It isn’t enough to focus on Doing Business rankings

The enactment of the Insolvency and Bankruptcy Code itself, even without implementation, will improve India’s ranking in the World Bank report


Photo: AFP
Photo: AFP

The Indian government has taken great interest in addressing the problems of doing business in the country and improving India’s rank in the World Bank’s “Doing Business” report. One parameter evaluated in this report is “resolving insolvency”. India ranks 136 in the world in the ease of “resolving insolvency” and 130 overall. The enactment of the Insolvency and Bankruptcy Code (IBC), 2016 is likely to change this. The formal resolution process laid out in IBC is a significant improvement on current procedures. Passing the law is a big step forward. It will result in the ancillary benefit of improving India’s score in the Doing Business report but in and of itself, it will not create a framework for effective insolvency resolution in India. The key now is implementation and this will require time, planning and building adequate State capacity.

The “Doing Business” rankings reflect a de jure approach of evaluating what should happen under the stated law, as opposed to what happens in practice. The “resolving insolvency” parameter in the report consists of two indicators: the “recovery rate” and “strength of insolvency framework index”. The “strength of insolvency framework index” is calculated based on the provisions of the law. It analyses the strength of the legal framework applicable to insolvency proceedings and tests whether a country has adopted internationally recognized good practices in the area of insolvency resolution.

The “strength of insolvency framework index” is the sum of four component indices. Each component index in turn consists of sub-components ranked on a scale of 0-1. The overall index is measured on a scale of 0-16, with cumulative scores across 16 sub-components.

A simple calculation based on the provisions of IBC shows that the enactment of the law can improve India’s “strength of insolvency framework” index from 6 to 12 (see table). The corresponding score for OECD (Organisation for Economic Cooperation and Development) high-income countries is 12.1. This will place India ahead of developed economies such as Canada, France, Hong Kong, New Zealand, Netherlands, Norway, Singapore, and the UK, emerging economies such as China, Colombia, Indonesia, Malaysia, Mexico, Peru, Russia, Thailand, Turkey and Vietnam, and on a par with Australia and Sweden. This improvement will come about merely because the law has been passed, even though it has not been implemented yet.

The other element of the “resolving insolvency” parameter is “recovery rate”. This is assessed through questionnaires filled out by insolvency professionals. The questions are based on a case study such as insolvency resolution of a limited liability company in a big city. It will be interesting to see how India’s estimated “recovery rate” changes now that IBC has been enacted, given that the industry of insolvency professionals is yet to take off. Any case study should not take into account a law that has not yet been implemented.

Many times in economic measurement, we can observe the de jure status, but what really matters is the de facto outcome. This distinction is important when using the “Doing Business” scoring. In a recent paper (2015), Mary Hallward-Driemeier and Lant Pritchett, show that there is no correlation between the findings recorded in the “Doing Business” report and the ground realities of doing business. Large gaps often exist between laws and regulations on paper, and the manner in which these are enforced, especially true of developing countries.

For instance, one of the questions asked in the World Bank questionnaire is: Does the insolvency framework allow a creditor to file for the insolvency of the debtor? The answer to this is “Yes” based on the IBC provisions. In reality, the filing process may be cumbersome in the absence of a good enabling infrastructure. This may distort creditors’ incentives to trigger insolvency proceedings. These issues are ignored because of the way the question is designed.

Successful implementation of IBC is contingent upon four institutional pillars: a private competitive industry of information utilities, a private competitive industry of insolvency professionals, effective adjudication infrastructure and a well-functioning regulator. While the law has proposed setting up this infrastructure, the related provisions lack clarity and are often inadequate. For example, one strength of IBC is that it specifies finite timelines for completing various stages of the resolution process. This needs an efficient judicial infrastructure. But the law itself is silent on what is needed to set up this institutional pillar.

Excessive focus on a de jure ranking may divert attention from what is needed now, which is proper implementation of the law. Energy and resources need to be devoted to a full-fledged implementation plan that involves creating good institutions and building adequate State capacity. If getting a higher rank on the “Doing Business” report were the sole objective, cosmetic changes to the Companies Act, 2013 would have sufficed.

The success of the bankruptcy reforms should be measured by well-defined outcomes in the context of credit market development. The specific outcomes to look out for are higher values of leverage, financial debt share in total debt, non-bank debt share in financial debt and share of unsecured borrowing in total debt (goo.gl/yoFWdO). These are the metrics against which the success of IBC should be assessed—not the “Doing Business” ranking.

The author is grateful to Bhargavi Zaveri, researcher at IGIDR, for useful discussions.

Rajeswari Sengupta is assistant professor of economics at the Indira Gandhi Institute of Development Research, Mumbai.

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