Industrial Sickness - Problem of Growth, Business Environment Video Lecture | Business Environment - B Com

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hello and welcome to today's episode I'm
VP Tunisia teaching economics in Delhi
College of Arts and Commerce Delhi
University following independence in
1947 India has made create efforts to
foster industrialization with the aim of
promoting economic development javelin
hero its first prime minister had great
faith in the merits of a plant economy
which he envisaged would be the most
effective and efficient way to realize
the four long-term objectives of
industrial growth full employment
reduction of inequality and the
establishment of social justice
accordingly the first five year plan
commenced shortly after independence in
1950-51
and it has been followed by a series of
five-year plans up to the very present
however an examination of India's
industrial performance since
independence reveals that a number of
industrial units were reporting sick in
India the term six unit refers to
economically unviable firms which are
kept alive in the public interest by
means of subsidies of various kinds
since this practice is common and large
parts of the industrial sector are
affected this phenomenon is referred to
as industrial sickness to give some idea
of the scale of the problem in 1985
there were already one lakh twenty
thousand six units of which only about
sixty closed during that year this was
according to World Bank 1989 report
recognising that scarce resources were
locked up in unviable firms on a great
scale the government of India eventually
enacted the special legislation to
tackle this problem namely the sick
industrial companies special provision
Act 1985 in this backdrop today's
lecture will focus on the problem of
industrial sickness the specific
objectives of this episode would be
understanding the concepts and
tyria for identification of secured nets
factors responsible for the industrial
sickness measures adopted by the
government to tackle sickness in the
small scale and the non small scale
industrial sectors understanding the
problems with the sick industries
Companies Act Sica and finally answering
whether declaration of a unit as sick
may be used as a strategic device the
Reserve Bank of India identifies sick
industrial units on the basis of a mix
of criteria including continued cash
losses imbalances in the financial
structure and deterioration in the
liquidity according to the definition of
the Reserve Bank of India given in the
year 1978 a unit may be considered sick
if it has incurred cash losses for one
year and in the judgment of the bank
that is the RBI it is likely to continue
to incur cash losses for the current
year as well as the following year and
the unit has an imbalance in its
financial structure such as current
ratio of less than 1 is to 1 and versing
debt equity ratio certain term lending
institutions identify sickness on the
following criteria continues defaults in
meeting for consecutive half yearly
installments of interest or principle of
institutional loans continued cash
losses for a period of two years or
continued erosion in the net worth by 50
percent or more
mounting areas on account of statutory
or other liabilities for a period of one
or two years the most stringent
definition is given by the sick
industrial company's special provision
Act of 1985 which identifies a sick unit
as an industrial company being a company
registered for not less than 7 years
which has at the end of any financial
year accumulated losses equal to or
exceeding its entire net worth and has
also suffered cash losses in such
financial year and the financial year
immediately preceding such financial
year taking into consideration the above
various definitions of the sick
industrial unit
the following features may be identified
with such a unit a sick unit is one that
has incurred cash losses in the
immediately preceding two years and in
the judgment of credit institutions it
is expected to incur losses during the
current year as well this may be called
the cash loss criterion a sick unit is
one whose net worth that a sped-up share
capital plus reserves has been eroded to
the extent of at least 50% this may be
called the net worth erosion criterion a
sick unit is the one whose working
capital advance account with the banks
or other financial institutions was
irregular and this persisted over a
period of time say 12 to 18 months and
is likely to become more persistent this
may be called the working capital
criterion a sick unit is the one which
has defaulted in paying for consecutive
half-yearly or two consecutive annual
installments of principal and interest
on term loans if any this may be called
the loan repayment failure criterion a
sick unit is the one which operates
below 20% of its installed capacity this
may be called the low capacity
utilization criterion however these
definitions view sickness in terms of
extreme deterioration in the financial
health of the unit the criteria do not
want sufficiently well in advance about
the impending closure of a unit for
instance the wiping out of the entire
net worth of a unit accompanied by at
least two consecutive years of cash loss
clearly signals extreme form of sickness
which would in fact take the enterprise
to the brink of closure
similarly severe cash losses with
persistent defaults in institutional
debt servicing also indicate fairly
advanced stage of sickness on the part
of the industrial unit though this stage
would certainly precede the stage of
complete erosion of the net worth of the
unit these criteria in fact delayed the
identification process by at least a
couple of years or more
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according to literature the key factors
responsible for the emergence of
Industrial sickness are the licensing
system the promotion of priority sectors
such as small-scale or backward
industries on ideological grounds
restrictions on foreign trade and
foreign collaborations labor market
rigidities and development financing
these are discussed in detail now
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originally the license system had been
established to direct the process of
industrial growth in a resource Kazakh
anomie such as India licensing served as
an instrument for translating the broad
priorities and targets of economic
policy into concrete industrial
capacities unless a proper license was
granted it was not at the management's
discretion to establish a new
undertaking or to close down an
established one or to manufacturer a new
article or to expand capacity or change
location or import capital goods or
secure foreign collaboration to name
only a few of the most important
restrictions in particular the
industry's development and regulation
act IDR in 1951 identified a list of
industries considered important on
strategic grounds that should be
exclusively owned by the government like
arms and atomic energy railways etc
moreover some key or basic industries
like coal iron and steel and
infrastructure facilities like aircraft
ships and telephones was subject to the
control of both the national and the
state governments the rationale behind
such practice was grounded in the
mistrust of private profit maximization
and the belief that only state-owned
enterprises could reliably supply basic
needs in these fields however this
created a major cause for mismanagement
of some state-owned enterprises
fuelled by the belief that the
government would always be at the rescue
in case some failure happens it was only
the new economic policy of 1991 that
virtually dismantled licensing only
eight industries remained on the list
reserved for the public sector and
compulsory industrial licensing was
abolished for all but 16 strategic
industries
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with the objective of encouraging the
diffusion of entrepreneurship promoting
employment and improving the standard of
living in backward regions small-scale
industries SSI as well as companies
located in remote areas benefited from
preferential treatment in many respects
SSI firms were exempted from the
requirement to obtain an entry license
and were allowed to expand capacity at
their own discretion other measures in
compassed areas like infrastructure
support priority lending at concessional
rates of interest and favorable
repayment schemes lower rates of duty or
even full exemption from excise duty
technology up gradation and export
incentives furthermore the government
maintained preferential purchasing
contracts and followed a policy of
generous project reservation the extent
of small-scale product reservation rose
steadily until by 1991 the manufacturing
of 836 items was exclusively reserved
for small scale industrial undertakings
not surprisingly these forms of
favorable treatment of the small sector
led to widespread abuses of the system
the small industries were encouraged to
remain small and when they grew this
strategically split so that they
remained within the definition of
small-scale units and enjoy special
protection and incentives this
preferential treatment by the government
led to widespread sickness of the units
in the small scale sector
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India's post-independence foreign trade
policy was guided by the massive trade
protection in the course of an import
substitution search strategy import
substitution policy was based upon the
infant industry argument according to
which infant industries can neither
develop not mature without protection
from foreign competition
hence in order to provide protection to
domestic industries from the foreign
competition a complex system of import
licensing was set up supplemented by
high tariff rates under the garb of
protection the domestic industries
continued adopting policies that were
neither feasible nor profitable in the
long run which ultimately led to
widespread sickness among such protected
enterprises
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in India there are numerous labor laws
on the books
the mayor number of labor related laws
may serve as a first indicator that
labor issues assume overwhelming
importance in India according to some
economists labor problems are the major
cause of industrial sickness while
others feel that even if labor related
factors are not mainly responsible for
the emergence of industrial sickness it
would be virtually impossible to solve
any management problem without imposing
severe hardship on labor it is precisely
for this reason that the process of
restructuring is prolonged and
industrial sickness is allowed to
continue where social security systems
are in an infant State and alternative
job opportunities are very limited it is
hard to close companies and to solve the
sickness problem in a rigorous manner
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industrialization hinges upon the
availability of adequate sources of
finance because industrial undertakings
require funds to finance initial fixed
capital expenditure and working capital
needs by the time of Independence
conventional sources of finance such as
shares and debentures commercial banks
and indigenous bankers proved to be
insufficient to meet the growing demand
for capital funds with the best of
intentions to overcome such an obstacle
to Industrial Development the indian
government subsequently established
various term lending institutions like
the Industrial Finance Corporation of
India IFC I the Industrial Development
Bank of India IDBI the small industries
Development Bank of India SIDBI
and the state financial corporation SFC
etc these and other institutions have
been set up for other reasons than
short-term profit maximization rather
they are conceived in the role as
catalyst through Industrial Development
and accordingly are referred to as
development financial institutions or
deifies for short in fulfillment of
their role the df' is run programs to
promote balanced regional development to
develop priority sectors and to assist
priority customers in 1979 the
government mandated that 33 percent of
all credit extended by banks should be
reserved to certain priority sectors in
1985 this ratio was increased to 40
percent of neck loans which is also the
current ratio it is widely believed now
the consequences of direct lending
policies have been very damaging and
that such policies became an obstacle to
achieving the long-run objective of
economic growth banks and TF eyes have
been constrained in their ability to
allocate credit freely and the lack of
sufficient numbers of viable projects in
the priority sector has led to very poor
quality loans where interest rates were
subsidized and often negative in real
terms and where the creditor could not
credibly enforce loan repayment firms
would become excessively leveraged and
increasingly exposed to the risk of
default in bad states of business once
these had
actually plunged a firm into financial
distress additional loans were readily
sanctioned with the hope that grunting
even more finance would protect
outstanding claims and could thereby
ensure debt repayment at some point in
future however this hope rarely
materialized for many priority sector
Lending's and resulted in massive
sickness among these priority sectors
especially the small-scale industrial
sector some economists have categorized
these factors for industrial sickness
into two groups namely the exogenous
factors and endogenous factors some of
the exogenous factors relate to such
factors as government policies
pertaining to production prices and
distribution change in the investment
pattern following new priorities in the
plans and shortage of power transport
raw materials etc among the endogenous
factors the most important factor
causing industrial sickness has been
weak management or mismanagement in a
large number of units sickness was
caused by bad management
this causes are the problems like
diversion of funds wrong dividend policy
excessive overheads lack of sufficient
provision for depreciation over
estimation of demand bad planning etc
all of which become the cause for
sustained losses and eventual sickness
of an enterprise
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we shall now turn our attention to the
measures and policies adopt adopted by
the government to tackle the problem of
industrial sickness several policies
have been implemented by the government
for both SSI and non SSI sectors in this
regard the problem of industrial
sickness in the SSI sector needs to be
treated differently from the problem of
sickness of the large units the need is
for increasing the competitive strength
and viability of small units to tackle
the problem of rehabilitation of
potentially viable sick SSI units the
RBI constituted a working group on
November 25 2008 a man ship of Shri SS
Kohli
the then chairman of Indian banks
Association to look into the issue the
Working Group submitted its report in
May 2001 all the major recommendations
of the Working Group have been accepted
by the RBI including a change in the
definition of sick s SI units norms for
deciding on the viability of secure nets
etc the revised definition would enable
banks to take action at an early stage
for revival of the units based on the
accepted recommendations of the working
group the RBI has drawn up the revised
guidelines for rehabilitation of sick s
SI units which have been circulated On
January 16 2002 to all the banks for
implementation
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to tackle the problem of industrial
sickness in the non SSI sector report of
the working group of central trade
unions 1978 recommended that the two
relevant statutes namely the industries
development and regulation Act 1951 and
the Companies Act 1956 should be amended
to provide for deterrent penalties to
party is responsible for sickness of the
unit's and for recovering all dues
including compensation from their
corporate oblique personal assets
secondly Expedia's takeover of the
unit's likely to become sick or already
sick thirdly simultaneous financial and
management restructuring of the unit and
finally preparation and implementation
of a revival plan for the unit with
provision of the requisite funds barring
revision of the unit to the erstwhile
management the most important measure
taken by the government was the
implementation of the sick industry's
company's special provision act 1985 the
sick industrial company's special
provision Act 1985 called Sica
henceforth came into force in 1987 the
law applies to both public and private
companies which have been registered for
at least five years employ at least 50
workers and do not belong to the small
scale or ancillary sector any such
company is declared sick if it's
accumulated losses exceed its net worth
position
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the way the law is framed timing and
sequencing under Sica becomes a problem
area on its own it is a time-consuming
process as is now being explained when a
company meets the sickness criteria the
law requires it to make reference to the
board for industrial and financial
reconstruction the IFF or shot within 60
days the BI effort has to determine
within a period of another 60 days if
the company in concern is indeed sick if
it does it has to make an official
declaration on the matter it may appoint
one or more special directors to
safeguard the financial and other
interests of the firm if the presumption
of sickness is verified the be IFR has
to decide whether or not it is in
principle practicable to restore the
company to economic viability why our
reconstruction where this is not the
case it might still be in the public
interest to prevent winding up also at
this stage the be IFR has to decide
whether or not the company is able to
recover within reasonable time which
translates into long 7 to 10 years
without external expertise and without
financial assistance if the answer is
negative the be IFR appoints so called
operating agencies and charges them to
work out a scheme of suitable measures a
company may also set up an endogenous ly
determined scheme either way
rehabilitation of the sick company may
come about through one or more of the
following financial reconstruction
dismissal of the old and establishment
of a new proper management amalgamation
partial sale or lease of any industrial
undertaking owned by the company
adjustment of the labor force in
accordance with the law next the draft
plan needs to be approved not merely by
the BI effort but also by
representatives of the sick company that
is the management and the workers and by
shareholders and creditors no matter how
small this take may be since a plan can
only be sanctioned by unanimous consent
the process of revision is typically
quite time-consuming the scheme all
parties eventually agree on carefully
prescribes the necessary measures to be
taken where in general financial
assistance will play a key role
sanctioning an actual implementation of
the draft scheme then hinges on the
consent of those persons or institutions
that are required to provide financial
assistance if no approval is received
within 60 days it shall be deemed that
consent has been given finally it is
only when and if all the persons or
institutions explicitly refused to
provide financial assistance that the
board may adopt other measures including
the winding up of the sick industrial
company as it may deem fit if the be IFR
actually recommends winding up its
responsibility with respect to the sick
company comes to an end
hence the entire process of revival or
winding up of the sick unit typically
involves long 10 to 12 years which
imposes huge financial losses on the
Exchequer there is a diagram which will
explain the problem of timing and
sequencing under seeker
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considering that these were the problem
with seeker there have been other recent
measures also adopted by the government
which I will now discuss with economic
liberalisation and the new Industrial
Policy announced in 1991 it was believed
that there was a need to re-examine the
role of government in tackling the
problem of industrial sickness meddling
with the operation of in horrible
economic laws in the name of reviving
sick units may prove counterproductive
and detrimental to the effective working
of the industrial economy of the country
accordingly
several important changes have been
brought about in the government policy
relating to secure nets in recent years
emphasis has now been placed on the need
to select only such units for reviving
which are viable on strictly commercial
considerations an important change in
the policy has been a shift from ad-hoc
nursing of sick units in the past
towards making available assistance
under well integrated packages to remove
the causes of sickness this policy lays
stress on various reliefs and
concessions to be extended not only by
banks and term lending institutions but
also by the promoters government and
labor another development has been a
shift in emphasis in favour of
prevention of sickness rather than
undertaking remedial measures at a later
stage measures have also been suggested
to overcome delays in the formulation
and implementation of packages of
remedial measures
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certain firms run on the notion that
being officially declared sick entails
create advantages in particular sick
units do not have to honor their debt
contracts they are exempted from debt
repayment or other obligations for
example to suppliers lenders etc
moreover outside experts are called on
without their payment burden lying on
the unit's head to help to work out a
rehabilitation scheme in which generous
financial assistance is usually given to
this sick unit for poorly performing
firms it might therefore play to gamble
in the hope of acquiring the status of
sickness this is especially true for
potentially sick or weak firms which
have no hopes of revival and have huge
mounted debt obligations in the Indian
scenario therefore it is not unheard off
that the unit has been declared sick but
their promoters are enjoying all the
amenities of life just as before the
incidence of sickness among firms thus
is sometimes the result of conscious and
rational behavior the principal actor is
some politician who assists highly
indebted firms with further government
and TFI funds precisely in order to run
them into sickness hence the sickness
loss certainly provides several ways for
the firm stakeholders to find advantages
in sickness and thereby to get rid of
their financial responsibilities
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this episode has been an attempt to
understand the economics and politics of
industrial sickness sickness is not
defined in precise terms in the various
acts and whatever acceptable definition
does exist it is not really a definition
of sickness but the existence of various
parameters which if present would
indicate that the industrial unit is
sick
after identification of secure nets an
analysis of the factors for sickness is
done with respect to both the small
scale industries and the non small scale
industrial sectors and besides
government policies mismanagement of our
poor management of funds is found to be
one of the most important factors in
explaining the sickness of each unit
with regard to the efforts taken by the
government to tackle the problem of
industrial sickness special emphasis was
laid on the most widely used measure
based on the recommendation of the sick
industrial companies Act Sica 1985 the
problem of Sica with respect to the
timing and sequencing of revival or
winding up of a sick unit is discussed
and this paved way for certain other
recent measures that were adopted by the
government that laid emphasis on the
prevention rather than the cure of
industrial sickness finally using the
sickness policy as a strategic device by
certain firms to avoid their debt
obligations was discussed and it was
established that the incidence of
sickness can sometimes be the result of
conscious and rational behavior to a
great deal more is required to revive
the sick undertaking than is being done
today in particular one could be more
systematic about it and act faster
however in an extreme case if viability
cannot be clearly established a sick
unit should be allowed to die peacefully
without much lingering on by the
government that is all that we have for
today hope all of you have understood
what industrial sickness is that is all
have a good day bye bye
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