Banking and Debt Recovery in Emerging Markets

The Law Reform Context

Sonali Abeyratne

• Publisher: Taylor & Francis
• Year: 2019
• Print ISBN: 9781138635425
• eBook ISBN: 9781351791397
• Edition: 1
• Topic: Law
• Subtopic: Law Theory & Practice
• Index: Law

This title was first published in 2001. A developing country that is pursuing free market economic policies requires a modern commercial law infrastructure, which enables the emerging economy to have in place properly functioning credit and other financial systems which stimulate domestic and foreign investment. This book provides a comparative analysis of the law and practice of debt recovery in India, Sri Lanka and Malaysia, demonstrating that a suitable debt-recovery system for a developing economy requires not only good laws and judicial remedies, but also appropriate financial industry practices such as credit and loan supervision policies.

1 Introduction

Economic and Financial Development – Policy Issues

Economic development needs to be a dynamic process. Most nation states seek to enhance the welfare of their people by following a development process that is designed to achieve specific goals that accelerate the economic growth of their countries. In all countries, the objectives may be common, but each country chooses from a variety of strategies to achieve its desired results.¹ The policies that a country may wish to pursue will depend largely on its historical and ideological backgrounds. Further, the internal and external challenges facing a nation would also influence its development strategies. This may include examining the existing infrastructure, the legal and regulatory framework and the role of the State in a country’s economic development process.

Inward Orientated, Closed Controlled Economies

A nation may choose to pursue commercial, industrial and exchange rate policies, which taken collectively, can be identified as “inward orientated”.² These countries may also be referred to as planned economies.

In early years, the economic and social achievements of the centrally planned economies were considerable.³ They were able to eradicate poverty, create jobs for most of its people and provide them with adequate education, health care and housing through an extensive welfare system. Income was seen to be distributed evenly. In such economies, supply and demand were irrelevant; in fact, they were non-existent.⁴ The state allocated resources and controlled production. Enterprises were not motivated by profits, quality, variety, customer service or competition because what was required by the state was fulfilling the “plan” or at least to be seen fulfilling the “plan.” The state would set production targets, determine which enterprises were expected to meet them and managers’ performances were judged in terms of output rather than client satisfaction. Local enterprises were protected from competitive pressures, and the state provided any necessary subsidies to prevent industries from closing. The governments exercised direct controls over exchange rates and restricted foreign imports.

The centrally planned economies were less stable than they appeared.⁵ None of these countries traded extensively with the world at large. The system of allocating resources were bureaucratic and created serious distortions in the market. For example, emphasis was given to developing heavy industries, and other light industries and services were severely repressed. Housing, food, transport and energy were extremely cheap but consumer goods if available, were of poor quality. Over a period, central planning became inefficient, consumer demands were not satisfied, social indicators began to worsen, and economic crises appeared to be inevitable. President Gorbachev explained the shortcomings of the former Soviet Union’s economic system as follows:

It is above all the lack of inner stimuli for self-development. Indeed, through the system of plan indices, the enterprise receives assignments and resources. Practically all expenses are covered, sales of products are essentially guaranteed and, most importantly, the employees’ incomes do not depend on the end results of the collective’s work: the fulfilment of contract commitments, production quality and profits. Such an economy is likely to produce medium or even poor quality of work, whether we like it or not. How can the economy advance if it creates preferential conditions for backward enterprises and penalises the foremost ones? ⁶

The socialist countries realised that their experiments with central planning policies had to be abandoned, and that it was necessary once again to adopt liberal economic policies, to open their economies to the world at large, and encourage local and foreign investors. The newly independent states of the Soviet Union, and the Central and East European countries abandoned socialism. China and Vietnam initiated reforms that would enable their economies to integrate with other world economies, but refrained from political changes. Yergin and Stanislaw observe:

Nowhere else has the recasting of the relationship between state and market been so extreme as in the former communist world, for the upheaval has set off a turbulent struggle to establish market systems in the very countries where markets had for so long been banished. The communist system claimed to be the vanguard of the future, but it buckled under the pressure of its inner decay. The machinery of central planning and state ownership failed to foster innovation and distribute the benefits of economic growth - and then it failed to deliver any growth at all.⁷

Thus, the transition from systems, which had no markets to being market systems, had now begun.

Outward Looking, Free Market Economies with a Strong Export Orientation

In contrast, a nation may follow an “outward looking” development strategy that facilitates international trade. In a free market system, the economy is open to domestic and international competition and any barriers of entry are removed. The state adopts free trade policies and local industries are expected to compete in international markets. It does not discriminate between production for the domestic market and exports, or between purchase of domestic and foreign goods. Government subsidies are not available to enterprises and they have to bear the risks of market transactions, ensure financial discipline and generate profits. Market forces are allowed to determine the interest rates and foreign exchange rates, and the state is expected to exert minimum influence over such matters. Bank credit is not available on concessional terms and a government will not write off arrears of taxes and customs duties due to it.

Naturally, the open economies are vulnerable to market fluctuations and inflation and the closed economies are immune to these external changes, but with a few exceptions most nations have now adopted the “law of the markets” and economic liberalisation has become a conventional policy line. The financial markets in developing countries perceived to be in the process of promoting liberal economic policies and opening the economy to domestic and private sector investors are commonly described as “emerging markets”.⁸ These countries often follow policies of rapid deregulation of the financial sector and privatisation.

Privatisation The key objectives of privatisation are to create a market economy that is efficient and well developed. Privatisation is expected to improve private enterprises and expand the private sector in general, foster economic flexibility and eliminate rigidities, promote competition by abolishing monopolies, improve access to foreign markets for domestic products, encourage local and foreign investment and maintain or create employment.⁹

Private sector participation may be increased either by privatising the existing state enterprises or through the entry of new private businesses.¹⁰ Extensive empirical research has shown that in industrialised market economies, private enterprises have higher productivity levels than the public enterprises. Similarly, in developing countries that have launched privatisation programmes, the private enterprises performed better than the public enterprises. For example, sixty-one private companies in twelve industrial and six developing countries showed that at least in two thirds of privatised state enterprises sales, profitability, operating efficiency and capital investment improved without loss of employment.¹¹

In an economy where private sector development is given priority, the role of the state must essentially be regulatory as well as being promotional in nature.¹² The State needs to be primarily responsible for creating and maintaining an economic and political environment that allows private entrepreneurs to carry on business activities free from unfair competition or interference from state institutions. In addition, the legal environment should be such so that laws and regulations are not liable to the risks of changing interpretations. It should also be stable, so that investors will be assured that sudden changes in government decisions will not be taken, which may adversely affect their business ventures. In case of a dispute, it is important that investors have access to independent courts and alternate dispute settlement mechanisms.¹³

Hybrid Approach to Economic Development

Countries that did not wish to follow either of these models for economic development totally have freely borrowed practices from both types of economies. The best known is the approach adopted by Japan and South Korea.¹⁴ They are both market systems that promote export trade but maintain strong co-operation between the government and corporate sector. The governments provide “administrative guidance” to businesses, so that they may adapt to the world export markets. It therefore sets prices, allocates quotas for imports and market shares, provides licences and approves quality and standards. It also channels new information and knowledge to the industries and facilitates the flow of new technology. These are only a few examples. Spira observes:

[S]ince Korean business culture has evolved with absolute central government power as a feature, companies seek government approval even for actions which are not subject to regulation. Moreover, companies routinely accept requests and suggestions from government as quasimandates and comply with these in order to maintain good relationships. ……. This type of behaviour may be considered to be nothing more than good govemment-industry co-operation.¹⁵

However, the Japanese recession that began in the early 1990s has opened the debate whether the relationship between the market place and the state must be changed to facilitate more deregulation of the economy.¹⁶ The debate is continuing.¹⁷

The extent to which countries have adopted policies from planned or market economies varies according to the social and economic needs of each country. Whatever the economic policies had been followed in the past, the current trend in most of these economies is a shift towards a decentralised, free market system, underpinned with widespread private ownership. Countries are abandoning those elements of the planned system that hindered or stifled economic growth and are engaging in far-reaching privatisation programmes.

Foundations for a Sound Market Economy

A country that fosters a free-market economy, needs to promote a stable economic and political environment which would be conducive for economic development, establish a sound legal and judicial framework where independent and expeditious resolution of disputes are possible, and install the necessary regulatory and institutional arrangements for a sound financial system.¹⁸

If a free market economy were to thrive, such a country would require laws that are fair, clear and known to its people. Enforcement agencies should maintain such laws applying them when conflicts arise. It is vital that the legal system is independent, and resolves disputes within a reasonable time and cost. The World Bank has recognised that:

In many countries the inappropriateness of laws, uncertainty in their application, weak enforcement, arbitrariness of discretionary power, inefficient court administration, slow procedures, and the subservience of judges towards the executive branch greatly hinder development, discourage and distort trade and investment, raise transaction costs, and foster corruption. Laws may be unenforceable because they contradict economic logic, thereby destroying the incentive for compliance.¹⁹

In addition to a stable economic environment and sound legal and judicial systems, emerging market economies require regulatory and institutional arrangements that would assist the...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• Dedication
• Table of Contents
• Preface
• Table of Cases
• 1 Introduction
• 2 Credit Allocation and Debt Recovery: The Reform Context
• 3 Credit Allocation and Loan Supervision
• 4 Enforcement of Security
• 5 Recovery Through the Courts
• 6 Final Observations and Recommendations
• Bibliography