Dr. Bimal Jalan - Governor, Reserve Bank of India     


Cost of Delays: Who pays? *

In these brief comments, I propose to make some general observations on the continued relevance of legal or providing judicial approach to the problem of industrial sickness. I would also touch upon another subject of current interest, namely, the impact of the recent financial crisis in East Asia on our economy.

The Sick Industrial Companies (Special Provisions) Act or SICA, for short, is expected to deal with the rehabilitation of sick or potentially sick industrial undertakings. How this matter is handled is, of course, of vital importance for the affected companies, affected creditors as well as employees working in the affected companies. What, however, I want to emphasise is that this issue has now acquired an importance which goes, beyond the firm or micro level. The matter has acquired a new “macro-economic” relavance in recent years, as distinguished from micro-economic or firm level importance, because unlike - say in the 60s or 70s, we are relying more and more on the financial markets, such as equity and debt markets, and deposit taking institutions such as banks and financial institutions to mobilise and allocate savings.

Unlike earlier times, when the bulk of savings flowed to Government owned institutions at pre-determined interest rates, we are increasingly moving to a market-determined system with a multiplicity of financial intermediaries. In the new situation, efficient functioning of the financial markets in a transparent way has assumed great importance. If we think about it for a moment, it will also be clear that these markets cannot function efficiently unless financial contracts have a “sanctity” and capital is mobile from one sector to another. This also means that quick redressal of sickness or insolvency is essential. Creditors or investors who have invested in these companies have to accept losses in their investments but whatever securities they have either by way of collateral, or by way of guarantees, need to be realised quickly so that necessary provisions can be made, balance sheets can be clean and capital can move from one sector to another.

By any standards, our record in respecting financial contracts is pretty poor. While we have an enviable reputation for integrity and sagacity of our judicial system and legislative processes, unfortunately, the question of endemic delays still remain to be tackled. For example, a study examining 1849 companies that were in the process of liquidation in High Courts showed that in 59 per cent of these cases the procedure took more than ten years, and in 32 per cent of the cases, more than 20 years. In this situation, how can capital be mobile?

The greatest sufferers have been unpaid workers and secured creditors, as well as India’s reputation for sanctity of financial contracts. Our liquidation process has concentrated more on the process and procedures being technically right and less on outcomes. What I want to emphasise is that the cost of these interminable delays goes beyond those who are directly involved. It is the economy as a whole which pays the price as substantial resources including land, machines and workers get locked up in unproductive uses which have no social value.

The other consequence, as a result of locking up of so much capital, which does so little, is that the economy as a whole becomes much less competitive than what it should be. The cost of capital becomes higher, the risk premium becomes greater and interest rates for everyone, including Government, becomes higher.

This is the heart of the problem. All of us, individually and collectively, are paying for delays and inefficiency in settlement of financial contracts and speedy enforcement of insolvency or default cases. There is another startling statistic that I would like to bring to your notice. Over an eleven year period, between July 1987 and November 1998, BIFR considered 1954 cases as “maintainable”, i.e. nearly 2000 cases seemed to hold out some hope of reconstruction and rehabilitation. Despite BIFR’s hard work and constant attention, only 11 per cent of these are no longer sick. In other words, only 11 out of 100 cases which were believed to be viable have actually survived. An interesting point about this statistics is that even if nothing were done, there is a high probability that in any sample of 100 sick cases, 10 or 15 would have actually turned around on their own because of changes in market conditions or voluntary or negotiated restructuring. Thus, it seems that we have put in a lot of effort with very little to show for it. The reform of the system is, therefore, now essential.

The impact of globalisation and cross border insolvency on the Indian economy has acquired particular significance after the recent financial crisis in East Asia. Financial crises in one country or another or a group of countries are not unknown. They have happened with uncomfortable frequency throughout history. Among recent examples are, of course, the great depression of the 30s, or the oil crisis of the 70s, the saving and loan crisis in the US in the 90s, continuing problems in Japan since 1993 and so on.

What made the impact of East-Asian crisis different than the previous crises was that it was centered around financial issues such as weakness of the domestic financial institutions, unrealistic exchange rate management, too much reliance on short-term capital flows rather than on real economic factors such as rate of growth of the economy or macro-economic mismanagement (e.g., high inflation). At the time of crisis, in East Asia, growth was still respectable, inflation was low, and fiscal deficit was not a problem. Yet, East Asia had a devastating crisis.

The other aspect which is distinct from the earlier crises is the “contagion” effect. It became clear that in the context of globalisation and considerable mobility of capital across the globe, a crisis in any one part of the world can have an impact on other countries which may not even have a strong trading or financial relationship with the affected country. Thus, what happened in East-Asia, Russia or Brazil during 1997-98 also had its impact across the globe, including capital exporting countries like US or Europe, and the rest of Asia.

India was also affected. Fortunately, we were able to manage our affairs reasonably well by taking timely action. Our growth rate has been one of the highest in the world. Despite the East-Asian crisis, inflation has been one of the lowest (below 3 per cent) and foreign exchange reserves are at their highest.

Without going too much into detail, for information of this distinguished audience, let me just highlight a few precautions that we have been taking in order to protect our economy from contagion and undue volatility.

  • We have been extremely prudent in respect of short-term capital flows. External commercial borrowings are subject to overall ceilings as well as certain restrictions in regard to minimum maturities. As a result, our short-term debt is relatively small in relation to total external debt. Over a period of time, we have also reduced the size of external debt in relation to our GDP. Most international agencies now consider India’s debt profile to be a very healthy one.

  • We have current account convertibility but in respect of conversion of domestic assets into foreign currency assets as well as investment by residents in equity or financial instruments abroad, we have been extremely careful. In times of volatility or when there are pressures in the external markets, residents cannot move out of domestic assets into foreign assets and thus create further pressure on the exchange rate. This was the principal cause of Mexican crisis in the 90s.

  • Our banking system does not directly invest too much in assets whose prices are volatile, e.g. real estate or stock markets. Such investments are subject to careful and prudent limits. This projects our financial sector from the effect of, say a collapse in asset prices or sudden impact of exchange rate changes abroad.

  • Our banks do not have unhedged foreign exchange liabilities of sizeable magnitude. We have non-resident deposits, which are denominated in dollars, but most of them are held in assets abroad. If some funds are brought in, generally institutions and banks also take a forward position in order to cover themselves against exchange risks.

  • We have an unblemished record of honouring our debt service payments and other obligations abroad. India has never defaulted nor put in any restriction on dividend or repatriation of capital by foreign companies, non-residents or any other entity. This is an article of faith. We have deliberately followed a policy of keeping our reserves at a level, which is much higher than our external short-term or liquid liabilities. We will continue to follow the same policy in future. Those who are operating should have complete confidence that if situation changes or if they so wish, they will have no problem in taking their funds out.

All these policy measures, and the strength of our economy, have helped us to avoid the cross-country effects of insolvency abroad and has kept us relatively free from excessive contagion. It does not mean that we can now rest on our laurels. It has been said that constant vigilance is the price of liberty. It is also the best safeguard against unanticipated turbulence. We have to be vigilant, we have to be forward looking, we have to stick to our principles, we have to be completely transparent in our dealings and above all, we have to keep our economy moving in the right direction in order to avoid excessive volatility and vulnerability to external pressures.

* Excerpts from the speech delivered at Insol India Conference at New Delhi on February 26, 2000.

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