India Should Help Businesses Go Bust

Giving creditors what they're due.

Photographer: Ramesh Pathania/Mint via Getty Images

Prime Minister Narendra Modi wants to help Indian businesses grow. One way to do that is to help some of them go bust. Efficient bankruptcy turns idle resources back to productive use.

Unfortunately, India, a thriving market economy, has never had a unified bankruptcy law. Unwinding a failed business takes on average more than twice as long as in the West; slow-moving courts are currently processing nearly 60,000 cases. And these delays allow shadier owners to strip their company's assets, which helps explain why creditors typically recover less than 26 cents on the dollar in India, compared with more than 80 cents in the U.S.

India's Aspirations

This dysfunction deters many entrepreneurs and investors from committing to new ventures. It hurts workers by offering them little incentive to invest in upgrading their skills. And it stifles growth. By next March, stressed assets at state-owned banks, which account for 70 percent of all lending in India, are expected to reach their highest level since 2001.

To avoid classifying even more loans as nonperforming, Indian banks often roll over debts indefinitely. This "evergreening" locks up unproductive capital in a capital-starved country. It also greatly diminishes banks' appetite for new lending, which is why successive rate cuts have yet to produce a substantial boost in private investment. Until this conundrum is solved, none of Modi's other initiatives to revive growth can easily succeed. In any case, most of them are held up in parliament.

Modi's attempts to bridge differences with the opposition Congress Party have so far failed to clear the way for a critical nationwide goods-and-services tax. By contrast, the draft bankruptcy code now under consideration should be relatively uncontroversial. Its key principles limit the period for deciding whether to restructure or close down a business to 180 days (with a 90-day extension available in rare circumstances); provide for professional outside managers to run the company in the interim; and mandate that 75 percent of creditors must agree to any restructuring plan in order to stave off outright liquidation.

Getting a bankruptcy law passed might ease cooperation on other matters, including the GST. For the changes to be effective, of course, an entirely new infrastructure of tribunals, insolvency professionals and regulators would need to be established. Rules would be needed to prevent endless appeals. And before banks start ramping up lending again and entrepreneurs gain the confidence to launch new companies, the new system would have to demonstrate results. Modi shouldn't need any more incentive to get started.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.