(Bagedari Sector)Business & Industry

Bangalore University

Prof Venkatesh GanapathyAssociate Professor

Presidency School of Business

Reforming the Reform Process – by R Vaidyanathan, IIM – Bangalore.

Wikipedia

Liberalisation 1991 Focus on corporate sector and government

actions

A significant portion of the national income, savings, and so on is generated by the non-corporate sector or what is referred to as the bhagidari sector.

consisting of partnership and proprietorship firms.

Reforms have to also focus on issues pertaining to this sector.

Roughly equivalent to unorganised, non agricultural sectors of the economy.

Certain bhagidari activities (in manufacturing) exist in unorganised sector.

As per details of Central Statistical Organisation, share of unorganised sector in national income (%) was

1980-81 31.92% 1990-91 32.34% 1994-95 31.51% 1996-97 34.83%

Thus bhagidari sector plays an important role in Indian economy.

Unorganised sector is only a large subset of the bhagidari sector.

In US, a significant portion of the national income from corporate sector.

nearly 50 % of the total manufacturing activities each year can be attributed to the bhagidari sector

In case of activities like wholesale and retail trade, hotels and restaurant, road transportation, real estate and business services such as medical, legal and so on, more than 80% of the national income is generated by the unorganised sector

But in the last few years, situation is changing with the growth of organised retail and organised fast food industry.

80% savings in India (household sector) (wage earning households + mixed income ).

Portion of savings from farm households (this sector accounts for 10% of the total domestic capital formation).

Savings of this sector could, of course, flow to other sectors as well.

44% of household sector savings could be attributed to farm households.

bhagidari generates 35% of the national income and around 35% of the national savings.

Therefore, Bhagidari sector (partnership/proprietorship firms) is the major wealth creator in our economy.

Yet the reforms process has ignored this sector

Only on corporates, government and their mutual interface.

· Industrial policy (licensing, monopolies and restrictive trade practices, foreign direct investment)

· Foreign exchange & trade policy (negative lists for imports/exports, capital goods imports and tariffs)

· Capital market (pricing of shares, regulations on merchant banking/mutual funds/ foreign institutional investments)

· Banking (interest rates de-regulation, policy on asset classification and provisioning, capital adequacy norms, and private banks)

Tax structure (reduction in tax rates, tax incentives to FII, reduction in exemption notifications)

· Foreign investments (50%+ equity allowed, technology imports, usage of foreign brands etc).

· Insurance (privatisation, tariffs)

government controlling some sectors versus private corporate sector getting more space through market reforms

role of foreign firms and domestic firms (family owned) and the need for level playing field for the domestic companies.

Thus even though bhagidari sector pays taxes and contributes to national income and savings, [ wealth creation] their names are conspicuous by their absence in the reforms agenda.

Address the concerns of the largest wealth-generating sector of the economy, the bhagidari sector.

more relevant issues are those concerning the bhagidari sector, which are of immense importance in modernising the economy as well as making it more efficient and productive. 

Bhagidari  financing is done mainly through the private money markets where the rates of interest are at least twice that of commercial banks.

This is one of the major reasons for the large margins seen in both wholesale and retail trade. For many of the FMCG items, the gap between the company balance sheet figures and the retail value figures is more than 25%. One contributing factor to this is the open market interest rates paid by the trade channels.

In the case of cash crops and vegetables, the gap between producer prices and consumer prices can be as high as 70% to 80%. Here again the financing cost, both on holding and transport, plays a major role.

Trade, transport and other professional activities, mainly conducted by the bhagidari sector, have therefore to depend upon funds from open market borrowings at prohibitive cost.

That the sector is profitable even with this additional burden is testimony perhaps to its entrepreneurship.

Reforms, if they are to be meaningful need to address the problem of financing of trade, transport, construction, hotels, restaurants and dhabas spread over the length and breadth of the country and other such activities in which bhagidari predominates.

Government banks are not geared towards financing these activities since they do not possess relevant market knowledge and information about them.

The non-banking finance companies (NBFCs) are the best route to finance these activities, because they are market savvy and have the ability to rate such customers and recover the money lent to them.

The government banks could have financed the NBFCs on a wholesale basis and they in turn could have funded the requirements of the bhagidari sector.

If commercial banks finance credit-rated NBFCs even at 18%, they could fund the bhagidari sector: even at say 22 %, this would compare most favourably with the open market rates of 30% to 36% charged to bhagidari sector.

The reforms have not focused on such issues since it is not part of the paradigm of the debate concerning multinational banks / government banks.

Instead, the effort has been mainly on regulating the NBFCs in the name of capital adequacy and so on, effectively driving them to extinction, without a full appreciation and utilisation of their market knowledge and consequent contribution.

This is not to say that prudential regulation is unnecessary, but only to highlight that the baby should not be thrown out along with the bath water. 

Retail financing in areas like automobiles and white goods trade is slowly being taken over by the global players, such as GE Capital and Citibank at the premium end of the spectrum. Global companies with their deep pockets can meet the needs of the premium segments. But the requirements of the wholesale and retail trade for cash crops and horticultural products as well as the large distribution segments of FMCG and white goods are left to fend for themselves at open market rates from the informal sectors.

State provides no social security net for bhagidars

To compound matters, even contributions made by partners to a pension scheme like Jeevan Suraksha are not treated as deductible expense of the firm for tax purposes. Compare the situation with government and corporate sectors (with lower value-creation record) where contributions to employee retiral funds are tax-deductible!

Reforming Legislation and Regulation The reach of the bhagidari sector is largely

regional and therefore most of the regulations pertaining to their activities is in the domain of state governments. An illustrative, but certainly not exhaustive, list would cover commercial taxes, road tax, entertainment tax, excise duty on liquor, urban land ceiling and regulation, shops and establishments Act, laws governing educational and medical institutions, money lending and contracts. Most of these are extortionist in nature and completely unfriendly to the bhagidari sector, and are used to harass its functioning.

The street corner grocer has to keep municipal authorities, food and adulteration officials, local police, telephone, electricity and other utilities administrators, sales tax, factories and boiler inspectors and an assortment of such other extortionists, in good humour. A transporter of goods from one location to another sends cash through drivers/cleaners since at check posts in a multi-lingual country like India, what is commonly understood is only the language of cash. Restaurants, the Darshinis of Bangalore, the Udupis of Mumbai and the dhabas spread over the length and breadth of our country, must pander to the whims of a demanding officialdom. The entrepreneurial spirit of the bhagidari sector has been curtailed and caged by central, state and local governments and regulators. That the sector continues to survive and contribute is truly a tribute to its resilience and indomitable will to succeed.

Contract Enforcement A major area of concern is the timely enforcement of

contracts. The legal system and its processes are notorious for delays, showing scant regard for time and money that is the basis of sound functioning of the market system. Over two million cases are pending in eighteen High Courts alone and more than 200,000 cases are pending in the Supreme Court for admission, interim relief or final hearing. This is not the full story since millions of cases are pending in the lower courts. For instance, in Karnataka alone there were around 163,000 cases pending in 1996 and another 177,000 cases were added in 1997 and 1998.9 The most protracted lawsuit ever recorded was in India (earning dubious distinction of entering the Guinness Book of records). A mahant, keeper of a temple, filed a suit in Pune in 1205 AD and the case was decided in 1966 - a full 761 years later. However, one can take heart in that this is not the general rule, and the average time taken by Indian courts for deciding a case is estimated at no more than five to fifteen years.10

In such a situation the bhagidari sector which has relatively less financial flexibility suffers the most. It is not in a position to use the legal route and hence resorts to arm twisting tactics to assert its rights. This points to an ominous trend in the system, wherein the aggrieved parties take law into their own hands for enforcement of property rights. On the flip side, it is also subject to the same treatment when in default

Reforms should have addressed this issue. For example, creation of courts to deal exclusively with the problems of the bhagidari sector will go a long way to facilitate the functioning of the latter. These courts should be fully computerised and function along the lines of family courts. Another alternative would be to encourage community based arbitration recognised by law as binding on both the parties. This type of system is prevalent for instance in the stock exchanges where disputes pertaining to member brokers are settled through arbitration which is binding on members.

Child Labor and Reforms Children and women packing match sticks in Sivakasi

(Tamil Nadu), preparing slates/pencils in Mandsur (MP), quarrying in Haryana or washing in the tanneries of Ambur (Tamil Nadu), rolling beedies in Belgaum and Mangalore (Karnataka), helping diamond cutters in Surat (Gujarat), constructing buildings in semi-urban and urban areas, washing plates and serving customers in restaurants all over the country, and working as mechanics and helpers in automobile garages: all these are part of employment in the bhagidari sector. Reforms are silent on these activities. The chattering legions offer simplistic solutions on television, like abolishing child labour and/or increasing government funding for primary education.

Other plausible alternatives are not even discussed. For instance, part time educational opportunities can be encouraged for the child labourer by giving tax breaks for the bhagidari sector (even more than 100%) for financing the education of these children. This can be done without any ceiling and local schools can double-up during the evening for the benefit of these children. In this way financing the education of these children can also be taken care of. This is one way by which the government can enhance the educational activities of the children while they are working, without significant financial outflows.

MNCs and the Bhagidari Sector Significant segments of our economy are reserved

for small and tiny sectors. For instance, tooth pastes, soaps, shoes and several hundred other such items are supposedly to be made by small sectors. But MNCs which were in these activities at the promulgation of these reservations (typically 1956) were allowed to carry on the business (for instance Hindustan lever in soaps, Colgate-Palmolive in toothpaste, Bata in shoes, and so on). This has prevented even Indian business groups like Tatas from entering these activities as part of their corporate structure. Not only that, this has pitched the bhagidaris against the global companies in these areas.

The crucial issue in the reform process is the future of the bhagidari sector when the economy is opened up to global companies in manufacturing, trade, transport, construction, and hotels and restaurants. Some of the important questions that need to be asked and answered are:

· In the long run, should the millions of partnership/proprietorship firms get corporatised ? Is that the objective of reforms ?

· Should the process encourage and even force the self-employed to become wage earners ? (street corner cobblers employed by Adidas and Nike, and roadside tailors by Van Heusen, and the mom-and-pop grocers by J C penny’s or Walmarts).

· Globalisation and direct foreign investment processes are pitting the bhagidar against the MNC. Is it fair competition ?

Visualise the scenario in the none-too-distant future: · Udupis/ Iranis and other such small restaurants and

dhabas run by bhagidars all over the country are expected to face competition from Macdonald 's and KFC’s

· Street corner grocers and wholesale dealers are expected to compete with Sears and Walmarts.

· Small contractors who are involved in roadwork are expected to compete with global construction firms.

· Transport operators having a fleet of 1 to 5 trucks are expected to compete with Federal Express or Greyhound.

· Local fishermen using catamaram are expected to compete with trawlers of global players.

Not that the bhagidars would shy away from competition. If they have access to bank funds and cleaner control by regulators, they would probably give the bigger brothers a run for their money. Many of them have done so in several fields elsewhere in the developed world. It is a level playing field that one would expect from the reformers. But the political spectrum (from left to right) is silent on this crucial aspect of the reform. None of the political parties have thought about the future role of the bhagidari sector in our country. There is not even a debate on these issues. Government-sponsored and lobby-orchestrated debates and seminars are common, for example, on insurance sector, foreign media, and such sundry topics. When was it last that there was some debate on the concerns or the potential of the bhagidari sector that accounts for a third of the country’s national income and savings ?

This sector cannot be ignored. It is the most productive and efficient manifestation of the private sector, which thrived even during the socialist days of the sixties and seventies. By focusing on corporate India, ministry mandarins are trying to uncage the wrong tiger. The right tiger is the bhagidari sector, which requires uncaging.

It is attractive to listen to the grievances of Associated Chambers and the Confederation of Indian Industry. But it is even more critical to listen to the problems of Nashik Vyapari Mandal and Tindivanam Transport Operators, Renigunta Restaurant Owners and Cooch-Beehar Construction Contractors. As the reforms are not related to their concerns, often smaller groups try to take things into their own hands and demonstrate their entrepreneurial spirit and risk taking ability. Even then, rebuke, not approbation, is quick to come.

The little known Kadavari village, situated on the border of Tamil Nadu and Kerala is a case in point. In August 1998, the 80-odd families of this village, in the true spirit of capitalism, set up their very own power station in the form of a makeshift turbine to provide power to their village. Their initiative in not taking government help and doing this out of their own hard earned resources only made the state electricity board declare that they had broken the law.12 It would perhaps have been different it were a Murdoch or a Daewoo or even a SAIL, since the reform script appears to be intended for them alone; but how can the dhoti clad, pan chewing, English illiterates decide to reform the reform process, even if they are significant wealth-creators ? 

According to the Companies Act, an unregistered company includes any partnership, association, or company consisting of more than seven persons at the time when petition for winding up is presented.

But it will not cover the following:-

A railway company incorporated by an Act of Parliament or other Indian law or any Act of the British Parliament;

  A company registered under the Companies Act, 1956;   A company registered under any previous company laws.   An illegal association formed against the provisions of the Act.

Such a company can be wound up by the Tribunal but never voluntarily.

 

Circumstances in which unregistered company may be wound up are as follows:- 

◦ If the company has been dissolved or has ceased to carry on business or is carrying on business only for the purpose of winding up its affairs.

 ◦ If the company is unable to pay its debts.

 ◦ If the Tribunal regards it as just and equitable to wind up the company.

No suit in a civil court by a partner against the firm or other copartners :

However, criminal proceedings can be brought by one partner against the other(s). Thus, if a partner steals the property of the firm or puts fire to the buildings of the firm, any partner can prosecute him for the same.

2. No suit in a civil court by firm against third parties:

An unregistered firm cannot file a suit against a third party, if it so becomes necessary, to enforce any right arising from contract, e.g., for the recovery of the price of goods supplied. Of course, criminal proceedings can be brought against the wrong doers. Thus a suit can be filed against a person who causes damage to the goods of the firm.

Similarly, an unregistered firm can sue the drawer of a cheque dishonoured for insufficiency of funds which is a criminal offence under Section 138 of the Negotiable Instruments Act, 1881.

3. The firm or its partners cannot make a claim of set-off or other proceeding based upon a contract

if a third party sues the firm to recover a sum of money, the firm cannot claim a set-off, i.e., the firm cannot say that the third party also owes some money to the firm and the same should be adjusted against the claim in question.

All India Resort Development Association Associated Chamber of Commerce & Industr

y of India Automotive Components Manufacturers Ass

ociation of India Confederation of Indian Industry Electronic Components Industries Associatio

n

Federation of Hotel & Restaurant Associations of India

Federation of Indian Export Organisations Indian Association of Amusement Parks and

Industries Indian Machine Tools Manufacturers Associa

tion Manufacturers Association of Information Te

chnology National Association of Software & Service C

ompanies

All-India Manufacturers Association Association of Mutual Funds in India Society of Indian Automobiles Manufacturers Electronic & Computer Software Export

Promotion Council Engineering Export Promotion Council Federation of Indian Chambers of Commerce &

Industry India Trade Promotion Organisation Indian Electrical & Electronics Manufacturers'

Association

Indian Merchants Chamber Mumbai (Bombay) Chamber of Commerce &

Industry Organisation of Pharmaceutical Producers of

India