Our paracetamol for business ailments
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FRIDAY, MAY 27, 2022
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Our paracetamol for business ailments

Economy

Zahid Hussain
20 January, 2020, 12:55 pm
Last modified: 20 January, 2020, 02:58 pm

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Our paracetamol for business ailments

What we euphemistically call “policy support” is more generally known as bailouts across the globe and the Bangladeshi version of such deals include cash subsidies, tax preferences, default loan rescheduling, regulatory and trade protection and so on

Zahid Hussain
20 January, 2020, 12:55 pm
Last modified: 20 January, 2020, 02:58 pm
Photo: Rehman Asad/TBS
Photo: Rehman Asad/TBS

Policy support to business has acquired the role paracetamol plays in addressing our health problems. Generally taking the form of supporting businesses facing losses because of tougher competition from new entrants, poor risk management or sheer bad luck, it is the option of first resort in Bangladesh. Is there any business problem where policy support is not recommended as a mitigating response?

What we euphemistically call "policy support" is more generally known as bailouts across the globe.  It is not uncommon. In 2008, the US bailed out commercial banks, investment banks and the automakers. When the Indian markets crumbled on the back of the global financial crisis, the government bailed out many adversely impacted sectors. At home, we have the cases of the Farmers' Bank, BASIC Bank, and many others.

The Bangladeshi version of such deals include cash subsidies, tax preferences, default loan rescheduling, regulatory and trade protection and so on. They can be crafted to benefit virtually any sector of the economy.  Each deal has its defenders or else it would not exist.  Politicians make these "concessions" from the pocket of taxpayers.

How does this work?

Profits and losses are treated differently. When companies are profitable, the owners reap the rewards. But when the losses these companies experience are steep, taxpayers bear the burden through policy support in different forms. The first on the agenda is flat cash incentive, followed by low-cost credit, higher tolerance of default, duty waivers, tax waivers and so on. Defenders of such support contend that some sectors (garments) are too big to fail. Allowing them to collapse would have much more dire effects on the working- and middle-class population than rescues do.  

Photo: Rehman Asad/ TBS
Photo: Rehman Asad/ TBS

With declining exports in the first half of the current fiscal year, the demand for policy support has become more vociferous and ambitious.  Now the garment industry wants Tk 5 per dollar of the 25 per cent value-added over imports by the industry.  This alone could cost the government over Tk 42 billion (based on last year's garment exports). Domestic import substitution industries seek high protection combined with subsidies, cheap credit and many others. When a downturn hits members of a certain industry or the industry as a whole, policy support for all is seen almost like a birthright.  

Bailing out a business whenever it is in trouble has all the disincentive effects on business behaviour as free insurance policies do—taking excessive risks and not investing in resilience—not to speak of the significant price tag for the taxpayers. They incentivise businesses to be reckless, allow delaying a needed upgrading or a merger with a healthy acquirer and induce waiting until the firm's condition is desperate enough to deserve taxpayer assistance. The prospect of support contributes to the exact instability that the support intends to prevent. Like paracetamols, policy support is at best a palliative, not a cure. If used as a cure, it could turn out to be worse than the disease.

Policy support cannot be unconditional and permanent if it is to achieve the intended results. The government has to place strict requirements such as restructuring of organisation, freezing dividend payment, changing management and even capping executive salaries until graduating from the support. Linking improvement in corporate governance systems, in particular, play important roles in making the support a cure.

Policy support without a clear vision of the end game never solves the real problem, as our own and experience globally has shown. There are some obvious hopeless cases in Bangladesh.  All you need is to look into the financial solvency of many subsidised enterprises in energy, jute and textiles and the stunting of "infants" in the private sector.

What is an alternative way of dealing with the distressed business? It is bankruptcy with or without policy support. A firm is bankrupt when what it contractually owes is greater than the value of its assets.  Failing institutions can be reorganised or be allowed to fail under bankruptcy protection. This will mean their creditors, shareholders, and executives would take bigger hits than they would if taxpayers bailed them out. Losses have to be borne by someone. Bankruptcy avoids many of the distortions and taxpayer commitments required from the standard, more popular policy support.

There are two reasons why this option is hardly used in Bangladesh:

First, Bangladesh lacks a well-functioning insolvency framework. Globally, Bangladesh ranks 154th out of 190 economies on the ease of resolving insolvency, scoring 28.1 per cent on the Distance to Frontier (DTF) measure. This is below the South Asia regional average of 38.1 per cent. Secured creditors can recover 29.1 cents for every dollar loaned at the end of insolvency proceedings which takes four years. On the strength of the insolvency framework index, Bangladesh receives four out of 16 possible points.

Photo: Rehman Asad/ TBS
Photo: Rehman Asad/ TBS

Second, political entanglement in corporate restructuring distracts the process from discovering opportunities that market-based restructuring would have unveiled. Influential business interests manage to defend their commercial privileges against technically sound restructuring propositions. A variety of state and private actors find mutual accommodation within a broad framework of policy support under which the incumbents live and let live. Most of the interventions implemented by the government to support business redistribute funds to well-connected corporate interests. The government ends up subsidising big institutions' risky behaviour and penalising better-managed institutions' good behaviour. This can be good politics, but never good economics.

Good economics requires reforming the insolvency framework. The ongoing revisions of the 1994 Companies Act is an opportunity to improve the existing insolvency procedure of judicial reorganisation for commercial entities under the Bankruptcy Act of 1997. This could be an alternative to the available options of voluntary and involuntary liquidation under the 1994 Companies Act. It will allow both the debtor and creditors to initiate judicial reorganisation while clarifying and streamlining all liquidation related provisions.

The choice between bankruptcy and reorganisation is a choice between alternative arrangements for corporate governance. Reorganisation of viable business, when feasible, should be preferred to liquidation. Keeping viable businesses operating is among the most important goals of bankruptcy systems. A good insolvency regime inhibits premature liquidation of viable businesses. Reorganisation friendly insolvency reforms reduce both failure rates among small and medium-sized enterprises and the liquidation of profitable businesses. If financial viability of a debtor's business cannot be restored through a reorganisation plan agreed in-court or out of court, such that the business cannot continue to operate without debt forgiveness or rescheduling, the sale of the business as a going concern is the next option. Absent any interest from buyers, liquidation is inevitable.  Policy support in such cases only drains fiscal resources.  It does not cure.

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supplement / Bangladesh Economy

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