Search interesting materials

Saturday, August 12, 2017

Indian corporations have weak earnings growth

by Ajay Shah.

The broad set of Indian listed companies have a high trailing P/E ratio. This suggests that the market believes there will be high earnings growth in the future.

Some finance practitioners back out an earnings time series as Nifty market capitalisation divided by Nifty P/E. This `Implied Nifty Earnings' series shows strong growth over long time horizons.

In this article, we show that this quick-and-dirty method has an upward bias in the estimation of aggregate earnings growth. In truth, earnings growth by Indian firms has been stalled for a decade.

The trillion dollar question

Figure 1: The long time-series of the CMIE Cospi P/E ratio

The graph above shows the long time-series of the trailing P/E ratio of the CMIE Cospi index, which measures the broad market valuation. This shows that we are near some of the highest valuations in history.

These high P/E ratios would generally suggest that the stock market expects that a period of great earning growth is around the corner. It's important to look back at the recent history of earnings growth in order to evaluate this optimism.

Estimating aggregate earnings: a quick and dirty method

The P/E ratio is market capitalisation divided by earnings. Hence earnings is market capitalisation divided by the P/E ratio. It's easy to obtain a time-series of the Nifty P/E (from NSE), and the Nifty market capitalisation (obtained by summing up the market capitalisation of all Nifty member firms as seen in the CMIE database). This gives the time-series:

Figure 2: Time series of Nifty earnings (nominal rupees), quick and dirty method

As Nifty market capitalisation is measured in rupees, and the P/E ratio is dimensionless, the division yields an earnings value in rupees.

This shows pretty good growth in the earnings of the Nifty companies. In the latest few years, the growth is slow, but when compared with a decade ago, the earnings expansion is remarkable. Overall, it's a gain of 18$\times$ in 18 years, which is quite a performance. It is consistent with the common view that India is a high earnings-growth economy.

The quick and dirty method over-estimates earnings growth

The set of firms that make up Nifty changes through time. From 1996 to 2017, there were 118 firms which have been a member of Nifty atleast once.

The Nifty components at time $t_1$ are often different from those prevalent at time $t_2$. Some firms are added and some are removed. We tend to think that these are a few random fluctuations which would tend to cancel out. However, the changes in the set are non-random, and they do not cancel out.

The management of Nifty uses a rule set that roughly summarises to this: (a) A pool of eligible firms is formed where the firms have adequate stock market liquidity based on the Impact Cost measure, and (b) If an eligible firm is over 2$\times$ larger (by market capitalisation) than the smallest incumbent, then a set change is effected where the smallest incumbent is removed and the large new liquid firm is brought in. The earnings of the new entrant will generally be higher than the earnings of the smallest incumbent who is removed, as the market value of the new entrant is over 2$\times$ higher.

Here is one example, from the April-May-June 2016 quarter. In this quarter, three firms were removed (Vedanta, Cairn India, Punjab National Bank) and three firms were added (Aurobindo Pharma, Bharti Infratel and Eicher Motors) to Nifty. The remaining 47 firms were unchanged. Let's pull together the information about earnings across these changes.

Q1 2016 (Rs. million)
Q2 2016 (Rs. million)
Change (Per cent)
The 47 common firms 735,021 635,358 -14
Cairn India-2,459
Punjab National Bank-53,671
Aurobindo Pharma3,910
Bharti Infratel14,769
Eicher Motors3,371
The full 50 at a point in time 717,713 657,408 -8

Table 1: Example of how the quick and dirty method over-estimates earnings growth

The best estimator of earnings growth is that which is made using the identical set of firms observed at two points in time. In the above example, there are 47 firms in Nifty who were present at both points in time. Their aggregate earnings declined from Rs.735B to Rs.635B, a decline of 14%.

Three firms were present in Q1 2016 -- Vedanta, Cairn, PNB -- and when their earnings data is used, the aggregate earnings of the 50 firms in Nifty at that point in time works out to Rs.717B. These were replaced by Aurobindo Pharma, Bharti Infratel, Eicher Motors in Q2 2016, and when their earnings data is used, the aggregate earnings of the 50 firms in Nifty at that point in time works out to Rs.657B. The earnings growth obtained by comparing these two inconsistent sets was -8%, which is a more optimistic picture when compared with the decline of 14% for the consistent set.

There is a big discrepancy, of 6 percentage points across one quarter, and the direction of the bias in in favour of greater optimism.

The wrong method (merely comparing the profits across inconsistent sets across time) does not just introduce random noise, it is biased. It systematically overstates earnings growth of the Nifty set.

What actually happened to earnings growth of Indian firms?

How should we do this right? We exercise care with the following steps:

  1. Oil companies have extreme earnings fluctuations based on fluctuations of global crude oil prices. Their profits do not describe what is going on in India. Finance companies have problems in earnings data, such as the concealment of bad assets by banks. Hence, we look at non-oil non-finance companies only. Aggregation of accounting data for this set of firms is an excellent source of insight into India's business cycle fluctuations.
  2. At every two consecutive quarters, we construct a set of listed firms which are observed in both quarters. We sum up the earnings of this set at each of the two quarters. These two summed earnings are comparable across time, as they pertain to the identical set of firms.
  3. This yields a nominal percentage growth of aggregate earnings from one quarter to the next.
  4. We start an index at 100 and cumulate it up through time using each of these carefully constructed estimates of earnings growth.

This yields the following picture of the index of nominal aggregate earnings of the Indian corporate sector:

Figure 3: Index of earnings of all listed non-finance non-oil companies

This tells a story where the average earnings index grew from 126 in 2000 to 996 in 2010, but declined to 783.98 in the Oct-Dec 2016 quarter. Nominal earnings has stagnated in the last decade.

Ruling out an alternative explanation

There is one problem of non-comparability in the above analysis. The time-series of the P/E that was shown in Figure 1 pertains to the 2500 odd firms in the CMIE Cospi index. The time-series of earnings that's shown in Figure 3 pertains to the performance of all listed non-finance non-oil firms. These two groups are slightly different. Could this difference be an important issue? In order to examine this, we apply the careful method (that was used for Figure 3) to the full universe of all listed firms. The two series are superposed here:

Figure 4: Index of listed non-finance non-oil firms earnings and lll listed firm earnings (nominal)

This shows that there are some differences between the two groups, but this difference is small. From Oct-Dec 2006 to Oct-Dec 2016, i.e. in the latest decade, we have three estimates of the compound growth rate of earnings:

The quick and dirty method8.19%
All listed firms, the careful method-1.11%
Non-finance non-oil listed firms, the careful method      -0.41%

The compound average growth rate of earnings of all listed firms is similar to that of non-finance non-oil firms. Both estimates are roughly 8 percentage points per year below the quick and dirty method.


Fine points in handling firm data matter! It appears easy and expedient to use the Nifty market capitalisation time series, and the Nifty P/E ratio time series, to back out an estimate of Nifty earnings time series. The use of the phrase `Implied Nifty Earnings' sets off an analogy with the genius of implied volatility. However, this procedure is highly misleading. Let's superpose the wrong and the correct index time-series on one graph:

Figure 5: Superposing the quick and dirty earnings index and the careful index

The quick and dirty method suggests 18$\times$ earnings growth in 18 years. The correct method shows 8$\times$ earnings growth in the same period, and stagnation in the last decade.

The stock market believes that a great wave of earnings growth is around the corner, and India is generally considered a market with high earnings growth. However, earnings growth has been elusive for the last decade. More generally, in the past, the Indian stock market has done well on differentiating between firms -- in voting with a high P/E ratio for firms that will do well in the future -- but has fared poorly at macroeconomic thinking.

Reproducible research

This R program when run using data from CMIE Prowess DX (Mar-2017 vintage) replicates Figure 3 above.

I thank Nilesh Shah and Mahesh Vyas for valuable discussions. Pramod Sinha wrote the code and it was audited by Dhananjay Ghei and Shekhar Hari Kumar.

Monday, August 07, 2017

Interesting readings

Elements of the recovery by Ajay Shah in Business Standard, August 6, 2017.

A judgment for the ages by Chinmayi Arun in The Hindu, August 3, 2017.

Needed, a financial redressal agency editorial in The Economic Times, August 2, 2017. Also see.

India's complicated infrastructure story by Ashwini Mehra in Mint, August 2, 2017.

The Past Week Proves That Trump Is Destroying Our Democracy by Yascha Mounk in The New York Times, August 1, 2017.

Equity Derivatives versus Cash Equities in India by Jayanth Varma in Prof. Jayanth R. Varma’s Financial Markets Blog, July 31, 2017. Also see: Strategic thinking in financial markets policy, July 24, 2017.

Artificial Intelligence Is Stuck. Here's How to Move It Forward. by Gary Marcus in The New York Times, July 29, 2017. Also see: Project Tanzanite: Obtaining fundamental progress in the macroeconomics of developing countries, October 24, 2011.

Trump is something the nation did not know it needed by George F. Will in The Washington Post, July 28, 2017.

Why the Scariest Nuclear Threat May Be Coming from Inside the White House by Michael Lewis in Vanityfair, July 26, 2017.

Agrarian crisis: the challenge of a small farmer economy by Sudipto Mundle in Mint, July 21, 2017.

Emerging infectious diseases, One Health and India by Shahid Jameel in The Hindu, July 15, 2017.

Bitcoins are business as usual in Bengaluru by Aditi Phadnis in Business Standard, July 15, 2017.

History of Aadhaar: How Nandan's core team came together by Shankkar Aiyar in Yourstory, July 13, 2017.

How Do We Contend With Trump's Defiance of 'Norms'? by Emily Bazelon in The New York Times, July 11, 2017.

The Danger of Deconsolidation: The Democratic Disconnect by Roberto Stefan Foa and Yascha Mounk in Journal of democracy, July, 2016.

The empty brain by Robert Epstein in Aeon, May 18, 2016.

Wednesday, August 02, 2017

RBI's proposal for a Public Credit Registry

by Prasanth Regy.

In his recent speech at RBI's Annual Statistics Day Conference, RBI Deputy Governor Viral Acharya called for the creation of a Public Credit Registry (PCR). A PCR is a comprehensive database of all borrowings in the country. The Deputy Governor suggested that submission of information to this registry should be compulsory, and that it should be managed by the RBI. He added that the RBI intended to establish a task force for setting up the PCR.

In this article, we argue that there is no market failure that justifies the establishment of a PCR, and that there is no evidence that a PCR is required for an efficient credit market. Given that India has a surfeit of credit information entities, the creation of a new PCR in the RBI is unlikely to help.

The market failure test

The public economics approach is that markets work reasonably well in most situations. State intervention should be avoided if possible. Public choice theory suggests that a bureaucracy will try to expand its own budget and functions. A proposal by an agency that tries to enlarge itself should be treated with scepticism.

In this light, does India require a PCR run by the RBI? World Bank data shows that most countries around the world do not have PCRs. Countries such as the US, UK, Canada, Australia, New Zealand, Netherlands, Sweden, Norway, Japan, South Korea, all have highly developed credit markets without having PCRs. In these countries, private sector credit bureaus fulfil this function. The international examples the Deputy Governor cited in his speech (Thomson Reuters Dealstreet, and Dun & Bradstreet) are both private entities. The major Consumer Reporting Agencies in the US, as well as the Credit Reference Agencies in the UK, are all private entities functioning in competitive markets.

These examples suggest that the credit information industry need not suffer from market failures, as long as appropriate statutory frameworks are in place to deal with issues such as the privacy, safety, and sharing of information. The absence of PCRs in most well-functioning credit markets indicate that PCRs are not required for competitive credit markets.

Too much of a good thing

India already has a large number of entities involved in providing credit information. There are four Credit Information Companies (CICs), all regulated by the RBI. It is mandatory for institutional lenders to provide credit information to these companies. The RBI has extensive powers over CICs: even their membership fees and annual fees are decided by the RBI. Apart from this, the RBI has previously created the Central Repository of Information on Large Credits (CRILC). The Central Registry of Securitisation, Asset Reconstruction, and Security Interest (CERSAI) was created by the government to record the creation of security interests over property. The MCA21 database of the Ministry of Corporate Affairs is used to record charges on the assets of companies.

The Insolvency and Bankruptcy Code (IBC) has introduced yet another type of entity to this space: Information Utilities (IUs). The design of IUs has been thought through by the Bankruptcy Law Reforms Committee and by the Working Group on Information Utilities. The Insolvency and Bankruptcy Board of India (IBBI) has recently issued regulations that enable the registration and operation of IUs, though no IUs have started operations as of yet.

To justify a PCR, the RBI needs to explain not just what market failures it seeks to solve, but also why all these other entities were (or, in the case of IUs, will be) ineffective in solving those market failures, and why PCRs will succeed.


To make a case for having a PCR in India, the RBI needs to articulate what market failures the PCR will solve. We have seen above that market failures are not necessarily a feature of the credit information industry, and that PCRs are not necessary to achieve competitive credit markets.

In India, a number of entities exist that are related to providing credit information. They include four CICs, CRILC, CERSAI, other databases in the RBI and the Ministry of Corporate Affairs, and the upcoming IUs. Given the existence of all these entities, the RBI also needs to argue why the existing entities are not sufficient, and why yet another government agency needs to be set up. In the absence of such articulation, it is not clear that further state intervention in the form of PCRs is warranted.


World Bank, Credit Registry.

Shah, Ajay, Solving market failures through information interventions, Ajay Shah's blog, April 2015.

Government of India, The Report of the Bankruptcy Law Reforms Committee, chaired by Dr T K Vishwanathan, 4 November 2015.

Government of India, The Insolvency and Bankruptcy Code, 2016.

Ministry of Corporate Affairs, The Report Working Group on Information Utilities, chaired by K V R Murty, 11 January 2017.

Insolvency and Bankruptcy Board of India, Insolvency and Bankruptcy Board of India (Information Utilities) Regulations, 2017.


Prasanth Regy is a researcher at the National Institute of Public Finance and Policy, New Delhi.

The author would like to thank Anirudh Burman, Pratik Datta, and an anonymous referee, for helpful comments.

Saturday, July 29, 2017

Interesting readings

Strategic thinking in financial markets policy by Ajay Shah in Business Standard, July 24, 2017.

Indian poultry farms are breeding drug-resistant superbugs: study by Natalie Obiko Pearson in Mint, July 21, 2017.

Why Aadhaar transaction authentication is like signing a blank paper by Jayanth R. Varma in Jayanth R. Varma's Financial Markets Blog, July 19, 2017.

Data protection and privacy: choices before India by Rahul Sharma in Mint, July 18, 2017.

Secret Millions for 0x00A651D43B6e209F5Ada45A35F92EFC0De3A5184 by Tom Metcalf in Bloomberg, July 18, 2017.

Sadanand Dhume - A conservative's take on India by Sidin Vadukut in Mint, July 17, 2017.

The perils of endogamy: In South Asian Social Castes, a Living Lab for Genetic Disease by Steph Yin in The New York Times, July 17, 2017.

Patrick French, eminent writer, historian and biographer, joins as inaugural Dean of the School of Arts and Sciences on Ahmedabad University news, July 14, 2017.

Vibrant democracy, dormant Parliament by Deepak Nayyar in Mint, July 14, 2017.

Is CBI the handmaiden of the government? by Prashant Bhushan in The Hindu, July 14, 2017.

The Passion of Liu Xiaobo by Perry Link in New York Review of Books, July 13, 2017.

Photos: Life inside of China's massive and remote bitcoin mines by Johnny Simon in Quartz, July 12, 2017.

You asked for it, so the Bankruptcy Code is here to stay by Sridhar Ramachandran in The Economic Times, July 12, 2017.

I went on a hunter-gatherer diet to improve my gut health-and it worked by Tim Spector and Jeff Leach in Quartz, July 10, 2017.

The Uninhabitable Earth by David Wallace-Wells in Nymag, July 9, 2017.

Do Political Institutions Still Rule? Thoughts on Acemoglu and Trump by Jared Rubin in, January 26, 2017.

How a Chinese Billionaire Built Her Fortune by David Barboza in The New York Times, July 30, 2015.

Ark of Taste products in India on Slow food foundation for biodiversity in fondazioneslowfood.

Friday, July 21, 2017

Implementing loan waivers: Lessons from the 2008 All India Debt Waiver Scheme experience

by Renuka Sane and Amey Sapre.

This has been the season of farm loan waiver announcements. Starting with Uttar Pradesh, state governments of Maharashtra, Madhya Pradesh, Punjab and Karnataka have made similar announcements. Details regarding eligibility criteria for the loan waivers, and the delivery mechanisms have yet to emerge. The estimated fiscal burden of these schemes is likely to be INR 2 Lakh Crore, or close to 2% of GDP by 2019. These numbers have led to concerns regarding further deterioration of already weak state government finances, as well as the adverse impact on credit culture. Loan waivers have primarily been criticised as a bad policy decision.

In this article, we explore a less discussed aspect, that of implementation. Towards this end, we summarise key findings of the audit reports of the 2008 All India Debt Waiver Scheme. Past experience suggests that the ability of public administration in India to deliver the intended benefits is limited.

The audits of The All India Debt Waiver Scheme, 2008

The All India Agricultural Debt Waiver and Debt Relief Scheme was launched in February, 2008. The scheme was aimed at providing relief to farmers through a complete debt waiver to small and marginal farmers, and a partial relief to other farmers. The guidelines on the implementation of the scheme were issued by the Department of Financial Services (DFS) and also covered the details of the scheme such as eligibility conditions, categorisation of beneficiaries, cutoff dates for eligible amount, types of loans and the implementation structure to be followed by lending agencies.

Post implementation, the scheme was audited by the Comptroller and Auditor General of India and a report was presented to the Public Accounts Committee (PAC) of the Lok Sabha in March 2013. Based on the findings of the audit report and evidence from the DFS, the PAC submitted its report in January, 2014.

Audit findings

The CAG report pointed numerous irregularities in implementation and concluded that the scheme did not achieve its intended objectives. Irregularities in identification of beneficiaries and a cavalier approach of the nodal agencies led to the failure of the scheme. The audit was conducted in 715 bank branches covering over 90,000 accounts spread over 25 states. There were three main problems.

  1. Identification of beneficiaries: Errors in inclusion and exclusion of beneficiaries was one of the major problem in successful implementation of the 2008 loan waiver scheme. As per the audit report, inclusion of in-eligible beneficiaries and excess benefits given due to errors in identification costed nearly INR 270 crores. The Public Accounts Committee noted in its report that due to administrative indiscipline of the nodal agencies, errors in identification of beneficiaries led to problems of over payment, non-extension of benefits to eligible farmers and funds lying idle with banks. The problem was complicated further as reimbursements were given to several micro-finance institutions in violation of the guidelines of the scheme.

  2. Lack of proper documentation: For successful identification, banks were required to prepare lists of farmers eligible for loan waivers and partial relief. However, the audit report revealed that lists were prepared in a cavalier manner leading to major financial lapses in the scheme. In almost 32% of cases, nodal agencies were unable to obtain an acknowledgment from the beneficiaries on the issuance of loan waiver certificates.

  3. Lack of monitoring: The Public Accounts Committee (PAC) after taking evidence from the audits and representatives of the nodal agencies concluded that lack of monitoring and administrative indiscipline resulted in bad implementation of the scheme. In nearly 2800 cases, there was evidence of tampering of records, manipulations and forging of documents to claim benefits. Based on the CAG's audit report, the PAC ordered a re-examination of the claims in December 2012 and initiated disciplinary action against officials of nodal agencies and lending institutions. Cases were also filed against banks and recovery proceedings were initiated against NABARD and other lending institutions. In its report, the PAC states that disciplinary action was taken in over 5400 cases, and nearly 600 crores were recovered on account of financial lapses.


The findings of the audit suggest that any loan waiver scheme is likely to face at least three administrative challenges - a) of identifying and reaching beneficiaries; (b) verifying eligibility and subsequently receipts; (c) coordinating across budgets, treasuries and payment channels. State loan waivers might get more complicated as banks are not even subject to state government control, unlike the 2008 waiver which was a central government initiative. It is unclear what role (if any) the DFS will play in monitoring the banks. In addition, the audit of such schemes is time consuming, and additional resources will have to be spent on cleaning up the mess they create.

Against this background, it is useful to ask if this is the most optimal use of tax-payer funds. Leaving aside questions of credit culture, in the best of circumstances, every rupee of benefit to the farmers from the waiver, should not cost tax-payers more than a rupee. Put differently, when the government spends INR 2 lakh crore on farm waivers, the opportunity cost is the Rs.2 lakh crore plus the welfare cost in acquiring the funds. In the public finance literature, this is known as the Marginal Cost of Public Funds (MCPF). In India, the MCPF is expected to be very high. As an example, healthcare spending in India has been found to be highly inefficient. The leakages demonstrated in the 2008 debt waiver indicate that inefficiencies in administration will lead to the state waiver programs doing worse. The costs of loan waivers will outweigh the potential benefits.


Renuka Sane is a researcher at the National Institute of Public Finance and Policy. Amey Sapre is a PhD student at IIT Kanpur.

Thursday, July 13, 2017

Author: Prasanth Regy

Prasanth Regy is a researcher at the National Institute for Public Finance and Policy.

The Indian bankruptcy reform: The state of the art, 2017

by Ajay Shah and Susan Thomas.

There is an urgency about bankruptcy reforms in India. The credit boom of the mid 2000s gave rise to many failed firms. There are 14,900 non-financial firms in the CMIE database with recent accounting data, and of these, there are 1,039 firms where there is not enough cash (PBIT) to pay interest. Firms under extreme financial stress are a drag upon the economy: they are unlikely to add capital or labour or obtain productivity growth. The exit of such zombie firms will free up capital and labour, and will help improve the financial strength of healthy firms. The economic purpose of the bankruptcy process is to close the circle of life; to recycle this labour and capital into healthy firms.

The numbers above are likely to be an under-estimate. CMIE only tracks the biggest companies. There are a very large number of smaller firms which are likely to be in default. There are other organisational forms used by firms, where we do not have data, and where there will be failed firms. Demonetisation and GST have stressed firms' health. Taken together, tens of thousands of cases are likely to be headed for the bankruptcy process.

When the Insolvency and Bankruptcy Code came into effect on 28 May 2016, we raised questions about the Indian bankruptcy reforms in an overview article (Shah & Thomas, 2016). A year has passed and we revisit those question. What is the state of the play in bankruptcy reforms? What of the new process is working well, and what are the areas of concern?

When the government and RBI decided to put 12 big defaults into the IBC, some felt this demonstrated the capabilities of the new bankruptcy code. When we speak with practitioners, we get a rush of war stories and practical detail. In this article we try to distill the hopes and fears, and try to see the woods for the trees.

Inputs, Outputs, Outcomes

In public policy, it is useful to think in terms of inputs, outputs and outcomes. As an example from the field of education, the inputs are schools and teachers. The outputs are kids who enroll. The outcome is what kids know, as measured through tools like OECD PISA or Pratham's ASER.

For bankruptcy reform, once the Insolvency and Bankruptcy Code was pased, there are:

Laws (both Parliamentary law and subordinate legislation), the institutional infrastructure that is required for the IBC to work, and capabilities of various private persons.
Transactions that go through the system.
Recovery rates, the growth of broader credit markets, and the deeper changes in behaviour by private persons who borrow and lend, who will re-optimise as the bankruptcy process starts working smoothly.

The inputs perspective

Nine inputs are required for the bankrutpcy process to work, as envisaged by the Bankruptcy Law Reforms Committee (BLRC):

  1. An Amendment Act to fix the mistakes in the 2016 law.
  2. The Insolvency and Bankruptcy Board of India (IBBI) has to achieve the scale required for a high performance regulator.
  3. An array of well drafted regulations have to be issued by IBBI, with a feedback loop to feed from practical and statistical experience into a robust regulation-making process to refine the regulations.
  4. A competitive industry of private Information Utilities (IUs) has to arise.
  5. A competitive industry of private Insolvency Professional Agencies (IPAs) has to arise.
  6. A competitive industry of private Insolvency Professionals (IPs) has to arise.
  7. NCLT has to find its feet in dealing with corporate bankruptcy, and DRT has to do similarly for individual bankruptcy.
  8. Financial firms have to develop capacity on how to best to initiate the insolvency resolution process and participate in the process to ensure an optimal restructuring plans collectively.
  9. Strategic investors, distressed asset funds and private equity funds have to gain confidence about expected outcomes, either when making a bid for a going concern or when buying assets in liquidation.

Input 1: IBC Amendment Act

The IBC, 2016, suffers from conceptual errors. There are contradictions in definitions, ambiguous definitions, problems in the establishment of the IBBI, failure to establish sound processes at IBBI, the lack of legal foundations in the institutional infrastructure including insolvency professionals, insolvency professional agencies and information utilities, the lack of clear integration of secured credit (i.e. SARFAESI) into the main bankruptcy process, etc. As an example, the Working Group on Information Utilities, chaired by K. V. R. Murty (MCA, 2017) has a chapter on amendments required in the IBC in respect of information utilities.

The IBC has elementary drafting errors. Some examples of these are discussed in Malhotra & Sengupta, 2016, and Singh & Mishra, 2017. A fuller examination will reveal a larger list of such drafting errors.

The insolvency resolution and liquidation processes are procedural law where drafting errors can lead to litigation. As an example, Sibal & Shah, 2017, analyse an anomaly about antecedent transactions.

Many laws in India undergo a constitutional challenge in their initial days. Some founders/shareholders may go to the courts claiming that the IBC violates basic constitutional rights. Well funded attempts of this nature are likely with the 12 big cases. The Bombay HC dismissed an early challenge to the constitutionality of the IBC, but it did this without substantively deciding on its merits. We believe that, in the design of the IBC, sufficient thought was given towards ensuring due process and fairness to all creditors as well as the debtor. There may be certain drafting flaws in the IBC which the government may need to rapidly solve.

An Amendment Act is required which addresses these problems. In our knowledge, there is no drafting effort that is presently in motion to solve this.

Input 2: IBBI emerging as a high performance regulator

Indian regulators suffer from low State capacity. Capacity in a regulator comes about through five processes: (a) The composition and working of the board; (b) The legislative process; (c) The executive process; (d) The quasi-judicial process; (e) Reporting and accountability. Hygiene in these world-facing processes should have been codified in the IBC, but was not.

Considerable new knowledge has developed in the last decade on how to achieve State capacity by setting up such processes. A good deal of this is discussed in the report of the Working Group on the Establishment of IBBI, chaired by Ravi Narain (MCA, 2016). Many aspects of this report have yet to be brought into IBBI.

The IBBI has been set up. It has an office and a team. It has been shouldering the effort of drafting regulations on a very tight timeline. IBBI has done a particularly good job in some respects, such as the recent unveiling of a mechanism to take feedback from the public in structured documents about the regulations that it has drafted. In this, IBBI is now ahead of SEBI and RBI on good governance practices.

The regulation-making process that has been used by IBBI so far has good features. The organisation structure used at IBBI respects the difficulties associated with setting up a regulator that violates the principle of separation of powers. However, these things are not in the IBC, or in rules under IBC, or in legal instruments issued by the board. There is the danger that good practices may be fall by the wayside at a future date.

IBBI is expected to perform a certain statistical system role, and a research capacity that can use this to strengthen regulatory capacity. The systematic process of using data to improve the working of the bankruptcy process is critical to the bankruptcy reform. Statistical system work at IBBI has, however, not yet commenced.

Thus, in critical aspects, IBBI is going down the route of conventional Indian regulators such as SEBI or RBI. This will reproduce the well known infirmities of conventional Indian regulators and runs counter to what the bankruptcy reform requires.

Input 3: Sound subordinate legislation

IBBI has issued 12 pieces of subordinate legislation. There are flaws in many of these regulations, some of which are described under the other sections in this article, which will hamper the working of the bankruptcy process and of the institutional infrastructure under the Act.

A critical part of the bankruptcy reform is individual insolvency. Advancing on this front will get India away from the recurrent loan waivers which spoil the repayment culture of borrowers, raise the cost of lending to individuals, and harm credit access to individuals as well as small entrepreneurs. This part of the law has not been notified, and IBBI has not released regulations that are required to operationalise the individual insolvency component of the IBC.

Input 4: The IU industry

Under normal circumstances in an insolvency resolution process (IRP), a considerable amount of human effort is required in order to construct the list of creditors and the size of their claims. The BLRC design envisaged that this information would be stored in `information utilities (IUs)', as electronic records of credit contracts in computer systems, authenticated by creditor and debtor, which would thus eliminate delays and costs. In the Indian legal system, disputes about facts are well acknowledged as the source of delays, wastage of judicial time, and payments to lawyers. Irrepudiable records from IUs would eliminate these problems.

So far, no IU has come into operation.

One part of the problem lies in the IU regulations issued by IBBI. Prashant et. al. 2017 point out its anti-competitive features. The licensing requirement for the IUs are overly stringent, particularly for an industry where the costs of implementation are likely to be low because of the constantly decreasing costs of information technology. The regulations ask for capital requirements that are excessive, given the low levels of value at risk in the business. This is a new business with no precedent anywhere in the world. Entrants into this are are taking on the risk of failure of the business model, which must be compensated by sufficient returns to investment. The IU regulations simultaneously prescribe shareholding arrangements that deter enterpreneurs from viewing this as a viable business opportunity.

These barriers are likely to keep the Indian bankruptcy system from achieving a competitive industry of technologically capable IUs to serve multiple types of borrowers and lenders, as was visualised by the BLRC when designing the IBC. There are also other technical flaws in the IU regulations as is pointed out in Prashant et. al, 2017.

Input 5: The IPA industry

Insolvency Professional Agencies were envisaged by the BLRC as a strategy to regulate professionals through the structure of a self-regulatory organisation. However, the IPA regulations issued by IBBI have many features that vitiate this objective. As a consequence, the key players who were envisaged in this industry by the BLRC have been barred from it.

The existing players are generally passive and are not performing the role that is required of IPAs in the bankruptcy reform. In most aspects, the IPAs are going down the route of conventional Indian regulators-of-professions such as ICAI or BCI. This is likely to reproduce the widely acknowledged infirmities of these organisations, and is counter to what the bankruptcy reform had attempted to achieve by way of well regulated insolvency professionals who act in the best interest of the stakeholders in the resolution process.

IPAs are expected to create certain supervisory databases. These would be extremely valuable in the process of diagnosing problems of the bankruptcy reform and addressing them. So far this has not come into being.

Input 6: The IP industry

A set of insolvency professionals (IPs) are in place. During the IRP, if required, the IP is expected to put together a temporary management team and temporary financing (under the guidance and approval of the creditors' committee) that will stabilise the firm. These are new roles for the IPs in India, who have yet to develop capabilities to carry out these functions, either within their organisations or through an extended network. It will take time and competition for IPs to develop the teams through which they are able to fully discharge such functions, particularly in complex cases.

One way to jump-start getting such capability would have been to open the industry to foreign insolvency professionals. Their participation, particularly at the early stages of the reforms implementation, would have helped augment capacity and diffuse knowledge. Most Indian IPs are likely to be in a repeated game with promoters; foreign IPs would be particularly valuable in their ability to be harsh with promoters, which would help set the tone for the working of the bankruptcy process. The entry of foreign IPs was, however, blocked by IBBI through the subordinate legislation (Burman & Sengupta, 2016).

A critical factor in dealing with a going concern is lining up interim financing. The IBC and the subordinate legislation fail to clarify the priority of interim financing, in case the firm goes into liquidation. This has hampered the ease of access to interim finance while in the IRP.

IPs are given considerable power in the working of the IRP. There is a need for regulation of the profession in order to deal with various kinds of misbehaviour that can arise. BLRC had developed sophisticated thinking on how the IP and IPA industries should work (Burman & Roy, 2015). A lot of this did not make it into the IBC or the subordinate legislation. The IPAs as constructed today are not performing the roles required of them in regulation of IPs. While IBBI has enforced against IPs on relatively trivial violations, IBBI itself is not equipped to enforce against the real challenge, of malpractice by IPs: it cannot overcome the lack of IPA capacity.

When IPs step into the shoes of the board, and make vital decisions, they are exposed to a new level of legal risk. There is a need for insurance against these risks. This is not yet available in the market.

Input 7: The working of NCLT and DRT

While the design of the IBC has many features that will yield speed under Indian conditions, the working of NCLT/DRT is still a key factor that will determine rapid resolution as part of the Indian bankruptcy reform (Datta and Regy, 2017).

At present, we see many problems, such as inconsistencies in the behaviour of NCLT across locations, a few orders that are wrong, the lack of orders organised as structured documents, low transparency on the web, and delays. These may be a small precursor of the difficulties to come, as the case load has thus far been mild. Most defaults are, as yet, not going to the NCLT as creditors are waiting to see how the IBC works out. If the bankruptcy reform progresses, we will go from a case load of 20 per month to $10\times$ or $100\times$ as much (Damle & Regy, 2017). At this level of load, the unreconstructed NCLT will experience an organisational rout and will become the chokepoint of the bankruptcy reform.

NCLT has gone down the route of conventional courts and tribunals, which has reproduced the well acknowledged infirmities of the judicial process in India. This is not commensurate with what the bankruptcy reform requires. New knowledge needs to be brought to bear on the working of NCLT (Datta & Shah, 2015).

Input 8: The thinking of financial firms

New thinking by banks and insurance companies is required if they are to play their part in the new bankruptcy process. However, their thinking is greatly shaped by regulations. Errors in the present body of banking regulations, and the associated enforcement machinery, have created an incentive to hide bad news, to not initiate the IRP and to vote irrationally in the creditors' committee.

Sound micro-prudential regulation is one which would require that when a default takes place, the lender must rapidly mark down the value of the asset to zero. This loss should go into the Income and Expenditure statement immediately. Once this is done, there is no overhang of the past, and the lender will be rational about recoveries. Whether the asset is sold off, whether IRP is filed, how to vote on the creditors committee: All these decisions will be based on commercial considerations alone. Recoveries in the future would flow back into the Income and Expenditure statement.

These issues have yet to make their way into micro-prudential regulation of banks and insurance companies.

Assuming RBI and IRDA address these mistakes in micro-prudential regulation, we may see a new cycle being established within two years. New defaults should immediately show up as expenditure, and there would be a flow of cash from old defaults where the bankruptcy process has been completed. This is the opposite of the present arrangement, where it is claimed that all loans are profitable other than some old loans which induce losses.

In the case of NAV-based financial firms, such as mutual funds and pension funds, the event of default should influence the marked-to-market (MTM) prices even if the secondary market for the bond is not liquid. Here also, the bias in micro-prudential regulation should be to mark down the prices to near zero values quickly. This will create incentives for these funds to sell off these assets to distressed debt funds, when these transactions would yield a price that exceeds the MTM price that was used internally.

On 4 May 2017, an Ordinance was promulgated that gave RBI powers to push banks to initiate IRP. There is less to it than meets the eye (Datta & Sengupta, 2017). Backseat driving in a few cases, even if done wisely, cannot solve the regulation-induced bad behaviour of banks. There is no substitute for the slow hard work of reforms of bank regulation and supervision.

Input 9: A pool of buyers

The reforms requires the presence of two key groups of buyers. These are strategic players in the same sector, such as Jet Airways for the Kingfisher bankruptcy, and private equity funds (Shah, 2017).

Small firms lack the ability to set up dedicated teams that focus on opportunities coming up in the bankruptcy process. However, there should be teams at the top 2000 companies that watch the bankruptcy process and look to buy up useful things that come along, either in the form of going concerns or the liquidation process. Private equity funds have not yet started looking at this area on a significant scale. A few pioneers will get started. As they reap strong returns, other funds will follow, and new money will be raised to pursue these opportunities.

We could have developed these capabilities through `asset reconstruction companies' from 2002-2016, but through mistakes in the RBI regulations for these (Shah et. al. 2014), that opportunity was wasted.

As long as the IBC and its institutions are unproven, there will be a shortage of buyers, which in turn will lead to very low prices for the stressed assets. At the early stage, buyers will fear legal risk in the IBC, and will shy away from investing in building organisational capital. The critical story in the evolution of insolvency institutions in India is the emergence of thousands of skilled professionals at private equity funds and the 2000 big companies, each surrounded by an ecosystem of lawyers, accountants and consultants, armed with capital, process manuals and authorisations, who are ready to go. We are at the early stages of that journey.


If completed transactions are the output of the bankruptcy process, we are still some way from observing outputs under the IBC. So far, roughly 100 transactions have begun on their journey in the IRP. None has completed it.

The intent of the law was that six months after the initiation, the IRP should end with either a successful vote for a restructuring plan or the start of the liquidation process. The threat of value destruction in the liquidation would create a focus in the minds of the creditors committee, and thus avoid the delaying tactics that are seen in India today.

The first case, Innoventive Industries, started on 17 January 2017. Six months from that date is 16 July 2017. The delay with which this first case is completed will be an important first milestone for the bankruptcy reform.

In the coming months, a series of important milestones is anticipated:

  • First case where interim financing is obtained.
  • First vote by a creditors' committee.
  • First case to complete IRP with a super-majority in favour of a restructuring plan.
  • First case where the IP ejects the promoters from the firm
  • First case to commence liquidation.
  • First case to complete liquidation.
  • First individual insolvency to commence and complete.

An analysis of the orders passed by the NCLT (Chatterjee et. al, 2017 (forthcoming)) shows that some of these milestones will come soon. We will soon be talking in the language of cases per month and Rs.Bln. per month, in the aggregate and across categories of defaulters, which will be the output measures of the bankruptcy reform.


The proximate outcome of the bankruptcy process is the recovery rate. This expresses the NPV of recoveries on the date of default as a ratio to the face value of the debt on the date of default. What would give us a high recovery rate?

  • The lack of delays in the IBC processes;
  • The extent to which liquidation is avoided for recent defaults;
  • Competition on the buy side, i.e. the number of prospective buyers; and
  • The extent that buyers feel there is predictability and certainty in the IBC processes (i.e. the lack of a lemon model problem).

The value of a firm is greater than the liquidation value only when the firm is a going concern. Financial distress disrupts the smooth working of the firm and damages organisational capital. For this reason, it is optimal that the resolution process must commence a day after the first default. However, for the bulk of the cases which are now being brought to the IBC process, the first default is likely to have taken place a long time ago. The recovery rates obtained there are going to be low. This is not a comment on the bankruptcy reform.

We should focus on new defaults that are brought into the IBC. These are the real test of IBC, where there continues to be organisational capital, and there is an opportunity to obtain higher recovery rates. If the bankruptcy reform is successful, new defaults should result in restructuring plans that achieve the super-majority in the creditors committee, obtain a new management team, avoid liquidation, and achieve high recovery rates. An equally important issue for new defaults is the ability of the market to correctly distinguish between firms that are worth rescuing as going concerns versus those that should be put into liquidation.

In liquidation, good outcomes will be rapid sales through which the recovery rate is enhanced, and predictable flow of cash through the IBC waterfall.

Once a certain recovery rate is consistently obtained --- even if it is a low value --- this will bring a new level of confidence to lenders. The first milestone is to gain confidence that we will consistently get a (say) 20% recovery rate. The second milestone is to get the recovery rate up to better values. As these milestones are achieved, lenders will become more comfortable with a broader range of credit risk and maturity. Once many transactions are completed, we will be able to do statistical analysis of delays and recovery rates, differentiated between firms across size categories (small/medium/large) and date of default (recent/old). That will yield report cards of the Indian bankruptcy reform.

Looking forward

A story about organisational capability. Almost everything described here is a story about the capabilities of organisations: of MCA, IBBI, RBI, SEBI, NCLT, DRT, IPAs, IPs, IPAs, IUs, the biggest 2000 companies, distressed debt and private equity funds. A well functioning bankruptcy process involves all these persons skillfully playing their own part. At first, these organisational capabilities do not exist. Nine months after being setup, IBBI has just five senior officers. We need to assess gaps in organisational capabilities, and undertake steps which foster this capability, both in individual organisations as well as jointly across them all.

There is a coordination problem here: organisation $x$ tends to underinvest in building organisational capacity as it sees that the remainder of the ecosystem lacks the requisite capabilities. This hampers the rate of return to its own investments in building organisational capability. If person $i$ were sure that person $j$ was going to invest in building organisational capital, then the marginal product of investment in organisational capital for person $i$ would be higher.

Too often, new organisations in this field are emulating existing organisations. IBBI is slipping into the mores of SEBI and RBI, NCLT is built like a conventional Indian court, IPAs have become like their parents, the quality of drafting law and regulations is slipping closer to conventional Indian standards. This ends up in an environment of low expectations and low organisational capabilities. Instead, we must create a climate of excellence, and work to build high performance organisations.

The lack of data is shaping up as a big barrier. The BLRC design had envisioned a data-rich environment for bankruptcy reform. This included the NCLT issuing structured orders, IBBI building a statistical system, IPAs building supervisory databases and large-scale data capture at IUs. So far, a small part of this has begun. The fog of war is heightened, and all persons are faring poorly on strategy and tactics. The creation of data, and downstream research based on this, that has been done by projects such as Chatterjee et. al. (2017, forthcoming) is a critical element of the bankruptcy reform process.

From uncertainty to risk, and reduction of risk. As with the establishment of all markets, private persons avoid committing resources that are required for building human capital in the field. This leads to a chicken-and-egg situation: lenders are loath to take distressed firms into IRP as the buyers are missing. The buyers are missing as there are not enough available transactions.

The ex-ante legal risk as seen by buyers is considerable. They know the inputs that are required to make the bankruptcy process work. They worry about the legal challenges that may materialise even after they have supposedly got a transaction. They compensate for these risks by low-balling their bids.

As cases move through the IBC processes, uncertainty about the working of the process is reducing for private persons. In time, uncertainty will be replaced by risk: they will understand the contours of the problem and they will build some priors about the process. In due course, more private persons will gain confidence and show up as buyers, thus yielding the ultimate desired outcome: high recovery rates.

Load and load bearing capacity. Big cases present a bigger load upon the fledgling institutions (Shah, 2017). With big cases, private persons have more to lose, and will use every means, fair or foul, to avoid losses. The high powered legal teams that have come together around the Essar Steel default are consistent with this prediction. Their actions, the precedents that they establish, and the way these events reshape the prior distributions of all the players, may end up harming the Indian bankruptcy reforms. The 12 big cases are hotspots for the bankruptcy reform where many things can go wrong. We are likely to obtain particularly weak recovery rates for these, as a big load is juxtaposed against a weak load-bearing capacity.

Success is not assured. There is universal optimism about the Indian bankruptcy reform. We worry that failure has not been ruled out. If the present effort at bankruptcy reform fails, it will be a tremendous loss of confidence in the eyes of creditors, and there will be sustained cynicism on the part of the private sector about future reform efforts. The Indian bond market is an example of persistent failure of reform, leading to endemic cynicism on the part of private persons. Such cynicism leads to reduced investments by private persons in organisational capital, and thus reduces the probability of success in the future.


The Indian bankruptcy reform is work in progress and there are many areas for concern.

A lot of the policy work in the bankruptcy reform has been approached as business as usual. In the Indian policy process, business as usual results in endemic failure. The success stories of the Indian policy process, like the telecom reforms, the equity market reforms, and the New Pension System, did not come from business as usual. The visible difficulties, after the first year of the bankruptcy reforms, call for higher resourcing and improved organisation for the nine areas of inputs, and a shift away from business as usual.

As Dr. Sahoo has emphasised, we will never have a perfect law and perfect regulations and a perfect IBBI at the early stages of a reform. What matters most is the intellectual capacity in discerning incipient problems, diagnosing them swiftly and correctly, and coming out with effective solutions. The private sector is ultimately watching the policy apparatus and waiting for this feedback loop to emerge.


Resource page on the bankruptcy reforms, IGIDR Finance Research Group, 2014 onwards.

Burman, Anirudh and Shubho Roy, Building the institution of Insolvency Practitioners in India, IGIDR Working Paper, December 2015.

Burman, Anirudh and Rajeswari Sengupta, Ushering in insolvency professionals, Business Standard, 20 November 2016.

Chatterjee, Sreyan, Gausia Shaikh and Bhargavi Zaveri, A taxonomy of insolvency cases before the National Company Law Tribunal (NCLT), IGIDR Working Paper, 2017 (forthcoming).

Damle, Devendra and Prasanth Regy, Does the NCLT have enough judges?, Ajay Shah's blog, 6 April 2017.

Datta, Pratik and Prasanth Regy, Judicial procedures will make or break the Insolvency and Bankruptcy Code, Ajay Shah's blog, 24 January 2017.

Datta, Pratik and Rajeswari Sengupta, Understanding the recent Banking Regulation (Amendment) Ordinance, 2017, Ajay Shah's blog, 8 May 2017.

Datta, Pratik and Ajay Shah, How to make courts work?, Ajay Shah's blog, 22 February 2015.

Malhotra, Shefali, and Rajeswari Sengupta, Drafting hall of shame #2: Mistakes in the Insolvency and Bankruptcy Code, Ajay Shah's blog, 18 November 2016.

Ministry of Company Affairs, Building the Insolvency and Bankruptcy Board of India, Report of the Working Group on the Establishment of the IBBI, chaired by Ravi Narain, 21 October 2016.

Ministry of Company Affairs, Report of the Working Group on Information Utilities, chaired by K. V. R. Murty, 10 January 2017.

Prashant, Sumant, Prasanth Regy, Renuka Sane, Anjali Sharma and Shivangi Tyagi, Issues with the regulation of Information Utilities Ajay Shah's blog, 12 July 2017.

Shah, Ajay, Anjali Sharma and Susan Thomas, NPAs processed by asset reconstruction companies -- where did we go wrong? Ajay Shah's blog, 23 August 2014.

Shah, Ajay and Susan Thomas, Indian bankruptcy reforms : Where we are and where we go next, Ajay Shah's blog, 18 May 2016.

Shah, Ajay, The buy side in the bankruptcy process, Business Standard, 10 July 2017.

Shah, Ajay, Beware of premature load bearing, Business Standard, 26 June 2017.

Sibal, Rahul and Deep Shah, Antecedent Transactions: An Anomaly in the Insolvency and Bankruptcy Code, 2016, IndiaCorpLaw blog, 5 May 2017.

Singh, Jyoti and Arushi Mishra, Dichotomy In Opinions Of NCLT Benches -- Meaning Of "Dispute" Under The Code, Mondaq, 10 July 2017.

Ajay Shah is a researcher at the National Institute for Public Finance and Policy, and Susan Thomas is a researcher at the Indira Gandhi Institute for Development Research. The authors thank Prasanth Regy, Bhargavi Zaveri and Rajeswari Sengupta for extensive comments and discussion on these issues.

Author: Sumant Prashant

Sumant Prashant is a researcher at the National Institute for Public Finance and Policy.

Replacing FIPB with Standard Operating Procedure not enough

by Pratik Datta, Radhika Pandey and Sumant Prashant.

Foreign investment into India has always been heavily regulated, requiring approvals from various government ministries. Post-liberalisation, a need was felt to create a single window for foreign investors applying for such approvals. As a result, the Foreign Investment Promotion Board (FIPB) was established in August 1991. Initially it was placed within the Prime Minister's Office (PMO) since its credibility needed to be projected speedily. Then it shifted to Department of Industrial Policy and Promotion (DIPP) and finally to Department of Economic Affairs (DEA) in Ministry of Finance. Here it functioned as an inter-ministerial body making recommendations to the Finance Minister for grant of approval for foreign investments as per the regulations under the Foreign Exchange Management Act, 1999.

Although FIPB was a single window for the foreign investors, at the back-end it was an agglomeration of various Ministries whose views were necessary. It comprised Secretaries from Department of Economic Affairs (DEA), DIPP, Department of Commerce (DoC) Ministry of External Affairs (MEA), Ministry of Overseas Indian Affairs (MOIA), Department of Revenue (DoR) and Ministry of Small, Medium and Micro Enterprises. Depending on the sector to which the investment proposal pertained, the concerned Ministry would also be asked to give comments. At times, views of RBI would also be sought. Naturally, this inter-ministerial coordination process took time and frequently delayed the approval process. Consequently, FIPB ended up being seen as another bureaucratic body delaying approvals. This fuelled the demand for a better substitute.

In a recent spate of reforms, the Cabinet finally decided to scrap FIPB. Now, foreign investment in any of the eleven notified sectors would require approval from the concerned Administrative Ministry. Last week the DIPP issued a Standard Operating Procedure (SoP) for processing FDI proposals under this new regime. The most promising feature of this SoP is the 8-10 weeks time-frame within which investment applications are required to be cleared by the government ministries. But will this reform ensure timely disposal of foreign investment approvals? To answer this, it would be useful to understand the legal institutional framework within which foreign investment approvals are processed in some advanced jurisdictions.

In Australia, the decision to approve a foreign investment proposal is with the Treasurer under the Foreign Acquisitions and Takeovers Act, 1975. When making such decision, the Treasurer is advised by the Foreign Investment Review Board (FIRB), which examines foreign investment proposals and advises on the national interest implications. Section 77 of the 1975 Act requires the Treasurer to make his decision within 30 days, which can be extended by 90 days. The Treasurer has to give reasons for rejecting substantial commercial proposals, which are published in Treasurer's press release.

In Canada, the decision to approve a foreign investment proposal is with the Minister under the Investment Canada Act, 1985. While taking the decision, the Minister is advised by the Director of Investments. A foreign investor is required to notify the Director before making an investment or within 30 days of making the investment. The investment proposal is subject to review only if the Director sends a notice for review to the foreign investor within 21 days. The Minister has 45 days to determine whether or not to allow the investment. The Minister can unilaterally extend the 45 day period by an additional 30 days by sending a notice to the investor prior to the expiration of the initial 45 day period. Further extensions are permitted if both the investor and the Minister agree. If no approval or notice of extension is received within the designated time, the investment is deemed approved. If a foreign investor's application is rejected, the law requires the rejection order to provide reasons for such rejection. Moreover, another opportunity is given to the applicant to reapply. If the applicant is unable to make its case stronger in the second attempt, the application is finally rejected.

Evidently, in these jurisdictions the primary law imposes time-limits on the Minister approving foreign investment proposals. The primary law is also clear on the precise purpose of the government approval. For instance, national security is a major concern while approving foreign investment proposals. Moreover, the primary law also lays down clear processes to handle rejection of investment applications, making the Minister more accountable. For instance, in the US, even the President, who has the final authority to reject an investment proposal, issues a presidential order providing justification for rejection. This institutional accountability hardwired within the legislative framework enables these jurisdictions to better handle foreign investment applications.

In contrast, the Indian primary law - the Foreign Exchange Management Act, 1999 (FEMA) - does not create any institutional accountability. It does not prescribe any time-limits for the Finance Minister to dispose of foreign investment applications. Neither is FEMA clear on the purpose of government approval itself. Further, the law does not require the government to give any reasons for rejecting an investment application. These are fundamental problems in the current Indian legal institutional framework around FDI approvals.

DIPP's new SoP does not resolve any of these fundamental issues. The timelines it imposes on the Ministries for various actions are not even binding. This is because the SoP is not a legal instrument. It is merely a pdf document uploaded as a public notice on the DIPP website. That does not make it a law binding on the different Ministries in the government. At most, it is an aspirational document laying out the good intentions of the government. But if a Ministry violates it, there are no consequences or sanctions. The SoP does not in anyway change the internal incentive structure of the bureaucracy to ensure that they comply with the timelines. Therefore, the SoP fails to solve the root cause of delay at FIPB - lack of time-bound inter-ministerial coordination needed for timely grant of approvals.

Any reform to the Indian FDI approval regime must start with a complete rethinking and redesigning of the primary law - FEMA - from first principles. What is the market failure in the field of capital controls? Why is government approval even necessary? How can the government be made accountable to ensure that approval decisions are made in time-bound manner without prejudicing the main purpose of such approval?

The Financial Sector Legislative Reforms Commission (FSLRC) answered these fundamental quesions based on a holistic review of international best practices. It recommended that the objective of capital controls should be to address national security concerns. In addition the report envisaged controls of temporary nature to address crisis situation. All these aspects are codified in the chapter on capital controls in the Indian Financial Code (IFC), the draft law prepared by the FSLRC. Even as we debate the objectives of capital controls, the law on capital controls must be unambiguous in laying down an effective procedure for processing FDI proposals. As an example, Clause 243 of the IFC provides for a 90 days time-bound process to be followed by the Central Government while approving or rejecting FDI proposals. Chapter 9 of the FSLRC Handbook released by the Ministry of Finance further elaborates this approval process.

The shortcomings of FIPB were merely symptoms of a deeper problem in the primary law, FEMA. This underlying problem can be resolved only by replacing FEMA with a coherent new primary law. The new law should require government approval only for foreign investment in sectors that are strategic from the viewpoint of national security considerations or to address emergency situations such as war, or balance of payments crisis. The law should also focus on accountability of the government. It should provide clear time-bound legal processes and require the government to give reasoned orders while rejecting an investment proposal. Only such fundamental legislative reforms can help create a better substitute to FIPB.


Pratik Datta, Radhika Pandey and Sumant Prashant are researchers at the National Institute of Public Finance and Policy, New Delhi.

Wednesday, July 12, 2017

Issues with the regulation of Information Utilities

by Sumant Prashant, Prasanth Regy, Renuka Sane, Anjali Sharma, and Shivangi Tyagi.

The Insolvency and Bankruptcy Code, 2016 (IBC) provides for the speedy resolution of insolvency. The process described in IBC hinges on the assumption that information will be easily accessible to the parties involved. It is for this purpose that IBC provides for the establishment of Information Utilities (IUs). As envisaged in IBC, as well as the Bankruptcy Law Reform Committee Report, IUs are repositories of information regarding debt and default, and are required to be able to produce this information quickly. This information can then be used for many purposes. For instance, the Courts can use it to decide whether to send a debtor company into a resolution process. But for this information to be widely used, it is essential that Judges, Insolvency Professionals, and other parties must be able to trust this information implicitly.

The timelines specified by IBC are quite strict. They can be met only if IUs stand ready to provide all requisite information quickly. IBC provides little guidance on how IUs are to function, leaving the details to subordinate regulation. A Working Group on IUs was set up by the Ministry of Corporate Affairs to draft the regulations governing IUs. The Working Group's suggestions (Draft Regulations) were put up for public comments. Subsequently, an Advisory Committee discussed the public comments, and the final regulations (IU Regulations) were notified on 31st March, 2017.

However, the regulations have some fundamental problems which are likely to impede the efficient and transparent functioning of IUs. In this article, we highlight some of these problems.

Core Services

IBC defines "core services" to be a set of services every IU has to provide. This includes accepting information, authenticating and verifying it, storing it, and providing access to it. There are several issues with how the current regulations treat the provision of core services:

  1. Authorising representatives: Regulation 18(5) of the IU Regulations says:
    An information utility shall provide a registered user a functionality to enable its authorised representatives to carry on the activities in sub-regulation (1) on its behalf.
    This can be very dangerous, because of the possibility of misuse. For instance, can a bank be a registered representative of its borrower? Imagine a situation where an individual takes a loan from a lender, and one of the signatures among the many he signs in the paperwork authorises the lender to be his representative for filing information with an IU. The lender can now declare, on behalf of the borrower, that the borrower has defaulted. This is a clear conflict of interest.

    This provision lends itself to misuse by the borrower, too. A borrower may borrow money and confirm this debt in an IU, but he could later claim that some authorised representative committed fraud.

    If the functionality of enabling authorised representatives is desired, appropriate safeguards need to be added to the IU Regulations.

  2. Registering users: According to section 214(e) of IBC, IUs are supposed to get the financial information authenticated before storing. But 18(1) of the IU Regulations suggests registration only for submitting and accessing information. Does this mean that unregistered parties can authenticate information? If yes, it can lead to the danger that IU records will have little sanctity in court.

  3. Accessing information from other IUs: Regulation 19(3) of the IU Regulations states that a user can access information stored with an IU through any IU. There are several issues here:
    • This is commercially sensitive information. We are asking IUs to share information they have with all other IUs. Can the destination IU store this information or use it in any way?
    • If incomplete information is provided at the time of financial information retrieval, it will not be clear whose fault it is: the primary IU's or some more distant IU's.
    • How is this to work? How are the other IUs to provide this info "directly" to the user? Presumably the intent is to avoid routing the financial information through the destination IU, but this is contradictory and unclear.

    The Draft Regulations expect that the user (or software deployed by him) would be able to query multiple IUs inexpensively and in parallel, as happens every day in online air-ticket booking. This is a simple and straightforward architecture that avoids the problems above.

  4. Acknowledgement: Regulation 20 of the IU Regulations mandates that the IU should provide an acknowledgement. The acknowledgement is important to ensure that the IU has not manipulated or lost information. For this reason, the acknowledgement must be irrepudiable. In the Draft Regulations, this is achieved by ensuring that:
    • The acknowledgement should echo the information submitted, along with the identities of the persons submitting and authenticating the financial information;
    • It should be digitally signed by the IU.

    The IU Regulations do not contain these requirements. Without them, it is difficult to detect if the IU loses data or manipulates it in connivance with parties to the debt. The information in the IU loses its sanctity, so that judges can no longer trust it.

  5. Accepting documents as part of information submission: Regulation 20(1) of the IU Regulations says:
    An information utility shall accept information submitted by a user in Form C of the Schedule.

    Items 37, 50 and 56 of Form C lay down the documents to be attached as proof. This suggests that an IU has to accept documentary proof of the financial information being submitted.

    This is a clear problem. The design of IBC intended IUs to be an electronic repository of financial information, and not a document management system. That is why the requirement of authentication and verification of information submitted to an IU was envisaged. While it may be possible for IUs to accept documents in electronic form, even this process creates two challenges. First, storing documents will add to the cost of the IU infrastructure, which will then be passed on to users. This may make storing credit contracts in an IU expensive and may disincentivise users from doing so. This in turn will pose fundamental viability challenges for the IU business model. Second, if an IU stores financial information as well as documents, its not clear whether both will need to be matched, and if so on whom the responsibility of doing so will fall upon.

  6. Information of default: Regulation 21(2)(a) of the IU Regulations places an obligation on the IU to communicate information of default to all creditors. The question arises, which creditors: the creditors on the same IU or the creditors of that debtor on other IUs as well? The IU that has learnt of default does not know of the creditors of that debtor on other IUs, but IBC clearly intends that all creditors of a debtor should learn of default, whichever IU they are on.

    The Working Group Report thinks this through properly: an obligation is placed on each IU to inform all IUs about default, and also on each IU to inform all creditors of a defaulting debtor.

  7. Marking records as erroneous: Regulation 25(2) suggests that a user can unilaterally mark any information as erroneous. This is very dangerous. A process needs to be specified for correcting errors, and it should involve confirmation by the counterparties, just like any other information that gets to the IU.

  8. Outsourcing: Regulation 30(2)(a) of the IU Regulations says:
    An information utility shall not outsource the provision of core services to a third part service provider.

    This clause is problematic, as it can create operating inflexibility for IUs. It is unclear how broad this clause is. For example: does this mean that the IU platform cannot be outsourced, or does this outsourcing ban apply to data center and related services, technology maintenance contracts, technology support personnel, physical security including guards, etc?

    Technically, it can be read as an IU having to create every component of its core services delivery entirely on its own. This will increase the time taken for an IU to be set up, as well as add to the costs of service delivery by an IU.

    Due to this problem, the Working Group Report suggested that outsourcing of core services could be possible, subject to approval by the IBBI. Alternately, instead of a blanket ban on outsourcing, the IBBI may consider a two stage outsourcing structure. First, a narrow list of services, such as authentication and verification, may be classified as those that cannot be outsourced. For the remaining, an outsourcing model similar to the one that the RBI follows for its regulated entities may be followed. Under this model, two elements are taken into consideration by the regulator when allowing outsourcing: (1) that the standards of service for the user remain the same, whether the components of service delivery are in-house or outsourced; (2) the primary liability, even in case of outsourced services, lies with the regulated entity.

  9. Portability of records from one IU to another: Since IUs have pricing freedom, if they charge for storage, there is a danger that they may increase the fees substantially if users whose data is with them cannot move their data to another IU. To prevent such price-gouging, the Draft Regulations provide that any user may migrate his information from one IU to another IU, and the source IU is prohibited from charging for this facility. The manner in which the IU Regulations seeks to avoid this problem is through its declaration that fees should be a reasonable reflection of the service provided. But this requires the Board to form a view as to what is a reasonable fee. The solution suggested by the Working Group uses the market to achieve the same outcome in a less intrusive manner.

IU Records as Evidence

  1. IU records admissible as evidence: Regulation 30 mandates that an IU shall adopt "secure systems" (as defined in the Information and Technology Act, 2000) for information flows. However, this alone does not ensure that the information stored in IUs will be admissible as evidence.

    The Draft Regulations provided the information stored in an IU should conform to requirements laid down in section 65B of the Indian Evidence Act, 1872 (Evidence Act). This section of the Evidence Act lays down the standards for storage and maintenance of electronic records so that they are admissible as evidence.

  2. Authentication and Verification: The manner in which the terms "authentication" and "verification" have been used in the IU Regulations creates confusion. It is not clear when authentication and verification will take place, after or before the information is submitted.

    As per Regulation 20(2)(ii), on receipt of information by an IU, the submitter of information will be provided with terms and conditions of authentication and verification of information. It is not clear why the terms and conditions should be provided once the information has been submitted. The user should be aware of these terms before the information is submitted to an IU.

    Regulation 21(1) states that on receipt of information about a default the IU shall expeditiously start the process of authentication and verification. This raises following questions:

    • Why is an IU is required to act expeditiously once information of default is received? The process of authentication and verification should be followed in case of any information received and not just for default.
    • What is meant by 'expeditious'? IUs should act expeditiously whenever any information is submitted and not just in case of default.

    Regulation 23(2)(b) and (c) states that an IU shall enable the user to view the status of authentication and verification. It is not clear why the status of authentication is required after information has been submitted. IBC mandates that information should be stored only after authentication, so an IU should never store any unauthenticated information in the first place.

    The Draft Regulations addressed the above issues by obligating an IU to do the following:

    • Once information is submitted, the IU should make the information available to concerned parties for authentication.
    • An IU should verify the identity of the concerned party before allowing it to authenticate the information, so that there is no unauthorised access.
    • Once information is authenticated, the IU should store the information in such a manner that it cannot be lost or tampered with.

Obligations on IBBI

  1. Access to IU records by IBBI: Regulation 23(1)(e) provides that the IBBI will be allowed to access any information from any IU. It doesn't impose any restrictions or conditions for accessing this information.

    Since the information submitted to an IU is highly confidential and commercially sensitive, it is essential that there should be some accountability for the access of information by the IBBI. The Draft Regulations provided that in order to access information stored in an IU, the IBBI must pass a written order.

  2. Exit management plan: Regulation 39 mandates all IUs to have an exit management plan. Clause 1(a) of this regulation requires the IU to have mechanisms in place so the users can transfer information to other IUs, in case there is a shut down of one or more IUs. This regulation places the onus of transferring information on the users of IUs instead of the IBBI or the IUs themselves. This onus is inappropriately placed, since an IU will probably have a large number of users, many of whom may not have the ability to ensure the transfer of their information.

    The Draft Regulations put the onus of making sure information is transferred from one IU to another on IBBI and the IU. This ensures smooth transfer of information since they will be better equipped with resources to perform this task.


  1. Entry Barriers: Regulation 3 of the IU Regulations requires that IUs have a net worth of at least Rs 50 crores, and prevents foreign control of IUs. Regulation 8 prevents any single shareholder from holding more than 10 percent of the equity share capital of an IU. Together, these have a chilling effect on the entry of firms into this industry.

  2. Annual fees: Regulation 6(2)(e) provides that an IU must pay a fee of fifty lakh rupees to the Board annually. This is a large sum of money, especially given that the business model is unproven. This will discourage entry, limit competition, and increase the fees charged to the users.

  3. In-principle vs regular registration: Regulation 7 is unclear on the difference between a regular approval and an in-principle approval. It is also unclear as to why an applicant would choose one form of application over the other. In the Draft Regulations, the idea was that in-principle registrations would be granted faster than regular registration.

  4. Non-discrimination: Regulation 29 makes a broad provision:
    An IU shall provide services without discrimination in any manner.

    An explanation follows that mentions specific kinds of discrimination. It is not clear whether the explanation is indicative or if it is exhaustive. If exhaustive, there is no need for the broad prohibition of all discrimination above. This creates confusion for potential IUs.

  5. Fees: Regulation 32(1)(a) provides that IUs shall charge a uniform fee for providing the same service to different users. Does this mean that an IU has to charge the same to an individual lender who wants to submit information about one loan, and a large bank such as SBI, which might want to submit information about thousands of loans everyday, on the basis that the service is the same?

    Regulation 32(2)(a) provides that the fee charged for providing services shall be a reasonable reflection of the service provided. This is a very broad statement in the absence of any test of what a "reasonable reflection" is.


Many of the issues mentioned above can create serious problems for the new (and as yet unborn) industry of IUs. High entry barriers will lead to a monopolistic industry with high prices and poor service. If courts are not convinced of the accuracy of the records stored in IUs, the parties will get stuck in lengthy litigation to establish even the basic facts about the debt. IUs established under these regulations might not serve their basic purpose — the creation of an information-rich environment which would bolster speedy resolution in the country.


Government of India, The Report of the Bankruptcy Law Reforms Committee, chaired by Dr T K Vishwanathan, 4 November 2015.

Government of India, The Insolvency and Bankruptcy Code, 2016

Ministry of Corporate Affairs, The Report Working Group on Information Utilities, chaired by K V R Murty, 11 January 2017.

Insolvency and Bankruptcy Board of India, Insolvency and Bankruptcy Board of India( Information Utilities) Regulations, 2017

Sumant Prashant, Prasanth Regy, Renuka Sane, and Shivangi Tyagi are researchers at the National Institute of Public Finance and Policy, New Delhi. Anjali Sharma is a researcher at Indira Gandhi Institute of Development Research, Mumbai.