Reforming the Reform Process
(R Vaidyanathan is professor of Finance and UTI Chair Professor in Capital Market Studies at the Indian Institute of Management Bangalore.)
(This has been published in the Silver Jubilee Research volume of IIMB.)
The economic reform process, initiated in 1991, focuses mainly on the corporate sector and government activities. An analysis of the Indian economy, however, shows that 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. It is important that the reform process focus on issues pertaining to this sector.
Share of the Bhagidari Sector in the National Income
The share of the bhagidari sector can be estimated roughly as equal to that of the unorganised, non-agricultural sectors of the economy. Even this is clearly an underestimation, since certain bhagidari activities particularly in manufacturing exist even in the organised sector. Table I sets out the share of different sectors like agriculture, government, private organised and unorganised sectors. It may be noted that agriculture here excludes government agriculture and that of private corporates even though they are only marginal; they are included respectively under government and organised private sector.
Table I Share in National income of various sectors (%)
Source: NAS 1997. Central Statistical Organisation, New Delhi.
This provides an insight into the importance of the bhagidari sector in our economy. The share of the government (central, state and all public undertakings) in the NDP in 96-97 was around 25% and that of agriculture, around 27%. Of the remaining 48% the estimated share of the unorganised sector was about 35%. Recall that the unorganised sector is only a large subset of the bhagidari sector. Developed economies like the US derive a significant portion of their national income from the corporate sector. For example, the share of corporate business in the US net domestic product during 1996 and 1997 was, respectively 66.4% and 67.4%.
Share in Manufacturing
Data is available pertaining to the manufacturing sector under registered (under the Factories Act) and unregistered categories. The former is considered as organised and the latter as unorganised by the NAS. The share of the unorganised sector in manufacturing was 39.1% in 1990-91 and 38.8% in 1994-95. 10.87 % of the net value added in the factory sector (organised sector) during 1993-94 was reported to be from partnership/proprietorship firms, or the bhagidari sector. Thus, nearly 50 % of the total manufacturing activities each year can be attributed to the bhagidari sector.
Share in Service Sectors
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 (Table II).
Table II Share of Unorganised Sector in Service Activities (%)
|Hotels and restaurant||87.7||86.7||75.0|
|Transport[Other than Railways]||65.9||77.7||79.1|
|Real estate, ownership Of dwellings & business services||99.5||99.8||98.5|
Source: NAS 1997. Central Statistical Organisation, New Delhi.
In addition, as already indicated, some of the service activities, carried out by bhagidari units may have been excluded from the above stated numbers because they may have been organised; to this extent, bhagidari sector shares estimated here could be understated.
It will be noted that a significant proportion of our service activities is in the bhagidari category; clearly, there are at present not too many corporates in this sector, unlike the developed countries; for example, the likes of Walmart, Sears, or Marks and Spencer in trade, or Greyhound in transportation, or Burger Kings and Pizza Huts in restaurants are not as yet the order of the day here.
Savings and the Bhagidari sector
Around 80% of savings in the country are due to the household sector that consists of pure consuming (wage earning) households as well as bhagidari (mixed income) households. A portion of the savings is due to farm households, details of which are not separately available. This sector accounts for about 10% of the total domestic capital formation. Savings of this sector could, of course, flow to other sectors as well.
The respective proportions of unorganised agriculture and other unorganised activities are 44% and 56 %, respectively. Assuming that savings of the farm sector are similar in proportion, 44% of household sector savings could be attributed to farm households. This may be an overestimation and to that extent, will only strengthen the present thesis.
On this basis, savings from the non-agricultural households works out to approximately 45% of the total (derived as non-agricultural 56% of total household savings of 80%). The bhagidari share in this is not separately available from our national income statistics. It is important to separate and exclude the salary income portion, so that comparison with savings figures from corporate and government sectors (which exclude employee salaries from the value added in their data) could be on a like-for-like basis.
Another method would be to infer the savings from the non-salary component of the income generated in this sector. This may be possible using available income tax statistics pertaining to salaried and non-salaried categories. (It must be remembered that agricultural income in India is not taxed in the hands of individuals). Table III provides selected tax statistics pertaining to salaried and non salaried categories that can offer a basis to estimate the possible share of the mixed income group in the savings activity. The share of salaried category in the returned income is around 25% of the non corporate categories consisting of non salaried individuals and partnership/Hindu Undivided Family form of activities.
The non salaried category includes the income of the mixed income persons consisting of income both from labour and profits. Savings coming from salary earners need to be estimated in order to get the correct picture regarding the savings in the bhagidari sector. If it is assumed that the proportion of the savings is similar to that of income proportions for these categories, then nearly 75% of the household (non agricultural) savings are in a sense attributable to the non salary component of the earnings by these organisations. That is, the household (non agricultural) sector savings, can be disaggregated into their two constituent parts of pure (consuming) households and producing households, using the proportions of salary income and mixed income in the tax data. This could provide an approximate indicator of the possible bhagidari share in the household savings data. On this basis, around 35% (75% of 45%) of the savings is attributable to the bhagidari sector. In other words, bhagidari generates 35% of the national income and around 35% of the national savings, while the corporate sector with 14% share in national income contributes around 14% to savings and government with 24% of the national income, has just around 7% of the savings. Therefore, Bhagidari sector (partnership/proprietorship firms) is the major wealth creator in our economy.
Table-3 Returned Income and Tax Payable for the Assessment Year 1994-95.
No of Returns (Thousands)
Returned Income (in Rs.Millions)
Tax Payable(in Rs. Millions)
Individual/ Salaried persons
Companies – Public sector
Companies – Private sector
Individual non-salary category
Source: All India income Tax Statistics. (AIITS) 1994-95. Directorate of Income Tax New Delhi.
Focus of Reforms
Despite this commanding contribution to the national economy, the reform process has hardly addressed the needs of the bhagidari sector. The reforms initiated in the nineties have focused on the following:
Clearly, the focus of reforms has mainly been on corporates, government, and their mutual interface.
In the process, the reforms debate has focused on the following two major points.
These two aspects of the debate have not only distorted the reform efforts but have also highlighted the dominance of the government and the corporate sector in our national psyche even though they are not significant players in terms of wealth creation. It is indeed fascinating that the largest segment of the economy is not the focus of our reforms. For the reforms to be meaningful, concerns of the largest wealth-generating sector of the economy, the bhagidari sector, need to be prioritised and squarely addressed.
The corporate sector dominated by one hundred or so companies in terms of market capitalisation has occupied disproportionate space in discussions on reforms. This sector which controls the national press defines the contours of the debate and its output is lapped up by the intelligentsia. Acres of paper and gallons of ink are wasted in repeating the worn out clichளூs on India Inc., market reforms, state versus market, disinvestments of public sector undertakings, corporate governance, and so on. The 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.
Financing of the Bhagidari Sector
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. The share of trade (excluding food procurement), transport and professional services in the credit limits sanctioned as well as outstanding as of end March 1996 was of the order of 15% of the total such limits of scheduled commercial banks8 . The share of these sectors in the national income is about 28%. These 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 vis-தூ-vis 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.
Social Security Net for the Bhagidars
Even though more than 4.4 million returns were filed by non-corporate, non-salaried assessees as early as 1994-95 (Table III), the state provides no social security net for these categories. Of this 4.4 million, nearly 1.2 million are partnership/proprietorship firms and the remaining 3.2 million belong to non-salaried group of professionals and other self – employed categories. In case of firms, the total number of persons could be at least 3.6 million, taking a conservative estimate of three people per firm. This adds up to more than 6.8 million productive and entrepreneurial tax assessed individuals without any state social security scheme for their old age. Given the inadequate tax coverage, this number could easily be more than double for the bhagidari sector as a whole; the magnitude of the problem of social security coverage to this value creating segment of the society is indeed enormous. 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!
The government could have made these pension schemes to bhagidaris deemed trusts and consequently income tax benefits could have been provided to them. The government could also have created a national social security scheme by contributing a corpus and encouraging the bhagidari sector to join in with tax benefits. Bereft of the social security provided by the traditional, but fast disappearing joint family system, measures such as these would have signalled responsiveness and encouragement to this vital contributing sector.
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.
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
It is difficult, if not impossible, for a tenant to be evicted by the landlord after the end of tenancy in a house property, for a creditor to collect his debts, for a lessor to repossess his leased assets from the lessee in default, for a depositor to collect his principal and interest from the borrower, for a bond holder to redeem the instruments from corporates, within a reasonable time using the legal machinery. The system, in practice, does not accept asset ownership as natural, and due perhaps to the socialistic indoctrination of half a century, considers default/illegal possession/occupation and so on as a natural right of the ‘underdogs ‘.
The right of the lessor to repossess the leased asset in case of default by the lessee was not very clear until the Bombay High Court ruled (and the Supreme Court upheld) that the ‘lessor has a right ‘ to so repossess.11
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.
The reformation of the legal system particularly at the lower levels of judiciary have not been addressed as a basic issue since the government itself is a major litigant and concepts such as value for money and time value of money are low on priority and acceptance.
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:
Visualise the scenario in the none-too-distant future:
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 ?
The National Accounts Statistics (NAS) uses the classification of ‘organised ‘ and ‘unorganised ‘ sectors in presenting national income data and what is indicated as ‘unorganised ‘ in NAS is not the same as non-company forms of organisations. ‘Generally, all enterprises which are either registered or come under the purview of any one of the acts like the Indian Factories Act 1948, Mines and Minerals (Regulation and Development) Act, 1957, the Company Law, the Central/ State Sales Tax Acts, the Shops and Establishment Acts of the state governments, are defined as part of the organised sector. Also included are all government companies, departmental enterprises and public sector corporations. Similarly, forestry, irrigation works, plantations, recognised educational institutions, and hospitals which are registered as non-profit making bodies are also classified as organised sector…all unincorporated enterprises and household industries which are not regulated by any acts of the above mentioned type and which do not maintain any annual reports presenting the profit and the loss and balance sheets are classified as unorganised. ‘ A partnership firm may, thus, be grouped under the ‘organised sector ‘ if it was covered under any of the statutes mentioned and if it maintained annual accounts. Otherwise it would be classified under the ‘unorganised sector ‘. Thus, bhagidari enterprises can figure under either of the two (organised and unorganised) sectors in the national income classification. Hence to estimate the share of the bhagidari sector in the economy, one must look at both ‘organised ‘ and ‘unorganised ‘ forms of activities, as this sector encompasses all activities in the unorganised sector and in the non-corporate part of the organised sector. In practice, however, corporate form is treated as organised for estimating purposes, except in the case of manufacturing.
The NAS elaborates the coverage of the organised sector for major activities in the non-agricultural sector as follows:
Thus, the organised sector is the same as factories registered under the Factories Act in the case of manufacturing and the public and private corporate sector in the case of all other activities.
References and Notes 1NAS, Sources and Methods [page 69] Central statistical organisation GoI. New
Delhi April 1980. 2NAS, Factor Incomes (New Series)1980-81 to 1989- 90 [page 7] Central Statistical Organisation, GoI 1994 ,New Delhi.
3The split up between organised and unorganised sector in various national income categories are available up to 1994-95 from the NAS 1997. For the year 1996-97, the shares have been estimated using the proportions of 1994-95 and the share of various sectors in 1996-97. This may not be an over estimate for unorganised sector since the shares of different sectors have not shown any dramatic changes in the past two years.
4Bureau of Economic Analysis, US Department of Commerce; Survey of Current Business, Selected National Income and Product accounts tables; [tables 1.16 and Exhibit I.14]; Jan 1999 .
5Annual Survey of Industries 1993-94. Summary Results for Factory Sector;
[p32.statement 19] Central Statistical Organisation New Delhi 1996.
6For example according to Reserve Bank of India data, 70 % of the
deposits with scheduled commercial banks was from the household sector and
around 11% from farmers.(Statistical Tables relating to Banks in India; 1995-
96 , Table I0 Reserve Bank of India 1998) .Applying similar proportions, nearly
13% of the total savings could be ascribed to agriculture sector. This
extrapolation, however, is likely to be an under estimate as it
ignores physical savings proportions.
7Again, if we look at the ownership of deposits with scheduled commercial
banks as of end March 1996(RBI 1995-96) we find that the share of ‘wage and
salary earners ‘ in the deposits of the household sector category is around 13%
As we already saw the share of ‘farmer ‘category is 11%. Household
category owns nearly 70% of the deposits. If we take this to be a
representative proportions for estimating the shares in household sector then the
share of Bhagidari sector will be 66% of the total household savings. Given the
fact that household sector savings are around 80% of the total savings, we can
estimate that 53% of the savings is due to Bhagidari sector. But this may be an
over estimate since it assumes that financial savings as
represented by Bank deposits is also mirrored in the physical savings.
8Statistical Tables relating to Banks in India; 1995-96 , Table I3. Reserve Bank
of India 1998 .
9Deccan Herald – 7th Jan 1999 Bangalore
10Sudhir Shah and Associates-. Indian Legal Hierarchy-1998.Mumbai
11Twentieth Century Finance Corporation vs SLM Maneklal Industries ltd.
12The Week -10th Jan 1999.