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Rethink role of crisis cartels, as Indian industries face risk of overcapacity

The adverse impact of Covid-19 on the economy is expected to create structural overcapacity in the Indian industries, which can wreak havoc if left unchecked.

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The disruptive effects that Covid-19 has had on businesses is undeniably severe. The pandemic, coupled with the resultant recession, is expected to create structural overcapacity in certain sectors of the Indian market, such as civil aviation and automobile manufacturing. Persistent overcapacity of this nature can wreak havoc, if left unchecked. Businesses in such sectors must be allowed to cooperate, and take coordinated measures to internally reduce such overcapacity. Such co-operation must, however, be vigilantly monitored by the Competition Commission of India.

This pandemic is likely to result in a massive economic crisis of an unprecedented magnitude, whose impact on the global economy, as several experts suggest, can potentially last for years.

Also read: India expects V-shaped recovery, growth likely next year, Economic Affairs Secretary says

India’s struggling economy and overcapacity

The situation is worse for India. Existing problems in our struggling economy, such as a steadily declining GDP and state measures such as temporary closure of non-essential businesses (for example theatres, gyms, restaurants, tourism, construction, etc.), has resulted in an acute increase in unemployment rates in India. This is expected to severely impact the overall purchasing power, consumption and consumer spending in India.

Demand in certain sectors will therefore slump. Consequently, many industries will face ‘overcapacity’ — a situation where an industry is designed to supply more than what is being consumed. During a crisis of this magnitude, such overcapacity can be ‘structural’ in nature and cannot be remedied by the interplay of market forces alone. In such times, market players, instead of altering their own capacity in line with the market’s demand, may continue production in full-scale in an attempt to induce rivals to exit the market. Persistent overcapacity of this nature, if left unaddressed, will result in over-investment of capital, over-employment, reduced returns for producers, and failure to achieve efficiency.

Also read: How Indian companies cutting capital spending is set to prolong economic slump

Anti-trust solution: Legalise crisis cartels

A solution to structural overcapacity, which countries such as Australia, Norway and the United Kingdom have been considering, is the legalisation of private industrial restructuring agreements. These agreements are also known as “crisis cartels” — a term used to describe agreements between, or concerted actions taken by, competitors during or as a result of an economic crisis, in an attempt to find a joint solution to their common difficulties. In times of overcapacity, this may be achieved by agreeing upon quantities of production, facilitating the opportune exit of a few players from the market, and/or setting ‘fair’ prices in order to avoid some industry players from going bankrupt.

Cartels are generally prohibited due to their ability to harm competition and consumer welfare. But such cartels, when effectuated cautiously during times of overcapacity, can have significant benefits. Such agreements can optimise the disrupted levels of demand and supply, facilitate orderly exit of companies, and enable firms that remain in the market to overcome losses and thereby enhance overall consumer welfare. In light of these benefits, the European Court of Justice has previously held such agreements to be legal as seen in the Synthetic Fibres case, (Case IV/30.810), the Dutch Bricks case, (Case IV/34.456), in times of structural overcapacity, as a deviation from their otherwise strict scrutiny of cartelisation.

The civil aviation industry in India, for instance, is expected to suffer from severe structural overcapacity. With the industry already operating under losses prior to the pandemic, any lasting improvement in passenger occupancy rates in the medium or long-term looks unlikely, especially in light of the forecasted economic downturn. Therefore, in order for the industry to survive, market players should be allowed to collaborate and collectively reduce internal capacity. This can be brought about by agreeing on routes to be served, coordinating schedules, frequency of operation, and if necessary, retiring parts of their aircraft fleets. Other industries that are forecasted to be affected by such overcapacity include those involved in manufacturing, oil, steel, automobile and tourism sectors.

Implementing and monitoring crisis cartels

Currently, the Competition Act, 2002, treats cartels as presumptively anticompetitive. Given the relative nascency of the Act, there is no antitrust jurisprudence in India that addresses the nuances of crisis cartels, although arguably such agreements can be justified on grounds of enhancing efficiency. It is therefore imperative that the Competition Commission of India (CCI) and the Ministry of Corporate Affairs jointly devise a mechanism that legalises and sufficiently regulates such agreements.

As a first step in this regard, the CCI must survey the various sectors that are likely to suffer from structural overcapacity and produce empirical evidence regarding the same. Based on such evidence, the CCI in consultation with the Ministry of Corporate Affairs, (MCA) should issue detailed guidelines regarding the manner in which such agreements shall be assessed. Such guidance must clearly lay down the criteria for qualifying as a restructuring agreement, the time period for which such arrangements are permissible, and factors and their relevant weightage in demonstrating efficiency in times of crises.

While the CCI has issued an advisory assuring that an efficiency-analysis approach would be adopted towards horizontal agreements during Covid-19, it has not, however, shed light on any new or pre-existing factors for demonstrating efficiency that would be prioritised in times of crises. Lack of clarity in this regard may discourage market players from coordinating, even if such co-ordination could potentially increase efficiency.

Additionally, a suitable notification regarding exemption for certain types of cartels for a defined period of time may be issued by the MCA using powers conferred on it under the Act.

Lastly, as cartels are presumptively harmful for competition, the CCI must also ensure that it proactively monitors such restructuring agreements to ensure that coordination between players does not go beyond the intended purpose of capacity reduction.

Towards a Post-Covid India is a briefing book with 25 legal reforms recommended by the Vidhi Centre for Legal Policy. Join a series of conversations — ‘Law with a Difference’ — on the book. ThePrint is the digital partner. Read all the articles here.

The author is a research fellow (Competition law) at Vidhi Centre for Legal Policy. Views are personal.

Also read: This recession is different & India can bounce back much faster than in the past


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