It’s ironic that the Left, which has been the most vocal about the wholesale transfer of public funds from banks into the pockets of unscrupulous corporate promoters, hasn’t uttered a word about the decision to bar promoters of defaulting firms to bid for their companies in the bankruptcy courts. Because the IBC ordinance is very strict, making it extremely difficult for promoters, shady or otherwise, to regain control of their companies after they goes into bankruptcy. As it is, promoters have been running around desperately trying to unload their assets, in an attempt to pacify their bankers. The amendments to the Insolvency and Bankruptcy Code (IBC) fans the fires already lit under them.
In essence, what the new rules do is tell company owners that they must either perform or perish and if you’ve defaulted for reasons beyond your control, tough luck. A right-wing government is doing what the Left could not.
Won’t the promoter ban affect price discovery in the distressed companies market, leading to lower bids? That’s very likely, although it’ll obviously differ from case to case. It’s also true that this could lead to bigger haircuts on loans for banks. And it will surely delay the resolution process for companies already on the block.
But that’s a short-term cost. It is entirely possible that the ordinance may put the fear of God, or at least the fear of bankruptcy, into promoters, who will now do their utmost to stay out of the insolvency process and leave no stone unturned to pay their creditors on time. It will make them think twice before they over-leverage their balance sheets. It might also goad them to becoming more efficient. That will be a boon to banks in the long run.
There’s also the powerful moral hazard argument. If a promoter knows that he can afford not to repay bank loans and buy back his company in the bankruptcy court at a discount with a reduced debt burden, he has a strong incentive to run his company into the ground, perhaps by siphoning off funds from it. Banning promoters from participating in bids removes that incentive. Or at least, allowing a promoter to participate only when he repays the overdues makes him pay a stiff cost.
In short, as with the goods and services tax (GST) and the Real Estate (Regulation and Development Act), or RERA, the promoter ban too will impose a short-term cost that has to be paid to clean up the system. It is yet another attempt to save Indian capitalism from its more odious capitalists.
Does that mean the move is against crony capitalism? Yes, but there are innumerable ways in which the powerful can reward their cronies—government contracts, loosening the rules for clearances, giving away land at concessional rates, a tax exemption here, an export incentive there, accelerated depreciation and merely looking the other way are some obvious ones. If one window closes, another can always be opened. It is also entirely possible that company owners and bankers collude to restructure loans under the myriad schemes very considerately made available for the purpose, without going to the bankruptcy courts. A belief in the possibility of a crony-free capitalism is one that is based on faith alone, much like a belief in Padmavati.
Is the move, like demonetisation and GST and RERA, against a section of the business class? Yes, it is, but the point here is that while incumbent owners will be hit by the promoter ban, there is perhaps an even more powerful constituency that will welcome the move—the businessmen who are in a position to snap up the companies on the block at a discount. Incidentally, the lower prices for distressed businesses could very well attract foreign capital keen on acquiring or enlarging their foothold in India.
What is important is that the Narendra Modi government has shown once again that it doesn’t shy away from disciplining Indian business. The hope is that, in the long run, it will strengthen Indian capitalism.
True, the law of unintended consequences is likely to operate here too. Smaller distressed companies could now face liquidation, as bidders may be more interested in their assets rather than taking them over as going concerns. This issue must be addressed. And the loophole that promoters can bid if they clear the company’s overdues could paradoxically help crooked promoters, since they could use the funds they have diverted to repay the overdues.
There will be instances where owners will have to give up their businesses through no fault of their own. But then, haven’t farmers been driven to suicide because they have been unable to repay bank loans? Does the bank refrain from enforcing a mortgage because the home loan borrower has lost his job? Unlike large companies that have been favoured by serial restructuring programmes, banks show no mercy towards small businesses. And if there is an industry-wide or economy-wide problem such as a deep recession, the government and the central bank are sure to tell banks to exercise forbearance instead of going in for bankruptcy.
What matters is that the project of changing the balance of power between the creditors and the promoters, initiated by former Reserve Bank of India (RBI) governor Raghuram Rajan, is now finally weighted in favour of the creditors. To be sure, the ordinance is certain to be tested in the courts, as promoters with their backs to the wall will fight tooth and nail to stall it. But as Rajan told reporters soon after taking over as RBI governor, “Promoters do not have a divine right to stay in charge regardless of how badly they mismanage an enterprise, nor do they have the right to use the banking system to recapitalize their failed ventures." That message is being hammered home.
Manas Chakravarty looks at trends and issues in the financial markets. Respond to this column at firstname.lastname@example.org.
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