When non-viable firms continue to be in the business, they also cause poor utilisation of resources and factors of production.
The World Bank’s Ease of Doing Business framework comprises of nine parameters, one of which is business exit/insolvency. This highlights the significance of exits in a market. Ease of doing business needs to unequivocally address all three stages of a firm, ie, starting, sustaining and exiting of a business. India ranks 136 out of 169 in resolving insolvency. In Mumbai, insolvency is resolved in seven years with a recovery rate of 15.1 cents on the dollar, while in Delhi insolvency is resolved in seven years with a recovery rate of 14.6 cents on the dollar.
The above data vindicates those who have constantly argued that ease of shutting businesses is of paramount and equal importance. Ease of Doing Business is not only about the effortless and rapid emergence of new businesses in an economy. It is also concerned about the ease of “exiting” business. Exit is an inevitable truth of any business cycle, and we need to equip the system to enable seamless exits. Investors and entrepreneurs need to be offered a round-trip framework for doing business. Entrepreneurs find the legal framework excessively convoluted and geared up to hamper exit, to the extent that foreign investors may not enter India for the lack of exit options. While entrepreneurs backed by organised private equity funds or venture capitalists turn to their legal experts, the real challenge lies for sick micro, small & medium enterprises (MSMEs). As per Entrepreneurship Development Institute of India Director, Sunil Shukla, it takes around 5 years to wind up the operations of a company. With an upsurge witnessed in the number of sick MSMEs, it is only imperative that we have a structured policy targeted towards ease of exiting businesses.
In our bid to create a generation of job creators, who would have a cascading potential to add jobs, we need to appreciate that no venture is free from the risk of failure. Notwithstanding the reasons that lead to the exit of an MSME, it is observed that an articulate, unambiguous exit policy is needed to facilitate painless exits. While it is counterintuitive to provide for exit enablers, it is only pragmatic that the Indian economy encourages only economically efficient businesses to exist. Lack of exit creates at least three types of costs (Bloom, N. & Jonh van Reenen, 2010) namely fiscal, opportunity and political. Inefficient firms that receive external support in the form of subsidies, are a direct cost burden for the economy. When non-viable firms continue to be in the business, they also cause poor utilisation of resources and factors of production. Political costs include hurdles to economic reforms, and influential entrepreneurs using sick firms to divert funds. If the cost of exiting a business is higher than the cost of being in one, an uncompetitive business will continue to operate in a market, defeating the very centrepiece of perfect market economy.
We appreciate that the Insolvency and Bankruptcy Code regime will see through landmark palliating insolvent firms. However, voluntary exit continues to be tiresome for solvent firms. Initiatives like single-window exit, time-bound revocation of licenses and NOCs from statutory bodies like Central Pollution Control Board, ministry of environment, forest and climate change, ministry of labour are some of the fundamental facilities need to be provided. High barriers to exit will force inefficient firms riddled with debt to be in the business. It makes a compelling case for DIPP to analyse the number of companies, that continue to be registered, yet not operate, primarily on account of the vortex of legal proceedings that get triggered in the event of deregistration. There is little rationale for ‘once upon a time’ active or dormant companies to exist and DIPP should push for dissolution of these units. These ghost companies eventually become havens for money laundering and providers of grey economy.
– Gunja Kapoor is associate fellow, while Padmaja Pati is research assistant, Pahle India Foundation