Four major crises in less than four years! From demonetisation, Goods and Services Tax (GST), economic slowdown, to COVID-19 catastrophe! The first killed many MSMEs. The second forced some to shut shop. The third led to fear and loathing. And the fourth, well, it decimated the sector. The future of more than 60 million Micro, Small, and Medium Enterprises (MSMEs) hangs by a thin thread. If the government-induced stimulus doesn’t work – the initial signs indicate that it is unlikely – the India economy is likely to go into a tailspin.
The policy makers assure us that we need to wait, as it takes a lot of effort to re-start a large economy like India after a nationwide lockdown for two months. They repeat that things have begun to move, and the positive impact will be visible in the coming months. “It’s too early to comment because many sectors resumed work only a few weeks ago,” says Anurag Thakur, Union Minister of State for Finance.
He adds that the government took “extraordinary steps” in an “extraordinary situation.” Sadly, time is at a premium. If the straggling MSMEs are unable to recover from their precarious state of a combination of near-paralysis and comatose by September 2020, be prepared for an economic mayhem. The pandemic will turn into a pandemonium. Remember that the MSMEs account for a third of gross value added, more than 100 million jobs, and half the country’s exports.
Without them, the economic and business skeleton that India carefully constructed over the past few years can come crashing down.
A recent sector-wide survey concluded that four-fifths of the MSMEs had no faith in the official stimulus package that was announced more than a month ago. They want more. They pray that the government realises that what it thinks is more than enough to revive the economy, and MSMEs, is too less. The reason: there are several challenges in the implementation of these measures. The ground reality is different from the reports that the officials receive. The various stakeholders do not seem to be on the same page.
Despite the government guarantee, the banks are nervous to lend more money to the MSMEs. Hence, the lenders give excuses to fob off firms, especially the micro and smaller ones. Lack of clarity on equity-related policies results in a lack of confidence among entrepreneurs. Political and non-economic actors seem to have a larger say in how the schemes operate. There is uncertainty about what to do first – push credit to the firms to kick-start supply, or put money in the consumers’ hands to rejuvenate demand.
The liquidity factor
There is no doubt that the MSMEs need funds merely to resume their businesses. They have run out of cash, saddled as they are with both raw materials and components that they couldn’t use, and finished products that they couldn’t sell for more than two months. This is where the government-backed emergency line of credit of `300,000 crore, which comes without collateral and at lower interest rate, will help. Until July 19 this year, slightly more than `20,000 crore was disbursed under the scheme.
“Many impacted businesses need funds to meet their built-up operational liabilities, working capital requirements, and salary payments. This will help MSMEs to resume their activities,” says Raman Sobti, Partner and National Leader, KPMG Enterprise, KPMG India. DK Aggarwal, President, PHD Chamber of Commerce, adds, “The various reforms will enable the MSMEs to produce and compete strongly in the marketplace.” It will allow them to get over the immediate crises, and stabilise their operations until revenues flow in.
However, the problem is that the banks are not interested to provide extra money to the MSMEs for two reasons. The first is that India Inc is in a wobbly situation. Most firms, whether large or small, and especially in critical sectors such as aviation, tourism, retail, logistics, and others, have either collapsed or are on the verge of bankruptcy. The MSME is one of the worst affected segments. The banks, therefore, are more worried about how to protect their existing loan exposures, and ensure that they don’t turn into NPAs.
Given this mindset among lenders, it is logical that they will be cagey to extend fresh loans, even if they are dictated by the government. They will find reasons, reasonable or otherwise, to delay and reject new loan applications. “The MSMEs face a number of difficulties. Some conditions or others are imposed by the banks on them. Sometimes, the latter are asked to furnish absurd documents,” claims Pradeep Multani, Vice President, PHD Chamber of Commerce, and Chairman, Multani Pharmaceuticals.
For example, an MSME that has availed of past loans from a bank can enhance its exposure by 20 per cent under the emergency credit scheme, as long as the credit has not turned into an NPA. No fresh documents have to be submitted as the bank already possesses the key papers under its KYC norms. Despite this, the bank insists on new financial records for the past three months. This seems preposterous because the firm has had no business in the past 90 days because of COVID-19, and has nothing to show for this period.
Add to this the fact that many entrepreneurs in the MSME sector are not trained and professional managers. They comprise business families that are nimble, flexible, and take advantage of new opportunities. They don’t understand the intricacies of government schemes, and are likely to get flustered by the jargon thrown at them by the bankers. A majority function in the semi-urban and rural markets, and have irregularly and intermittently dealt with the formal credit and banking system in the past.
Hence, says Arvind Sharma, Partner, Shardul Amarchand Mangaldas & Co, there is a need to “strengthen training of, and awareness among, MSMEs, as well as provide institutional support to ensure accelerated growth” in the near future. Both civil servants and bankers have to be sensitised to encourage loans, rather than dissuade potential lenders. “In India, 51 per cent of MSMEs are in the rural sector. Unless rural credit is opened up, the impact will be minimal,” explains KR Sekar, Partner, Deloitte India.
The political factor
One of the solutions, according to Sekar, is to mandate, rather than urge and nudge, banks to lend fresh money to the MSMEs, and make the process simpler. The second, feels Multani, is for the government to monitor disbursals of the loans at the ground level. “Mere issuances of loan sanction letters by the bankers are not enough,” he adds. According to union minister Thakur, in the first few days of the emergency credit scheme, while `25,000 crore of loans were sanctioned, `14,000 crore were disbursed.
Even if the banks open the credit pipeline, and let the money flow to the MSMEs, there is a skew or bias among the lenders. The first is that given the fears of future NPAs, there is the tendency to give loans to the larger MSMEs. This is because the bankers rightly or wrongly feel that they are in a better position to survive, and repay the amounts in the future. The bitter fact is that it is the smaller and micro enterprises that are in dire need of fresh funds. Without it, they will die, i.e. if they already haven’t.
As banks become choosy, which they have, political and non-economic actors can influence their decisions. State-owned banks are amenable to pressures, both at the national and states’ levels. Who gets the loan, and who doesn’t, can be decided by factors that are not related to the state of business or future viability. In such a scenario, nepotism and crony-capitalism can raise their ugly heads, and derail the recovery process.
Therefore, it is imperative to ensure that the sanctions and disbursals are transparent According to sources, there were 10-20 per cent of MSMEs which, in the pre-COVID period, had decided to exit their businesses due to various factors. Now, they may get a chance to do it profitably. Such firms can use their influence and clout to get fresh loans, siphon off the money, and later declare bankruptcy. The policy makers and bankers need to be aware of this, and make sure that the loans go to those who are serious to turn around their operations. Or else, a sizeable proportion of the new loans will turn into NPAs.
The equity factor
It is evident that the net worth of most MSMEs was eroded by COVID-19. Their balance sheets need to be bolstered by infusion of fresh equity. One of the ways that this can happen now is through the new ‘Fund of Funds’ (FFS) with a corpus of `50,000 crore. Sobti points out that other nations announced similar plans. In the UK, it is available to unlisted, but registered, firms that had raised £250,000 each in the past. In Poland, the equity fund can be used by those that meet fixed employees and turnover criteria.
Although the details of the MSME FFS aren’t available, there is a precedent to go by. For instance, the FFS for start-ups is modeled on the Mother-Daughters concept. The government gives the money to the ‘Mother’ fund, which distributes it among the daughters, the 650-odd, privately-pooled Alternate Investment Funds (AIFs) that are registered with Sebi. The professional managers of the AIFs take the final decision on which start-up to invest in. This ensures professional decision-making, and prevents the government from becoming a direct shareholder in the start-ups.
In the case of the MSME FFS too, Sobti insists that “an innovative approach” is required for the proper use of the funds. He adds that the government can seek “a hybrid model, which is operated under the government framework, and managed by professional fund managers”. These may seem to be a clear-cut strategy, but can create contradictions. While the government’s goal is to “support good firms” in the medium term, the desire of the professional managers is to seek high returns within a short period.
However, if the MSME FFS is handled properly, it can lead to several positive consequences for the sector. “The FFS can help MSMEs with good credit rating and GST record to expand their capacities and size. This will encourage them to get listed on the stock exchanges in the future,” explains Sachin Seth, Partner (Digital & Fintech Leader), EY India. A listing will enable the firms to raise more money, expand further, become more professional, adopt global best practices, and graduate into the mid-size segment.
The demand factor
At the end of the day, the schemes related to loan and equity infusion can spur supplies, and help the MSMEs to immediately commence production. However, this may prove to be irrelevant, if the consumers don’t have the money to purchase the goods. For example, if there are no buyers for cars, the MSMEs that supply to the auto component vendors will not benefit.
As Sekar puts it, the government has to “revive demand completely” or the supply-side measures will only have “a limited impact”. One of the policies to boost demand is to disallow global players to participate in government tenders up to `200 crore each. This will give the MSMEs an opportunity to grab new orders. Other decisions include moratorium on loan repayments, and delay in the filing of tax returns. However, these are temporary and limited moves, which are unlikely to excite the MSMEs. Critics contend that the government hasn’t focused enough to put more money in the hands of the consumers – and this issue has to be adequately addressed.
Apart from consumption constraints, more can be done on the supply-side. Seth feels the need to introduce holistic reforms to enable MSMEs to scale up, and become globally competitive. Existing policies have to be tweaked. A few states recently opted for stringent labor laws to benefit owners, and woo investments. Higher investment limits for MSMEs – sacross micro, small and medium segments – are aimed to encourage promoters to become bigger without the fear that they will lose the sops that they enjoy as MSMEs.
Such decisions can be counter-productive. Strict labour laws can dissuade investors, especially foreigners who are bound by pro-worker laws in their own countries. What they want are flexible rules. Similarly, higher investment limits in the MSME sector introduces more competition, as larger firms that were not defined as MSMEs can now avail of the benefits.
Instead of an enabler, i.e. help smaller firms to become bigger, they can prove to be a deflator, and enable the bigger firms to kill the smaller ones.