2024 under its Jal Jeevan Mission to install functional household tap connections.
The goal of reaching every rural household with functional tap water can be achieved in a sustainable and resilient manner only if the cadre of public health engineers is expanded and strengthened.
In India, public health engineering is executed by the Public Works Department or by health officials.
This differs from international trends. To manage a wastewater treatment plant in Europe, for example, a candidate must specialise in wastewater engineering.
Furthermore, public health engineering should be developed as an interdisciplinary field. Engineers can significantly contribute to public health in defining what is possible, identifying limitations, and shaping workable solutions with a problem-solving approach.
Similarly, public health professionals can contribute to engineering through well-researched understanding of health issues, measured risks and how course correction can be initiated.
Once both meet, a public health engineer can identify a health risk, work on developing concrete solutions such as new health and safety practices or specialised equipment, in order to correct the safety concern..
There is no doubt that the majority of diseases are water-related, transmitted through consumption of contaminated water, vectors breeding in stagnated water, or lack of adequate quantity of good quality water for proper personal hygiene.
Diseases cannot be contained unless we provide good quality and adequate quantity of water. Most of the world’s diseases can be prevented by considering this.
Training our young minds towards creating sustainable water management systems would be the first step.
Currently, institutions like the Indian Institute of Technology, Madras (IIT-M) are considering initiating public health engineering as a separate discipline.
To leverage this opportunity even further, India needs to scale up in the same direction.
Consider this hypothetical situation: Rajalakshmi, from a remote Karnataka village spots a business opportunity.
She knows that flowers, discarded in the thousands by temples can be handcrafted into incense sticks.
She wants to find a market for the product and hopefully, employ some people to help her. Soon enough though, she discovers that starting a business is a herculean task for a person like her.
There is a laborious process of rules and regulations to go through, bribes to pay on the way and no actual means to transport her product to its market.
After making her first batch of agarbathis and taking it to Bengaluru by bus, she decides the venture is not easy and gives up.
On the flipside of this is a young entrepreneur in Bengaluru. Let’s call him Deepak. He wants to start an internet-based business selling sustainably made agarbathis.
He has no trouble getting investors and to mobilise supply chains. His paperwork is over in a matter of days and his business is set up quickly and ready to grow.
Never mind that the business is built on aggregation of small sellers who will not see half the profit .
Is this scenario really all that hypothetical or emblematic of how we think about entrepreneurship in India?
Between our national obsession with unicorns on one side and glorifying the person running a pakora stall for survival as an example of viable entrepreneurship on the other, is the middle ground in entrepreneurship—a space that should have seen millions of thriving small and medium businesses, but remains so sparsely occupied that you could almost miss it.
If we are to achieve meaningful economic growth in our country, we need to incorporate, in our national conversation on entrepreneurship, ways of addressing the missing middle.
Spread out across India’s small towns and cities, this is a class of entrepreneurs that have been hit by a triple wave over the last five years, buffeted first by the inadvertent fallout of demonetization, being unprepared for GST, and then by the endless pain of the covid-19 pandemic.
As we finally appear to be reaching some level of normality, now is the opportune time to identify the kind of industries that make up this layer, the opportunities they should be afforded, and the best ways to scale up their functioning in the shortest time frame.
But, why pay so much attention to these industries when we should be celebrating, as we do, our booming startup space?
It is indeed true that India has the third largest number of unicorns in the world now, adding 42 in 2021 alone. Braving all the disruptions of the pandemic, it was a year in which Indian startups raised $24.1 billion in equity investments, according to a NASSCOM-Zinnov report last year.
However, this is a story of lopsided growth.
The cities of Bengaluru, Delhi/NCR, and Mumbai together claim three-fourths of these startup deals while emerging hubs like Ahmedabad, Coimbatore, and Jaipur account for the rest.
This leap in the startup space has created 6.6 lakh direct jobs and a few million indirect jobs. Is that good enough for a country that sends 12 million fresh graduates to its workforce every year?
It doesn’t even make a dent on arguably our biggest unemployment in recent history—in April 2020 when the country shutdown to battle covid-19.
Technology-intensive start-ups are constrained in their ability to create jobs—and hybrid work models and artificial intelligence (AI) have further accelerated unemployment.
What we need to focus on, therefore, is the labour-intensive micro, small and medium enterprise (MSME). Here, we begin to get to a definitional notion of what we called the mundane middle and the problems it currently faces.
India has an estimated 63 million enterprises. But, out of 100 companies, 95 are micro enterprises—employing less than five people, four are small to medium and barely one is large.
The questions to ask are: why are Indian MSMEs failing to grow from micro to small and medium and then be spurred on to make the leap into large companies?
At the Global Alliance for Mass Entrepreneurship (GAME), we have advocated for a National Mission for Mass Entrepreneurship, the need for which is more pronounced now than ever before.
Whenever India has worked to achieve a significant economic milestone in a limited span of time, it has worked best in mission mode. Think of the Green Revolution or Operation Flood.
From across various states, there are enough examples of approaches that work to catalyse mass entrepreneurship.
The introduction of entrepreneurship mindset curriculum (EMC) in schools through alliance mode of working by a number of agencies has shown significant improvement in academic and life outcomes.
Through creative teaching methods, students are encouraged to inculcate 21st century skills like creativity, problem solving, critical thinking and leadership which are not only foundational for entrepreneurship but essential to thrive in our complex world.
Udhyam Learning Foundation has been involved with the Government of Delhi since 2018 to help young people across over 1,000 schools to develop an entrepreneurial mindset.
One pilot programme introduced the concept of ‘seed money’ and saw 41 students turn their ideas into profit-making ventures. Other programmes teach qualities like grit and resourcefulness.
If you think these are isolated examples, consider some larger data trends.
The Observer Research Foundation and The World Economic Forum released the Young India and Work: A Survey of Youth Aspirations in 2018.
When asked which type of work arrangement they prefer, 49% of the youth surveyed said they prefer a job in the public sector.
However, 38% selected self-employment as an entrepreneur as their ideal type of job. The spirit of entrepreneurship is latent and waiting to be unleashed.
The same can be said for building networks of successful women entrepreneurs—so crucial when the participation of women in the Indian economy has declined to an abysmal 20%.
The majority of India’s 63 million firms are informal —fewer than 20% are registered for GST.
Research shows that companies that start out as formal enterprises become two-three times more productive than a similar informal business.
So why do firms prefer to be informal? In most cases, it’s because of the sheer cost and difficulty of complying with the different regulations.
We have academia and non-profits working as ecosystem enablers providing insights and evidence-based models for growth. We have large private corporations and philanthropic and funding agencies ready to invest.
It should be in the scope of a National Mass Entrepreneurship Mission to bring all of them together to work in mission mode so that the gap between thought leadership and action can finally be bridged.