My column in Wealth Insight Jan edtion is here. The unedited original follows:
Policy reform –
different strokes
Speak to a day trader in India’s equity market, and
government policy “reform” equals changes that help equity markets go up for
the day. Removal of STT (securities transaction tax) is a significant “reform”
measure. Speak to foreign brokerages (as the current finance minister often does)
and reform implies allowing foreign investment without restrictions and without
taxes in all sectors of Indian economy.
But what reform would actually change the Indian economy in a meaningful
and sustained manner – and would be good for Indian citizens and businesses? A
possible candidate is “administrative reform”.
Administrative reforms fall in the category of “most boring”
reforms. A paean on such reforms is unlikely to feature in the “must-do” list
of any equity strategist. Importantly, a government order is often all that is
needed to implement it – quite unlike many others that require “coalition
dharma” to be violated. Of many administrative reforms, one that can make an
immediate impact on the economic scenario of India is legal reform.
The economic effect
of poor legal systems
A study carried out some years ago found that in India, for
every 1000 citizens, only 1.2 cases were filed as against 17 in Malaysia and 14
in Korea. Does that mean that Indians are less prone to litigation? Details of
pending cases do not suggest so. There are approximately 3.5 million cases
pending in High Courts and over 20 million cases in subordinate courts. It
appears that lower per capita cases files is a sign of fatigue - litigants do
not expect to receive a judgement in their lifetime through the formal judicial
system – and do not approach it for resolution. This fosters informal or alternate
mechanisms – many that operate outside the legal system to “fix” problems.
There are several consequences – societal and economic.
Higher borrowing costs, lower leverage
Consumer lending in India has suffered considerably due to
lenders inability to recover dues from defaulters. Typically, lenders build in
6% or more as default risk. Borrowers of good credit worthiness are charged
almost 50% much more than they would need to pay, if defaulters could have been
legal proceeded against, and recovery achieved in a time bound manner.
Small and medium enterprises (SME’s) are even worse
affected. Since a lender knows that loan contracts cannot be legally enforced,
practices such as demanding a personal guarantee of a “promoter” for a limited liability
company have become commonplace. The purpose of limited liability itself is
lost – leading to slower growth in the organized sector.
Not only is lending cost padded up for potential losses,
multiple collateral is expected for every loan. This reduces the borrowing
power of small business in no small measure. Despite this, rising levels of
non-performing assets with banks reveals that liquidating collateral itself may
be a difficult legal process.
Delayed justice – slower development
India’s judicial system has civil suits lasting over 20
years. Decades old land disputes prevent development of prime real-estate,
leading to artificial land scarcity and higher costs of living.
Commercial contracts require quick and just remedies for
them to be effective. With no hope of achieving that in India, corporate India
has to often agree to use international jurisdiction (say Singapore) for
international contracts. This has an adverse impact on the legal business in
India. Longer term, it restricts the sovereignty of the Indian State.
Cost of justice
Another deterrent for going to court is cost. Often, cases drag
on through various levels of judiciary – with ever increasing costs of advocate
fees. The reimbursement of fees in event of a win is totally inadequate
compared to the real cost of legal representation in higher courts. Even a win
will often represent a pyrrhic victory. More often, less well-to-do litigants
will simply give up despite having a strong case – leading to miscarriage of
justice – and increasing social disparity.
Economic and human loss
Despite several judicial reform commissions and studies, the
problem of an ineffective judicial system continues to prove a drag to the
Indian economy. While no study seems to have estimated the economic costs of
delayed justice, it would not be difficult to accept that direct and indirect
effects reduce GDP growth by 0.5% to 1% per annum – and that may be a serious
underestimate.
The effect of this slower growth in terms of human cost of
unemployment - and consequent poverty, and unrealised potential of Indian youth
needs serious soul searching. Besides economic costs, demonstration effects of
unscrupulous behaviour going unpunished results in erosion in faith in rule of
law and leads to distortions in social behaviour and ethics that are far
reaching.
Simple solutions can help
In the current calendar year, the Supreme Court was on
“vacation” for 7 weeks – from 13th May till 30th June –
(13.5% of the year). Other courts too have similarly long vacation periods. This
is a colonial vestige and can be immediately removed.
While judges often lament the lack of resources and
infrastructure, courts can utilise existing infrastructure in two shifts and manage
the court calendar better to avoid having to postpone hearings repeatedly. Studies
have suggested the need for special courts to take up cases of similar nature
or requiring detailed domain knowledge. These can be implemented without
significant cost or effort.
Other more elaborate methods have also been suggested by
Judicial reform commissions. However, the urgency with which reform needs to be
implemented is sorely lacking. Perhaps judges too need reminding that like
politicians, they exist to serve the masses, not rule them!
