The Hindu Business Line : Let them have their exits and their entrances

A Mother Goose rhyme reads: "Jerry Hall, he was so small, a rat could eat him, hat and all." True, small may be beautiful, but to be small and yet survive is tough, not only for Hall but also more than half of the small players in business.

They are `susceptible to single shocks', though individual entrepreneurs take risk, borrow from friends and family, rely on personal networking and informal transactions, and manage with little access to professional advice, write Bibek Debroy and Laaveesh Bhandari in Small-Scale Industry in India Large Scale Exit Problems, Academic Foundation (www.academicfoundation.com) .

The book, edited by the duo, carries articles by experts on the malaise of bankruptcy that small-scale industries (SSIs) suffer from. Small units don't have the facility of exiting with the help of the Sick Industrial Companies Act (SICA), because that avenue is for large activities. Thus, they face "an inherently flawed system of insolvency procedures," says the introduction.

How big is the problem? "From about 23,000 sick units in 1980, the number of sick SSIs increased almost ten-fold to 2,18,000 in 1990, and by 2000 this had further increased to a little above 3,00,000." Strangely, the amount of outstanding bank credit per sick firm has stayed constant at about Rs 1,50,000 in nominal terms, points out the book. In real terms, therefore, the amount has halved.

Though statistics show that one in ten SSIs fall sick, the editors draw attention to the fact that this sickness can be as much as 60 to 80 per cent if one were to consider only non-defunct SSIs. Not only is Rs 4,600 crore of bank credit locked in these firms, but also "a large amount of capital, labour, and entrepreneurial skills."

To re-employ these resources and thus give the entrepreneur another chance, the options are insolvency and restructuring. To see business failure as a crime vitiates enterprise and "serves more as barrier to restart than to stop a loss making business."

An interesting `overview' of SSIs by Debashis Chakraborty classifies the sector into `traditional' such as khadi, sericulture, handicrafts and so on, and `modern', such as textile products, furniture, paper and metal items.

Lest you underestimate them, SSIs account for 40 per cent of industrial production and 35 per cent of exports. Calculating labour and capital productivity through net value added per employee and per unit of capital employed, the author shows that SSIs have scored better than the large ones. "While the growth rate of capital productivity in the SSI sector has been 10.41 per cent per annum during 1990-98, the same for the large-scale sector has been 4.70 per cent."

Peeyush Bajpai presents case studies from across the country "to obtain insights into the experience of entrepreneurs when their firms became bankrupt or insolvent."

He finds that what separates sick enterprises from successful ones "are just one or two negative shocks" such as "loss of an order, a strike, a delayed payment, personal tragedy and so on." Thus, it may take only a few months to become sick.

Labour problems may spread from larger units onto the smaller ones, and a well-performing SSI entrepreneur could soon find himself presiding over a sick baby, and spending as much as a third of his time in courts, and with bapus and creditors.

Sickness can be incipient, that is, beginning `with', or `of', sickness. These require `different treatments', according to B. Yerram Raju. Enterprises can be born sick because of poor planning, sanction delays, and lack of coordination among institutions.

To know the beginnings `of' sickness, you need to know the early warning signals, such as shortfall in turnover, reduction in capacity utilisation, inventory pileup, erosion in margins, arrears of loan instalments, bouncing of cheques and so on. Pay attention to project size, and don't presume product demand, exhorts Raju.

SSI credit has been the subject of many Committee reports that the book catalogues. For instance, Nayak Committee (1991-92) spoke of inventing a suitable incentive structure for managers and reducing procedural hassles.

This gave rise to the Seven Point Action Plan, about five years later, when the Budget announced the setting up of specialised SSI branches, composite loans, sensitising bank managers and such lofty measures.

It was the Abid Hussin Committee (1998) that recommended there be a separate law for SSIs. Around the same time, a High Level Committee of the RBI, chaired by S.L. Kapur found that the credit delivery system was not functioning properly.

With SSI-bashing being the penchant for the developed world, it may require a lot of political will to proffer attention on small units and let them have their exits as much as entrances.

"Do we need an insolvency code?" asks Debroy in a chapter on `The economic-legal perspective'. Constraints to efficient decision making emanate not always from statutory law, he states, referring to the plethora of "accompanying orders, rules and regulations".

Though attention has been paid to `legal constraints inhibiting entry', what he finds missing is the focus on `constraints inhibiting functioning'. Laws that cause problems can be the ones on indirect taxes, utilities, social security, bank dues and so on. Debroy's discussion of different laws makes for a good reading.

If the SSI insolvency law in India dates back to 1909 and 1920, the Netherlands' Bankruptcy Act is of 1893, and the Austrian law has its roots in the seventeenth century. Belgium has the Concordat Act of 1997 to deal with situations where companies are in fact healthy and profitable, but have "some momentary financial difficulty". Bajpai provides international insights, including how sickness is approached in the US and India.

`The way forward', as the editors of the book put it, lies in three reforms, viz. legal, administrative, and regulatory, to leverage on the "inherent flexibility" of SSIs.

They also argue for recognition of "the informality and tacitness of transactions" to reduce transaction costs. While that may fall foul with the taxman, a more attractive proposal is about a market for sick units.

At the end, you may disagree with that line in Antony and Cleopatra, "But small to greater matters must give way," and ask, "Pray, why?"

Economics@TheHindu.co.in

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Let them have their exits and their entrances