Doing business in India: a report card

In September, the International Finance Corporation published the third round of its annual rankings of countries, based on an index of ease of doing business. India finished 116th out of 155 countries surveyed, behind its south Asian neighbours (Pakistan was 60, Bangladesh, 65 and Sri Lanka, 75) and China (91).

The index is constructed from multiple categories, each with sub-categories. The only area where India does relatively well is investor protection (see table).

While India?s weakest ranking is in contract enforcement, in one of the components on ?closing a business,? namely time taken, it tied with Brazil and Chad for worst performer, with the survey estimate being 10 years.

India?s industry associations responded in mixed fashion to this report card. Surprisingly, two of these questioned the rankings? validity. Only Ficci used the report to press for further reform. This is at a time when India is on the cusp of potentially major reforms in company law. The minister of state for company affairs outlined this agenda at the economic editors? conference in November. In fact, his background paper stated that it takes 15-20 years to liquidate a firm in India, not ?just? 10.

Looking at the list, one can see how incomplete trade reforms affect the measured ease of doing business. The lack of reforms in labour law and tax administration also shows up. The enormous need for micro-level reforms in governance, general administration and judicial processes is reflected in India?s low rankings in licensing, registration and contract enforcement. Rather than trying to contradict the report, Indian industry ought to welcome it as an opening to take reform forward. After all, the company affairs minister said explicitly on November 18, ?In our NCMP, we are committed to unleash the creative energies of our entrepreneurs, businessmen, professionals and productive forces of society.? That surely means making it easier to do business. Indian industry might take a leaf from the United States? history and work towards new legislation. That is what US merchants and manufacturers did, 1881 onwards, until the US passed its first permanent bankruptcy law in 1898. The conceptual approach in that law continues to be the foundation of that country?s current legislation.

The anxious industry associations might also have noted that India received high marks for reforms that have yet to show up in the rankings. Significant developments are on the horizon with respect to closing a business. Recent pieces of legislation that promise to speed up the process of restructuring or liquidation of companies in financial trouble and the consequent repeal of the Sick Industrial Companies Act of 1985, can only help. At the same time, there are question marks about the new insolvency laws. Some of these have to do with the functioning of the new institutions, such as the National Company Law Tribunal, which will replace the ineffective Board for Industrial and Financial Restructuring, but may still be subject to the typical inefficiencies of India?s governmental institutions, including bureaucratic capture.

Other issues revolve around the fundamental analytics of restructuring and liquidation. Everyone recognises the high costs of the long delays that have plagued India?s industrial exit processes. Beyond that simple insight, however, there tends to be some loss of conceptual clarity. One of the problems has been the tendency of some company promoters to strip their firms of assets, using the old legislation (which gave them protections, both unintended and intended) as a cover. However, there is a tendency to extrapolate from these cases to potentially criminalise all business failure. Many new legal provisions are designed to deal with fraud by debtors. In fact, there is documentation of the opposite problem, where debtors face harassment from creditors. In one case, the bank that had lent to a small firm made accounting and transaction errors that created financial problems for its borrower, and then used the situation to drive the previously flourishing firm towards liquidation. Bankruptcy laws and institutions must balance the interests of creditors and debtors. They must separate failure from fraud and have different responses for these. They must also separate failure (requiring liquidation) from correctable difficulties (requiring restructuring). It is not clear that the new laws, while a great improvement over the old, deal fully with these conceptual distinctions. However, even the US has continued to tinker with its bankruptcy laws for a century?there is no perfect solution.

The case of small firms also deserves more attention in India. They have little bargaining power vis-a-vis the banks that lend to them, and little expertise to draw on when things go wrong. A US-style bankruptcy code for small firms that replaces the current mix of RBI regulations and free-form negotiation would give greater protection for entrepreneurs and support more effective risk-taking. Combine that with simpler, streamlined regulation, and the result will likely be more, and more robust, small enterprises, and higher job growth.

The writer is professor of economics, University of California, Santa Cruz