Is stimulus package to deal with COVID-19 pandemic enough for credit-starved MSMEs?
According to an estimate of Entrepreneurs Finance Lab, the MSME credit gap in India is approximated about 56 per cent. The supply of finance through banks stands at Rs. 1,038,948 crore against the demand of Rs.2, 803,628 crore.Sumanjeet and Bishnu Mohan Dash | Updated: 14-05-2020 08:55 IST | Created: 14-05-2020 08:20 IST
The micro, small, and medium enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector of the Indian economy over the last five decades. It contributes significantly to the economic and social development of the country by fostering entrepreneurship and generating the largest employment opportunities at comparatively lower capital cost, next only to agriculture.
This sector contributes nearly 28 percent of the country's GDP, employing over 111 million people in nearly 63.38 million widely dispersed enterprises across the country, accounting 45 percent of manufactured output, 40 percent of the country's total export and producing more than 8000 value-added products ranging from traditional to high-tech. According to Fourth All India Census, this sector has registered an annual compound growth rate of 30.72 percent at current prices (with base reference year 2006-2007) as compared to the Third Census (with base reference year 2001-2002). Further, these enterprises are the nurseries for innovation and entrepreneurship which will be the key to the future growth of India. It is also an acknowledged fact that this sector can help realize the target of the proposed National Manufacturing Policy of enhancing the share of manufacturing in GDP to 25 percent and creating 100 million jobs by the end of 2022 and considered the engine of economic growth. But this engine now is sputtering.
Despite such a significant contribution to the economy MSME's have been facing several bottlenecks inhibiting them from achieving their full potential, including the ability to access timely and adequate credit. The major hindrance in running and the expansion of MSMEs is the unavailability of sufficient and timely funds to finance their operations as well as growth plans. Various estimates on the credit availability to the MSME sector indicate a considerable credit gap, which is a matter of serious concern.
Hurdles before MSME's in India
In India, the overall demand for credit by MSMEs is estimated to be Rs. 87.7 trillion ($1.4 trillion) and in contrary to that only INR 69.3 trillion is the total supply of debt to MSMEs. Out of these total supply, INR 58.4 trillion is from informal sources, and the remaining INR 10.9 trillion is from formal sources. The supply of debt from formal sources consists of scheduled commercial banks (INR 8.8 trillion), NBFCs (INR 1.5 trillion), other banks (INR 0.56 trillion), and Government institutions (INR 0.04 trillion). The further subdivision of these formal sources is very interesting and it is like this- Public sector banks (INR 5.4 trillion), Private sector banks (INR 3.1 trillion), and Foreign banks (INR 0.3 trillion) is a subdivision of scheduled commercial banks and RRBs (INR 0.11 trillion) and UCBs (INR 0.45) is a subdivision of others banks and SIDBI (INR 0.01 trillion) and SFCs (INR 0.03 trillion) is a subdivision of government institution. This is what the Intellecap Analysis has revealed in its 2018 report. Thus the mismatch between demand and supply of credit is estimated to INR 25.8 trillion which can be addressed by the formal financial institution. It is argued that financial institutions are hesitant to lend to MSMEs as this segment has high NPAs. Though only about 15 percent of the total NPA in the country is on the account of the MSME sector.
In India, MSME credit gap is approximately about 56 percent. While there is an estimated demand of Rs.2, 803,628 crore, the supply of finance through banks stands at Rs. 1,038,948 crores, reveals a study conducted by US-based Entrepreneurial Finance Lab (EFL). Public sector banks account for over 70 percent of debt financing to the MSMEs, while private and foreign banks account for over 20 percent of credit flow. RBI has directed banks to provide 60 percent of the total loans extended to MSME units. But the figure stood at 47 percent.
While large industries have access to various sources of finance, the MSME sector depends primarily on finance from banks and other financial institutions. Conversely, banks are reluctant to provide loans to MSMEs due to lack of transparency about their financial conditions and reliability of data, lack of financial discipline, high administrative costs of small-scale lending, high-risk perception, and lack of collateral. Also, traditional banks and NBFCs consider MSMEs a risk lending proposition. A large percentage of MSMEs don't maintain consolidated financial data such as tax return fillings, P & L, and transactions. With institutional lenders having little to no visibility in MSME finances, their underwriting mechanisms fail to accurately gauge the creditworthiness of potential borrowers.
Despite their intrinsic strengths, MSMEs have low market credibility. Due to their small size and inherent vulnerability to market fluctuations, the mortality rates of MSMEs are relatively high. According to the new definition of sickness by Reserve Bank of India, of the 3.62 crore MSMEs in the country, over 12.2 lakhs are sick units. Alarming statistics show that around 29,000 units are being added to the sick list every year. These sick MSMEs amount to outstanding bank credit of over ₹7,000 crores. Consequently, due to doubt about the possibility of survival and growth in these enterprises, financial institutions are inclined to tighten their requirement to approve a loan or may require a lot of information about the investment.
Constraints in accessing bank credit force them to tap alternative sources of finance. According to a survey by Assocham and Resurgent India, only about 33 percent of MSMEs have access to banks and institutional financing channels, while the rest raise money through personal and family savings and even borrow money from friends and relatives at higher rates of interest to ensure their survival. Added to this, trade credit is also a popular form of alternative source of finance for the Indian MSMEs. Alternative financing typically involves higher transaction and interest costs as compared to bank finance. Poor access to finance limits the ability of Indian MSMEs to survive and grow. A study on the MSME sector also suggests that multiple growth constraints (like poor infrastructure, obsolete technology, inadequate market linkage, etc.) can be largely linked to inadequate access to finance.
In order to improve the flow of credit to this sector, certain measures have been taken by the Government in the recent past. The schemes such as Credit Guarantee Scheme, Credit Linked Capital Subsidy Scheme (CLCSS), Rajiv Gandhi Udyami Mitra Yojana (RGUMY) Performance and Credit Rating Scheme, Prime Minister Employment Generation Programme (PMEGP), Micro Finance Programme, Bills Discounting Scheme, are aimed at increasing flow of credit into MSME sector.
In the Budget 2018-19, Union Finance Minister announced Rs. 3,794 crore allocation to MSME sector for credit support, capital, and interest subsidy on innovation. Under the Interest Subvention Scheme for MSME, Rs. 350 crore was allocated for 2019-20 for 2 percent interest subvention on fresh or on incremental loans. To ensure working capital financing for small businesses, a scheme to provide subordinated debt for entrepreneurs of MSMEs has been proposed in the Budget 2020-21.
This subordinate debt to be provided by banks will count as quasi-equity and planned to be guaranteed through the Credit Guarantee Trust for Medium and Small Entrepreneurs (CGTMSE).In a recent move of RBI, banks are advised to achieve a 20 percent year-on-year growth in credit to MSME and 10 percent annual growth in a number of micro-enterprises. Banks are also instructed not to accept collateral security for a loan up to Rs. 10 Lakh for MSMEs. Despite various policy initiatives of Government and guidelines by RBI, there still exists a huge demand-supply gap in the credit flow to the MSME sector. Credit conditions for Indian MSMEs are expected to continue depressed as capital adequacy requirements under Basel III would adversely affect financing. Banks will have to hold additional cash in reserve to meet the terms of Basel III, they will have less money to lends, which is expected to have a disproportionately negative effect on SME financing opportunities. Nonetheless, this grim situation calls for holistic fiscal support and an enabling approach.
The Bottom Line
To end where we began, the MSME sector forms the very foundation on which the Indian economy is built. It has helped the country to tide over business disruption caused by the global financial crisis and large scale economic reforms. Fulfilling its credit requirement is, therefore, critical to ensure that India continues on its current trajectory as a major global economic power. However, is the stimulus package of a 3 lakh crores collateral-free loan scheme for businesses, especially MSMEs to deal with the COVID-19 pandemic, announced by FM good enough for the credit-starved MSMEs, and what else needs to be done?
In this regard, the MSMEs association, chamber, and bodies have an important role to play in promoting awareness among MSMEs about the policy measures and institutional measures aimed at facilitating credit flow to the sector. MSMEs should be encouraged to get themselves rated through specialized rating agencies like the 'SME Rating Agency of India Limited' (SMERA). The rating is likely to help MSMEs to obtain better credit facilities from a lender and also will help them to establish their credibility which could enable them to negotiate with their bankers for a reduction in interest rate, larger loan size, or even obtain faster processing of their loan applications, etc. At governance front, there is strong need to promote structural and operational transparency in financial institutions to track the status of the loan application, reasons of rejection and most importantly monitoring the overall lending procedure of banks to discourage the enticement to earn higher margin by charging high credit risk premium to finance MSMEs. In the banking sector, there is a need to devise standardize lending approaches like Credit Scoring to assess, approve, or decline loans to MSMEs. Last but not the least, Indian MSMEs should seek alternative finance options suited to their business needs and get a better deal. For high-growth units, factoring, supply chain finance, angel funds or venture capital funds could be alternative sources of funding- for MSMEs, and start-ups in this sector.
NOTE: Authors are working as Assistant Professors at Ramjas College, the University of Delhi, and Bhim Rao Ambedkar College, University of Delhi, respectively.
(Disclaimer: The opinions expressed are the personal views of the author. The facts and opinions appearing in the article do not reflect the views of Devdiscourse and Devdiscourse does not claim any responsibility for the same.)
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