Bridging The Credit Gap For MSMEs In India Through Sector-Specific Approach

There are more than 322 million formal and informal MSMEs responsible for generating up to 70 per cent of the employment and 50 per cent of the GDP across the globe.

Among the 76 million enterprises from the Indian subcontinent region, representing India, Bangladesh, Sri Lanka, and Pakistan, India stands tall with its thriving MSME ecosystem, including 63.38 million non-agricultural micro, small and medium enterprises.

Although India’s ‘MSMEs per 1,000 people’ are between 19-50 as compared to high-income economies like the USA, Australia, New Zealand with more than 50 ‘MSMEs per 1,000 people’, it does not undermine the fact that India reports the maximum number of small business units across the globe, followed by Indonesia, Nigeria, USA, and China.

MSMEs holds an economically dominant position in the growth and development of the Indian economy. The MSME sector has consistently contributed around 30 per cent share in the country’s GDP along with representing 45 per cent share in exports and generating 111 million job opportunities for skilled and semi-skilled labour.

Given its due importance, MSMEs are critical to unlocking the potential of India envisioned under the 'Make In India' campaign. Not only the sector serves the purpose of AatmaNirbharta, but it also paves the way for overall production, employment generation, and untapped export opportunities.

Despite being the bulwark of the Indian economy, the MSMEs are troubled by their financial constraints owing to constant working capital expenditure and inaccessibility to mainstream finance. With the addressable credit demand of Rs 37 trillion and existing mainstream supply of Rs 14.5 trillion, MSMEs face a wide lacuna of Rs 20-25 trillion, also termed as credit gap.

Credit gap is defined as the difference between the addressable demand of funds in the market and the existing supply of funds in the economy. It stems from macroeconomic conditions and microeconomic factors, hence, to blame the equilibrium failure on any side of the paradigm is not the correct way to approach the problem.

Demand-side, representing MSME owners, have rigid business policies, financial preferences, borrowing hesitancy, and strong inclination towards informal methods of financing.

On the other hand, supply-side, representing banks, NBFCs, and other financial intermediaries, operate in a constrained regulatory framework, underdeveloped financial infrastructure, and face insolvency and bankruptcy issues in MSME segment lending. Since the gap arises from both ends of the spectrum, its bridging needs to be mutually inclusive too.

The policy reforms in the face of initiating and propelling 'Start Up' ecosystem, MUDRA lending, Skill India movement, GST implementation, delayed payments and grievance monitoring, equity infusion through FoF, and credit guarantee programs have been consistent in translating the government’s efforts towards the vulnerable sector of MSMEs.

However, the discourse of such policy reforms is eyeing results by missing the sector-specific and segment-specific approach. The inherent complications of the MSME sector cannot be ignored with supply-side injections of policies and reliefs. Hence, the problematic areas of the MSME sector that hinder financial accessibility is important to address.

Sector Specific Approach

The Indian MSME sector is a complex cobweb of heterogeneity and informality of operations. Unlike other sectors, the MSME sector is highly unorganised in terms of business structure, methods of operations, and enterprise location.

Moreover, they represent different categories, carry different needs, and face different challenges across the rural and urban regions of the country. However, it is not the heterogeneity of the sector which makes it troublesome for the policymakers; it is the high degree of informality among business enterprises.

The lower levels of productivity and growth promote informality among small business enterprises. The trait of heterogeneity even in the decision of staying informal enterprise is visible owing to the fact that some enterprises are hesitant to register while others are not willing to formalise.

MSMEs indulging in small business activities for the sake of survival or cash market opportunities do not have sufficient means and motivations to get registered. On the other hand, a major chunk of the informal MSME economy has compliance concerns with the administration.

Segment-Specific Approach

The problem of informality and shadow operations is not an issue in the case of small and medium enterprises due to the nature and scale of their investment and turnover. Hence, it all boils down to micro enterprises dodging the formalisation.

However, this revelation does not help one bit. Almost 99 per cent of the Indian MSME sector is represented by micro enterprises, and less than 1 per cent categorises themselves under small and medium segments. Even with the latest amendments, the micro enterprises are the business entities with investments up to Rs 1 crore and turnover up to Rs 5 crore.

The definitions have been upgrading’ for long, only to squeeze ‘not at all homogenous’ enterprises into one club. As per the classification criteria, a boutique run by a household woman and wholesale trading of hosiery goods are the passengers of the same boat despite the distinct structure, scale, and ambitions of their respective modes of livelihood.

It is to be noted that under AatmaNirbhar Bharat campaign, the GOI included large enterprises with investments up to Rs 50 crore and turnover up to Rs 250 crore under medium enterprises category in order to benefit the emerging businesses. However, the manifestations and motivations of all micro firms are not similar as in the case of all medium classified firms.

The question now arises on the association between credit gap and sector/segment-specific issues. The answer is the dependency on informal finance. The inherent problems of informality, heterogeneity, and shadow operations that keep an entity deprived of formal credit is replaced by trust, character, and quality relationship between MSME and informal financier.

Indian MSME sector satisfies its 84 per cent working capital and capex requirements from the informal financiers, sometimes even at the cost of the higher rate of interest. The formal lenders stress upon the quality, reliability, and continuity in their borrowers; whereas, MSMEs assess their financial accessibility on the parameters of need, availability, and speed of credit disbursal.

Hence, the benefit of the difference between expectations of formal lenders and MSMEs is exploited by the informal moneylenders, and the same factor contributes to the MSMEs’ unwillingness towards formalisation.

The implementation of GST has been a successful measure in bringing maximum enterprises under the formal umbrella. As also advised by the RBI’s UK Sinha Committee, the linking of PAN-Udyog Aadhaar-GST identification number can curb the informalisation to a good extent.

However, the micro enterprises not linked with any of the above-mentioned platforms can be taken care of under the re-classified segments, where micro firms can further be categorised into nano and mini enterprises owing to their scale of operations.

The sub-categorisation of micro segment enterprises into nano and mini enterprises can be the true game changer for the cluster financing programs.

Enterprises with similar scale, risks, and motivations shall be able to access formal credit through respective segment’s cluster associations and unions. Moreover, the benefit of MUDRA collateral free loans up to Rs 10 lakh can be availed by nano and mini enterprises through the policy of priority sector lending. In a similar vein, formalisation incentives can be provided to nano enterprises in the form of tax exemption and holidays, doorstep enterprise registration, and other such incentives.

The push of credit exposure can not really work for those who are too comfortable staying under the blanket.