A code for growth


The insolvency code will help boost India's GDP

The Insolvency and Bankruptcy Code received the president’s assent on May 28, and has become a law. Is it a big deal?

Consider the fact that gross non-performing loans of Indian banks is estimated to be over Rs 4 lakh crore, while overall stressed assets is double at over Rs 8 lakh crore.

As the Reserve Bank continues to pressure banks to recognise hidden bad loans, these numbers will only rise. Bad loans have dented the profitability of banks and their ability to make fresh loans to those who deserve it.

Another consequence is that interest rates on loans to all types of borrowers, including ordinary households, stay high as banks try to cover their losses. As a result savers, too, receive lower interest on their deposits.

The higher provisioning for stressed assets erode banks’ capital levels, which in case of public sector banks, have to be replaced out of tax payers’ money. Entrepreneurs whose loans turn bad because of adverse business conditions get stuck with never-ending litigation processes preventing them from moving on to other ventures.

Employees and other claimants do not get their dues till the long legal process gets over, leading to continuing hardships of all stakeholders.

The new law paves the way for speedy resolution of insolvency within 180 days; down from the average 4.3 years. An insolvency process can be initiated by not just the company in trouble or its bankers, but also by unsecured creditors such as suppliers and even employees.

The National Company Law Tribunal will consider the application for insolvency resolution and hand over management control of the firm to an insolvency professional. Next, a creditors’ committee will decide, within 180 days, whether a resolution (through restructuring of the debt) is possible or the firms’ assets have to be liquidated.

During this period the insolvency professional will ensure that the original owners do not indulge in any asset-stripping. Leaving the resolution decision in the hands of the creditors ensures that, unlike in the past, the government does not interfere with business decisions of creditors.

Of course, there are appellate authorities envisaged in the law to handle appeals. Debt Recovery Tribunals will take up insolvency of individuals. These procedures are in line with the best practices across the world.

There are three ‘game changing’ aspects in the law. The time bound manner in which the resolution will be completed ensures higher chances of either survival of the business or realising greater value from the liquidation proceeds. Currently the recovery rate for secured creditors is only 25.7 cents on the dollar in India compared with the OECD average of 72.3. Second, secured and unsecured creditors will stand ahead of the government in the pecking order of claims. This will encourage more investment in corporate bonds–an important boost to the moribund corporate debt market in India. Third, companies with more than 100 employees can initiate voluntary liquidation proceedings. This gives troubled firms an exit option without having to seek permission of the government as in the past.

Of course all this is going to take time. A team of insolvency professionals and agencies have to develop in the country along with the Insolvency and Bankruptcy Board of India to regulate them.

Information utilities have to be set up that will be the repositories of data on credit and collateral in order to aid the insolvency process. But once the infrastructure is in place, the economy will come out of what the Economic Survey called ‘the chakravyuha challenge’, where it is easy for businesses to enter but difficult to come out of.

Ease of exiting business will help India improve its current position of 130 in the ease of doing business rankings. But, concerns are there. Can a small default lead to beginning of an insolvency process? Will part default or deferred payment constitute default? Unless this is clarified, frequent or frivolous referrals may weigh down the NCLT and the already overburdened DRTs.

But, if this minor gripe is resolved, the law will do wonders for the economy. It will help the banking system to resolve bad loans quickly. Banks will feel more confident in lending and pass on the benefits of monetary policy signals to the markets.

The law will give a big boost to entrepreneurship in India, as failed businesses do not always mean failed businesspersons. Entrepreneurs will be able to take risks and, if they fail, they can make fresh starts. The prime minister has spoken about a personal sector as the new pillar of the economy comprising of startups and entrepreneurs.

Proper implementation of the insolvency and bankruptcy code will breathe life into this sector and add at least 150 basis points to India’s GDP growth.

The writer is professor of economics, IIM Kozhikode.

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The Week

Topics : #economy | #banking

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