Govt reforms appear task-based; it's time to focus on structural changes to improve India's ease of doing business rankings

  • Two key areas in need of systemic reforms are enforcement of contracts and resolving insolvency

  • With cases languishing in courts for years on end with multiple appeals, legal costs escalate

  • While investors cheered the introduction of the Insolvency and Bankruptcy Code (IBC) in 2016, the massive backlog of companies going through the NCLT for liquidation or resolution shows that there are plenty of kinks in the system

The country's business environment suffered from a familiar problem in 2019. On the one hand, India now stands at a credible 63 out of 190 countries in the World Bank’s Ease of Doing Business rankings—a fifth consecutive year of improvement. More crucially, India’s overall doing business score—a more accurate reflection of its performance—is 71. On the other, there is an important caveat here: the government’s changes appear to be task-based and do not effectively tackle the structural reforms that are at the heart of investments and business.

India has improved its rankings—from rank 137 to 22 in getting electricity, 184 to 27 in dealing with construction permits and 126 to 68 in trading across borders. Yet, broader structural issues such as judicial inefficiencies, the difficulty of setting up a business and ease of exits are still cause for concern. Targeted changes are both important and necessary, but they must not distract from the core issues that facilitate ease of doing business.

Two key areas in need of systemic reforms are enforcement of contracts and resolving insolvency. While on paper there has been progress, there are several issues still that prevent these changes from being reflected in ground realities.

 Govt reforms appear task-based; its time to focus on structural changes to improve Indias ease of doing business rankings

Representational image. Reuters.

First, a complaint of several investors in India is that the judicial system fails to protect businessmen. Enforcement of contracts is a fundamental requirement of a stable and attractive business and investment destination. The World Bank Group’s Doing Business 2020 report notes that it takes 1,445 days to obtain a judgment and enforce a contract; the cost of litigation for the aggrieved party is 31 percent of the claim amount. This problem of contract enforcement feeds into a larger issue of judicial reform.

NITI Aayog and IDFC Institute’s 2017 report, Ease of Doing Business: An Enterprise Survey of Indian States, found that for pending legal disputes, enterprises reported an average duration of four years from the time the matter was taken to court.

With cases languishing in courts for years on end with multiple appeals, legal costs escalate. The Economic Survey 2017-18 estimated that the cost of infrastructure projects of six ministries in 2017 inflated by Rs 52,000 crore because of extended stay orders issued by courts. In the case of debt-financed projects, litigation-related delays raise costs by as much as 60 percent. Investors shy away from India due to this slow resolution and high case pendency. Therefore, to build trust in the business environment, carrying out structural reforms such as mindful acceptance of appeals by higher courts from lower courts, filling vacancies across the judicial system and augmenting the pecuniary jurisdiction of high courts is critical.

Second, while investors cheered the introduction of the Insolvency and Bankruptcy Code (IBC) in 2016, the massive backlog of companies going through the National Company Law Tribunal (NCLT) for liquidation or resolution shows that there are plenty of kinks in the system. So far, only 150 cases have been resolved and 600 companies have been ordered to liquidate out of the 21,000 cases that were referred to the NCLT. Moreover, the NCLT has only 27 benches to handle these cases. While more benches are being added, it is a slow process. Often, a single borrower with very little exposure stalls the resolution to the chagrin of other creditors.

The recently introduced amendments have upheld a secured creditor’s priority right on the liquidation and sale proceeds of companies in the IBC. This amendment will hopefully improve sentiment in the credit market. In addition to this amendment, a 330-day timeline for resolving bankruptcy including any litigation was also introduced. But this was struck down by the Supreme Court and is only the recommended course of action, but not mandatory. This was a significant game changer as the average time taken under the IBC is 1.6 years or 548 days against the envisaged timeline. The lack of legal precedents in the NCLT also makes it susceptible to litigation.

After the introduction of the IBC, a healthy market for bad loans emerged. At the same time, however, the backlog of cases and slow resolution has undercut this market, too. In some cases, there was interest from potential buyers but the process at the NCLT was so drawn-out that eventually, the credit dried up.

While the IBC was a structural reform that gave much-needed respite to ailing companies and their creditors, today there is an urgent need to boost the bankruptcy infrastructure, increase the scope of the IBC to cover group and individual insolvency, reduce the time taken to resolve cases and enhance the bench strength of the NCLT even further.

Plainly, while 2019 has seen considerable strides on the ease of doing business front, there are still several issues that require immediate attention. Successful structural reforms will have a cascading effect. By boosting business sentiment, they can create cross-sectoral buoyancy. Even if it doesn’t necessarily reflect in the World Bank rankings, that is perhaps the most important factor for enabling Indian firms to see business and productivity growth.

(Mistry is Co-Lead Programmes and Senior Associate and Shah,  Senior Associate at IDFC Institute, a Mumbai-based think tank)

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Updated Date: Jan 09, 2020 12:27:21 IST