Covid-19 Exposed Credit Faultlines In India’s MSME Sector, And Here’s How They Must Be Addressed

Touted as the ‘growth engine’ of the Indian economy, micro, small and medium enterprises (MSMEs) are responsible for propelling the three crucial ‘Es’ — economy, employment, and entrepreneurship.

National campaigns, coloured in socio-political elements, like the ‘Make in India’ programme, the National Skill Development Mission, and the recently announced ‘Atmanirbhar Bharat’ not only recognise the importance of Indian MSMEs but also rely on them for their success.

The sector substantially contributes to the country’s growth with a 30 per cent share in gross domestic product (GDP) and a 45 per cent share in the total exports.

In India, beyond agriculture, formal and informal employment prospects at relatively cheaper costs are found in MSMEs. More than 633.88 lakh non-agriculture MSMEs engaged in different economic activities, employ more than 124 million people, out of which 20 per cent of the job share belongs to women-led firms.

The sector is critical when it comes to ushering in socio-economic development, given more than 50 per cent of the MSMEs, almost 325 lakh, are engaging the rural population, against 309 lakh MSMEs in urban India.

However, for a sector that has been generating more than 110 million jobs in the country, the arrival of Covid-19 has resulted in a disaster.

Covid-19, which originally started out as a Chinese problem, before taking over the entire world, resulted in catastrophic loss of lives and livelihood. In India, the loss of livelihood was ushered in by the pandemic-induced nationwide lockdown that led to a migrant crisis for daily-wage labourers, rendering lakhs of workers without jobs or any informal employment prospects.

The reverse migration from cities to villages led to further disruption in supply chains, impacted production thus denting domestic supplies, international export and remittances, market demand and eventually plunging growth into negative.

The production and procurement of goods and services have been reduced due to fallen market demand. Since there is no visible and definite end to the current health and economic crisis, and private consumption has slowed down in the light of job losses and pay cuts, the re-activation of small businesses is a daunting ask in the present day scenario.

Staring at this bleak scenario, the Finance Ministry infused liquidity measures to help the MSME sector deal with the virus outbreak.

The announcements made in May 2020 included the revised classification criteria for MSMEs, subordinated debt of Rs 20,000 crore for MSMEs, collateral-free loans of Rs 3 lakh crore for businesses, partial credit guarantee programmes, and monetary assistance in getting stock exchange listing.

However, these measures were solutions on the supply side while the problems continued on the demand side.

Although the funds are assumed to be a silver lining for stressed MSMEs, the accessibility to these measures remains a critical question.

For a country of 6 crore and more MSMEs, 45 lakh firms are eligible to apply for loans through Emergency Credit Line Guarantee Schemes (ECLGS), that is, only 7 per cent of the total enterprises can borrow around 20 per cent of their outstanding credit.

Also, according to the recent report by Crediwatch, out of 45 lakh eligible firms, only 24 lakh MSMEs have secured loans through ECLGS at concessional rate of 9.25 per cent interest. This further reduces the actual number of beneficiaries to 4 per cent of the total enterprises.

Dominated by more than 99 per cent micro-enterprises, MSMEs are being cautious of the loans despite cheaper interest rates. However, there is more to the story of financing MSMEs, where credit gap limits the accessibility to the limited supply of credit in the market.

If one is to put it optimistically, the pandemic exposed the credit faultlines in India’s MSME sector, and for the government to continue its pursuit of being a $5 trillion economy, it must address the following problems instead of relying on measures that reach out to less than 5 per cent of the MSMEs in India.

First, accessibility. The perception of small businesses towards formal credit is flawed. Most of the firm owners consider formal borrowing as an expensive pursuit.

Discouraged by the lengthy and often unexplained documentation, formalities, collateral and guarantee concerns, and procedural delays demotivate MSME borrowers from applying for formal loans. Even now, borrowers are keener to apply for a personal loan instead of an ECLGS loan due to the time constraints involved in approval and sanction.

Second, availability. In the emerging economies, especially ones going through the financial crisis, the supply of funds is limited. Thus, banks are looking to prioritise lending, and often, are picky when it comes to lending.

Although the non-performing assets (NPAs) in MSME portfolio have remained lower than those of large corporate segments, the banks are still attentive regarding the credibility of borrowers. Presence of information asymmetries between the banks and MSME borrowers restricts lending through the strict credit scoring mechanism and relationship banking.

Relationship banking is becoming a hurdle for the MSME fund-seekers, who tend to share zero to little history with the banks. The cheaper loans are attracting more loan requests from MSMEs and way more vigilance from banks and institutions.

Third, reluctance to lend. To assess the creditworthiness of MSME borrowers is a difficult process.

Also, the cost of accessing soft information about the borrower leads to an exponential increase in transaction cost per loan. The entire process is not fruitful for most banks as the amount applied for loans are relatively less and the risk involved in lending is much higher.

Bank officials have also noticed that most small businesses do not perform well in sickness and turn into a flop show. The very same apparent unwillingness of bankers has been faced and felt by many small firm owners.

Fourth, self-abstaining. A major part of the Indian MSME sector is highly informal. Where registrations under Udyog Aadhaar and Goods and Services Tax Network (GSTN) have formalised thousands of small businesses, the willingness in MSMEs to borrow formally is yet to be discovered.

The self-abstaining in the current situation has further increased since most firm owners are unable to predict market demand and therefore, are not willing to add further loan liabilities.

Instead, they are minimising production and cutting costs to tide over the crisis. The same abstaining was also witnessed by bankers looking to reach out to their regular MSME clients for the emergency credit line programme.

Lastly, the lack of awareness. Indian MSMEs may possess a practical understanding of wealth creation and business management, but many of them lack awareness regarding the financing alternatives available to them.

The insufficient knowledge about the borrowing process, credit schemes, financing options such as Trade Receivables Discounting System (TReDs), SME stock exchange listing, venture capital, and FinTech lending create disinterest and hesitation among the firm owners to apply for formal credit from banks.

Even now, while the supply side is urging MSMEs to borrow, many firm owners are clueless regarding the application process.

To put things in perspective, Covid-19 was an opportunity in disguise for those MSMEs which were almost at the brink of sinking, given they could access emergency funds through the measures announced by the government.

However, given that these MSMEs accounted for less than 5 per cent of the total MSMEs, the lesson for other MSMEs was far bigger than the reward. The lesson is to move towards formalisation.

Perhaps, the government should have extended the emergency credit line scheme towards MSMEs in lieu of having their operations formalised.

Given that only a meagre fraction of the MSMEs availed the emergency credit funds, more than the success, it’s the credit gap faultlines in India’s MSME sector that comes across as a reason for concern as the nation looks to put the 24 per cent negative GDP growth behind it.

Silver linings and lessons are as good as the stakeholders, and India’s MSME stakeholders need to smell the coffee.