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The Indian government has been facing several cases of fraud every year. There are many chit-fund schemes like the Saradha scheme which have been used to dupe thousands of retail investors to the tune of crores of rupees.
After facing severe criticism from the public for the inaction of the government to stop such schemes and the inability to recover the money invested in such schemes, the government has issued an ordinance which bans unregulated deposits in India.
This regulation is expected to have a major impact since a lot of small businesses in India rely on advances and unregulated deposits to fund their business.
Now, since such schemes have been banned, the cost of capital of these companies will rise.
In this article, we will have a closer look at the effects that this ordinance will have.
Unregulated deposits in India were being taken mostly by two industries, i.e. the jewellers and the builders. It is a known fact that many builders were offering returns of 15% to 25% on promissory notes which were not backed by any assets.
The problem is that many of these builders went out of business and investors ended up losing their money.
At the present moment also, there are many developers who are paying interest which was due six to eight months ago. The return of capital invested in such schemes is highly doubtful.
Pune based DS Kulkarni group is the poster boy of these defaults. He built his business empire on the back of these unregulated deposits.
However, right now he is in prison because of his inability to pay them back.
The jewellery sector in India did not face any fallout because of these unregulated deposits. However, the government is of the opinion that investing in such schemes is highly risky.
Hence, in a pre-emptive measure, the government has decided to ban these deposit-taking schemes as well.
Hence, some jewellers whose schemes are regulated by SEBI and other government institutions can offer these schemes
Also, jewellers are not allowed to pay any interest or reduce the service charges while making such sales. If they do so, such a sale will fall under the ambit of unregulated deposits ordinance
Deposits cannot be undertaken unless they are secured against a specific property. In the event of liquidation, such depositors will have the rights equal to that of financial creditors.
Also, the government has created a rule wherein a cash refund is not allowed at a later date.
Hence, if a buyer makes an advance payment against a flat, they have to take delivery of that flat. They cannot ask for a refund as per the government norms.
The basic intention of the government is to segregate the genuine advance payments against sales from deposits. The government is apprehensive that once unregulated deposits are banned, they will still be masquerading in the system hiding as advance payments.
Hence, rules have been clearly defined to explain what the government will consider as advance payments and what will be considered as a deposit.
The government has introduced this law by way of an ordinance. The ordinance, by definition, is a speedy enactment of a law.
Hence, the market participants have not found the time to prepare for such an event. There is a lack of clarity regarding what is expected to happen to deposits which have already been made.
The government has clearly announced penalties for those accepting unregulated deposits even after the ordinance has been passed.
However, it is still not clear whether those penalties will apply to the schemes which have been started after the ordinance date.
Under normal circumstances, the government cannot make the earlier contracts between two willing parties null and void.
A lot of jewellers, builders and other businessmen will now face a sudden cash crunch. This is because many depositors who had invested their money in such schemes now want to redeem them instantaneously. There is significant pressure on the cash outflows which these businessmen had not anticipated.
Hence, it is likely that the passing of this ordinance itself may bring in a wave of bankruptcy amongst businessmen who are heavily dependent on such schemes to meet their cash flow needs.
In the short term, the small and medium sector may face a lot of pain. However, in the long term, the interests of the small investors in the Indian market are likely to be protected as a result of this regulation.
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What the Current Wave of Protectionism and Populism mean for the Future of Globalization and Free Trade
February 12, 2025
