Deregulation and decriminalisation

This post will argue that deregulation and decriminalisation of economic activities and their violations, 

A detailed history and timeline of the laudable Insolvency and Bankruptcy Code (IBC) would be an apt assessment of corporate governance and business practices in India. Promoters, big and small, have consistently tried to game the process, with no small help from the creditors, resolution professionals, tribunals and courts. When IBC was promulgated, I had blogged here arguing that given corporate India's track record such an outcome was almost inevitable. The IBC has since struggled with over-burdened and under-manned tribunals, crony capitalist practices, intimidation of RPs by promoters, poor quality and compromised RPs, and so on. 

The original IBC was a good and minimal legislation which assumed good intent by its stakeholders. However, questionable practices starting from the very first case resolved have forced the Ministry of Corporate Affairs to continuously tighten and become more prescriptive. The changes brought into Section 29A which defines those ineligible to be a resolution applicant is a case in point. 

A big worry is that promoters are using loopholes in the IBC, aided by liberal interpretations by Tribunals and Courts, to both retain control and also force large haircuts. The IBC thereby becomes a backdoor for debt-washing for connected companies, or cleaning up their balance sheets off debt at public cost using their relationships. 

As Debashis Basu wrote recently, the balance sheet of IBC therefore is not very impressive,

According to the data from the Insolvency and Bankruptcy Board of India (IBBI), in over 363 major NCLT resolutions since 2017, banks have taken an average loss of 80 per cent. Of the 4,300 cases that have been admitted to bankruptcy courts since FY17, only 8 per cent have been resolved, nearly 40 per cent are pending, and about 30 per cent have gone into liquidation. The bankruptcy resolution system is plagued with measly recoveries and long delays. The recovery figures skewed by top nine accounts, mostly steel companies, fortunately found strong acquirers from a sector riding a strong upcycle.

In the context of the IBC, the recent introduction of One Time Settlement (OTS) mechanism, under which 90% of the Committee of Creditors (CoC) decide to give the firm back to the promoter, is a case in point. Theoretically, this is a good idea given that it will help avoid the long drawn resolution process and also preserve equity. But as shown by the example of Siva Industries and Holdings Ltd which underwent OTS with the promoter paying Rs 500 cr for a Rs 5000 cr loan, such progressive ideas cab easily get subverted in the Indian context. An oped recently summed up the challenge,

The question of whether the OTS mechanism fits within the IBC framework in India is more fraught. It can be argued that since it preserves capital, and it involves the agreement of the original lenders, it is a valuable addition to the bankruptcy process. It also takes pressure off the tribunal, which is clogged up with cases. But it must be understood that in the Indian context in particular, the OTS mechanism to settle cases can be open to subversion. If, theoretically, one group of executives at a public sector bank conspired with a corporate group to make loans that turned bad, there is no reason to suppose that those same executives will suddenly be models of integrity when they have to make decisions regarding an OTS. The theoretical possibility therefore exists that promoters could borrow money from banks, take it out of the company, and then use the OTS mechanism to have the banks take a massive haircut on the loans — all with minimal legal oversight.

The oped is misleading in confining this problem unfairly to public sector banks, since the biggest banking scandals in recent times have been those at ICICI and Yes Bank. 

All this raises an important question of deregulation and decriminalisation. 

As an analytical framework, criminalisation is a symptom of lack of trust which is the source for excess regulation. Criminalisation becomes an extra layer of deterrence to buy adherence. While having regulation is one policy feature, criminalisation of failure to adhere to them is another distinct policy feature. 

We could seek to combat/address each of these features separately, or jointly. But in the prevailing circumstances, as a strategy the latter (criminalisation) has a very compelling case. Let me explain. 

We, in India (and also elsewhere), are stuck in a very bad trust equilibrium. Governments don't trust businesses to follow rules, so pad up the rules with criminal culpability to increase the deterrence value. And the private sector by and large confirms this perception by losing no opportunity to cut corners on standards of service delivery, skimp on contractual obligations, influence peddling to buy access, insider trading, indulge price gouging etc at the slightest opportunity (sample the ways in which promoters have sought to sabotage IBC, or the pervasive corporate governance problems, or the rampant price gouging demonstrated across the country with the medicines and other supplies and hospital care in the recent pandemic). It does not help that the judiciary, in its own very unique and India-specific ways of intervening, adds to entrenching this bad equilibrium.

At a micro-level, let's take the example of town planning or municipal/utility services. One consistently encounters the thicket of regulatory requirements on information disclosure and document submission as well as layers of inspections before service delivery. Whenever these issues are taken up for reform, it generates strong internal opposition (btw, this is universal across bureaucrats as well as politicians, and includes both the dishonest and also the honest ones - thereby pointing to concerns beyond the standard vested interests ganging up). The lack of trust is deeply entrenched and near universally evident.

Perversely, this bad equilibrium does not hurt the larger companies (who have found stable coping mechanisms, even if they have their costs). But large companies are only a small part of the private sector landscape. This bad equilibrium badly hurts all the other companies, who form the overwhelming majority, by imposing prohibitive costs and uncertainties that encourage bad practices and discourages productivity improving actions. This applies just as much to citizens - the rich and well-off have exited the thicket, leaving the vast majority to face the frustration.

This equilibrium can be broken only through an honest public debate where both sides (or representatives from each) are made to own up their deficiencies and faults. Any discourse which blames the government alone will only entrench and harden positions on all sides and is unlikely to yield the desired results. For every strongly argued logical view on decriminalisation and deregulation from the private sector, there will be equally strongly argued practical (located in Indian context) view to the contrary within the bureaucratic establishment.

Having said all this, deregulation and decriminalisation is hardly an all-or-nothing package, and can be done in parallel. But while talking about decriminalisation, we should also acknowledge the importance of addressing the concerns raised above.

In this context, this Lant Pritchett interview nicely illustrates the problem.