Industrial Sickness in India: Meaning, Causes and Suggested Remedies!
One of the adverse trends observable in the corporate private sector of India is the growing incidence of sickness. It is causing considerable concern to planners and policymakers. It is also putting a severe strain on the economic system, particularly on the banks.
There are various criteria of sickness. According to the criteria accepted by the Reserve Bank of India “a sick unit is one which has reported cash loss for the year of its operation and in the judgment of the financing bank is likely to incur cash loss for the current year as also in the following year.”
A major symptom of sickness is a steady fall in debt-equity ratio and an imbalance in the financial position of the unit. Simply put, a sick unit is one which is unable to support itself through the operation of internal resources (that is, earnings plough-back). As a general rule, the sick units continue to operate below the break-even point (at which total revenue = total cost) and are, thus, forced to depend on external sources for funds of their long-term survival.
Industrial sickness creates various socio-economic problems. When an industrial unit falls sick those who depend on it have to face an uncertain future. They fear loss of jobs. Even if they do not lose jobs they do not get their wages and compensation in time and are, thus, forced to live in extreme hardship.
Of course, sickness is not a special problem of India. It is, undoubtedly, a global phenomenon. Even in industrially advanced countries there are numerous cases of bankruptcy or liquidation. These sick units are nursed back to health through mergers, amalgamations, takeovers, purchase of assets, or outright nationalisation. When the-problem becomes really alarming or unmanageable, the unit is permitted to die its natural death.
Industrial sickness has become a major problem of the India’s corporate private sector. Of late, it has assumed serious proportions. A close look reveals that there are, at least, five major causes of industrial sickness, viz., promotional, managerial, technical, financial and political.
An industrial unit may become sick at its nascent stage or after working for quite some time. For instance, two major traditional industries of India, viz., cotton textiles and sugar, have fallen sick largely due to short-sighted financial and depreciation policies. Heavy capital cost escalation arising out of price inflation accentuates the problem. The historical method of cost depreciation is highly inadequate when assets are to be replaced at current cost during inflation.
Moreover, since the depreciation funds are often used to meet working capital needs, it does not become readily available for replacement of worn-out plant and equipment. The end result is that the industrial unit is constrained to operate with old and obsolete equipment, its profitability is eroded and, sooner or later, the unit is driven out of the market by the forces of competition.
External vs. Internal Causes:
The factors leading to sickness can be due to reasons of finance, technical issues, mismanagement, non-availability of raw materials, power or natural calamities or disasters such, as fire or earthquake or a combination of such factors.
The causes of industrial sickness may be divided into two broad categories:
(i) external and
External causes are those which are beyond the control of its management and seen to be relatively more important than internal causes.
The causes which have been identified so far include:
(a) Delay in land acquisition and building construction
(b) Delay in obtaining financial assistance from public financial institutions
(c) Delayed supply of machinery by the manufacturers
(d) Problems related to recruitment of technical and managerial staff
(e) Delay on the part of the Government in sanctioning licences, permits, etc.
(f) Shortages of basic inputs like power and coal. Other causes include
(g) Cost over-runs due to factors beyond the control of management
(h) Lack of demand for products or shift of demand to products of rival firms due to delays in project implementation
(i) Unsatisfactory performance by collaborators—financial and technical
(j) Large changes in the scale of operation and optimum product mix in the long run and, last but not the least
(k) Changes in the policy of the Government relating to movement of goods from one place to another within the country
The primary cause seems to be:
(i) “Lack of experience of the promoters in a specific line of activity”.
The other causes are:
(ii) Differences among various persons associated with the promotion and management of the enterprise
(iii) Mechanical defects and breakdown
(iv) Inability to purchase raw materials at an economic price and at the right time
(v) Failure to make controls effective in time, in case of deficiencies in workings
(vi) Deteriorating labour-management relations and the consequent fall in capacity utilisation
(vii) Faulty financial planning and lack of balance in the financial (capital) structure.
It is often observed that many projects are started without proper feasibility study. Hardly any long-term view of the future is taken. Instead, a project is sought to be managed on the basis of myopic vision, inadequate analysis and improper approach. Often industrial projects are started on an ad hoc basis without gathering much information about the expertise and competence needed for the purpose.
Moreover, once the construction work is started on the basis of a project report, there is no periodic assessment (or review) of the economic viability of the project. Often major changes in the political and economic environment (such as change in the party in power or change in Government) make the basic assumptions underlying the project unrealistic or inappropriate. Yet the project is made to remain operational without considering the after-effects.
So, there are various reasons that make industries sick. The prime among this is market-related. Market obsolescence is one of the prime reasons for units turning sick. A striking example is that of the jute industry, where “the non-avail- ability of raw materials and constant power shortages have made many units sick. And bankers are not normally very responsive in helping a company that has gone sick.
In Dec. 1980 the total number of sick units was 24,550, involving outstanding bank credit of Rs. 1,809 crores. As at the end of March 2000, the total number of sick units stood at 307,399 involving an outstanding bank credit of about Rs. 23,656 crores. Of these 14,793 were potentially viable, 278,423 were non-viable and the viability of the remaining 14,183 has not been decided.
Three major industries affected by industrial sickness are jute, engineering goods and textiles. Some of the industries such as the real estate, light consumer goods, automobile, diamonds and many others are reeling under the impact of steep fall in demand, inadequate supply of finance, large proportion of non-performing assets and constraints of finance due to huge amounts of funds getting blocked in ageing receivables
A number of measures have been taken to tackle the problem of industrial sickness. The importance of detection of sickness at the incipient stage has been emphasised by the RBI. The policy framework in respect of measures to deal with the problem of industrial sickness has been laid down in the guidelines issued on October 1981 (which were subsequently modified in February 1982) for guidance of administrative ministries of the Central Government, State Governments and financial institutions.
The salient features of these guidelines are the following:
(a) The administrative ministries in the Government will have specific responsibility for prevention and remedial action in relation to sickness in industrial sector within their respective charges. They will have a central role in monitoring sickness and coordinating action for revival and rehabilitation of sick units. In suitable cases, they will also establish standing committees for major industrial sectors where sickness is widespread;
(b) The financial institutions will strengthen the monitoring system so that it is possible to take timely corrective action to prevent incipient sickness. They will obtain periodical returns from the assisted units and from the Directors nominated by them on the Boards of such units. These will be analysed by the Industrial Development Bank of India and results of such analyses conveyed to the financial institutions concerned and the Government.
(c) The financial institutions and banks will initiate necessary corrective action for sick or incipient sick unit based on a diagnostic study. In case of growing sickness, the financial institutions will also consider taking of management responsibility where they are confident of restoring a unit to health. The Ministry of Finance will have to issue suitable guidelines for management;
(d) Where the banks and financial institutions are unable to prevent sickness or ensure revival of a sick unit, they will deal with their outstanding dues to the unit in accordance with the normal banking procedures. However, before doing so, they will report the matter to the Government which will decide whether the unit should be nationalised or whether any other alternative- including workers’ participation in management— can revive the undertaking.
(e) Where it is decided to nationalise the undertaking, its management may be taken over under the provisions of the Industries (Development and Regulation) Act, 1951, for a period of six months to enable the Government to take necessary steps for nationalisation.
(f) Finally the industrial undertakings presently being managed under the provisions of the Industries (Development and Regulation) Act, 1951, will also be dealt with in accordance with the above principles.
The Government has also provided certain concessions to assist revival of sick units without direct intervention. For example, the Government has amended the Income-tax Act in 1977 by addition of Section 72A by which tax benefit can be given to healthy units when they take over the sick units by amalgamation, with a view to reviving them.
The tax benefit is in the form of carry forward of the accumulated business losses and un-provided depreciation of the sick companies by the healthy companies after amalgamation. A scheme for provisions of margin money to sick units in the small-scale sector at soft terms to enable them to obtain necessary funds from banks and financial institutions to implement their revival scheme has been introduced from January 1, 1982.
Moreover, financial assistance in the form of long-term equity up to Rs. 15 lakh to units with a project cost not exceeding Rs. 10 lakhs at a nominal service charge of 1% is available to potentially viable sick SSI from the National Equity Fund.
Establishment of BIFR:
The Central Government has set up a Board for Industrial and Financial Re-construction (BIFR) with effect from 12 January 1987 in pursuance of enactment of the Sick Industrial Companies (Special Provision) Act, 1985. This is a major step for intervening at an early stage and detecting, preventing, as well as taking ameliorative, remedial and such other measures which to be taken with respect to sick and potentially viable companies.
The role of the Board for Industrial and Financial Reconstruction (BIFR) needs a re-look in the face of a steep rise in the number of industries turning sick. BIFR was constituted to facilitate the revival of industries deemed sick. When an industry turns sick, BIFR acts as an operating agency (generally the lead financial institution having the largest loan exposure among the creditors) to devise a revival strategy proposal.
Progress in the right disposal of sick company cases registered with BIFR has been slow on account of the conflicting interests between the companies and the creditors (banks and financial institutions, government bodies/agencies) and certain lacunae in the SIC A Act. The rehabilitation schemes met with 40-45% failure, as a result of which many of the cases had to be reopened.
The rate of registration/sickness increased substantially during 1997-98 due to (a) the recessionary trends prevalent in industry, (b) poor financial market conditions, and (c) the tough stance taken by banks/financial institutions (FIs) towards defaulters/potentially sick companies under their non-performing assets (NPA) accounts for rescheduling of repayments, etc.
The problem appears even more acute if we take note of potentially sick BIFR companies, as also the NPAs of FIs and banks. In fact, the NPAs of banks and others have continued to rise.
Upto 1997-98 the outstanding bank credit against sick companies has reached an abnormal’ proportion of over Rs. 23,658 crores, in March’ 2000. Over 15 lakh workers have been affected by companies turning sick.
The Industrial Reconstruction Bank of India (IRBI) set up in 1985 has initiated various steps for checking the growth of industrial sickness and helping in industrial revival. From April 1997 the name of IRBI has been changed to Industrial Investment Bank of India (IIBI). By March 2000, cumulative financial assistance sanctioned and disbursed by it stood at Rs. 10.090 crores and Rs. 7,353 crores, respectively.
A significant measure taken during 1986 was the setting up of Small Industries Development Fund (SIDF) in the IDBI. This is meant to provide special financial assistance to the small-scale sector. The Fund would be used for providing refinancing assistance not only for development, expansion and modernisation, but also for the rehabilitation of the small-scale sick industries.
The Government has set up two funds, namely the Textile Modernisation Fund and the Jute Modernisation Fund, for modernisation of the textiles and jute sector. Under these two funds, assistance is provided not only to the healthy units for modernisation at 11.5% rate of interest; but also’ to sick but potentially viable units. Special loans are given to the weak units for meeting a part of the promoters’ contribution.
Goswami Committee Report:
The Committee on Industrial Sickness and Corporate Restructuring under chairpersonship of Dr. Omkar Goswami submitted its report in July 1993.
The main recommendations of the Committee with respect to sick companies are:
(a) For early detection of sickness the definition of sickness should be changed to:-
(i) Default of 180 days or more on repayment to term lending institutions, and
(ii) irregularities in cash credits or working capital for 180 days or more.
(b) Amendment of the Urban Land (Ceiling & Regulation) Act, 1976 to improve generation of internal resources of sick companies.
(c) Empower the BIFR for speedier restructuring, winding-up and sale of assets of companies; and
(d) A sick company’s own reference of BIFR should be voluntary, not mandatory.
SICA Amendment Act, 1994:
The modifications brought in the Sick Industrial Companies (Special Provisions) Act, 1985 by the 1994 Amendment Act pertain to the changes in the definition of SICA, expansion of the term operating agency, clarification that an enquiry as to sickness shall be deemed to have commenced on receipt of a reference by the BIFR complete in all respects, scope for reverse merger, “deemed consent” after the lapse of 120 days, “single window concept” for release of funds by banks/financial institutions to the sick company, monitoring implementation of sanctioned revival schemes by BIFR, holding on operations by financial institutions/banks/State Governments, empowering the Central Government, State Government, banks, institutions, etc., to report cases of potential sickness, etc.
In the definition of sickness the period for the registration of an industrial company as sick has been reduced from seven to five years. Furthermore, the condition of incurring cash losses during the preceding two years has been waived. This means that an industrial company would be considered a sick industrial company once its net worth is completely eroded and has been registered for not less than five years.
Some of the effective measures which may be taken for revival of sick units are technical help, professional counselling and improved management. Also, the role of professionals and experienced management becomes more important in times of sickness.
In addition to technical and professional consultants, no sick industry will ever be able to recuperate without sufficient, timely and soft finance. Bankers are the key to the problem. The role of the bankers needs to be redefined and a new direction needs to be given to support aid and lift sick industrial units from the situations that befall them. It is also the level of service and support in terms of financial advice, assistance in related matters of insurance, release of hypothecated assets and timely finance.
The Sick Industrial Companies (Special Provisions) Bill, 1997, passed by Lok Sabha, introduced encouraging changes. It suggested that a time-bound procedure was to be adopted within which the scheme has to be sanctioned and BIFR would play the role of a mediator and not a court.
Technical obsolescence and financial mismanagement are also important factors that lead to industrial sickness. As per the new provisions, an opportunity will be given to get an unanimous consent to a scheme from all concerned, failing which secured creditors will attempt to form a scheme and, if all this fails, the undertaking would be sold off. Only if it is not possible to do that, the BIFR may order winding up of the company.