Ease credit woes of MSMEs to boost manufacturing sector growth

An able support from manufacturing will improve value addition and job creation potential in the economy. (Source: Shutterstock)

The ensuing growth season in India is distinct in bringing manufacturing back to the limelight. While the service sector should remain at the forefront, able support from manufacturing will improve value addition and job creation potential in the economy. Part of such benefits have already started flowing.

To make the growth durable, the benefits need to be optimised. And that would depend heavily on the scalability of the micro, small and medium enterprises (MSME), which form the supply chain to large industries and are the biggest employers. Unfortunately, there exists a serious gap in the area. Exceptions apart, India’s MSME sector is suffering from a plethora of problems, the most critical of them is the lack of easy finance.

The job at hand is to expand the scope of third-party credit guarantees and reduce the need for collaterals. Also, the Small Industries Development Bank of India (SIDBI) should start direct lending of cheap credit to the MSMEs. SIDBI currently uses its resources in refinancing banks and non-banking financial companies (NBFC) for lending to MSMEs. The arrangement helps during liquidity crunch scenarios.

However, in the present context, when banks are flushed with cash and are still not lending adequately to MSMEs or are lending at higher rates, SIDBI should disrupt the credit market through direct lending. For inspiration, they may look at the National Bank for Agriculture and Rural Development (NABARD) which directly lends to the farm sector through its subsidiary Nabkishan Finance.

Inadequate Credit Guarantee Coverage

The bigger change will take place when the quantum of third-party credit guarantee, offered by the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), will increase a few times from the prevailing Rs 1 lakh crore (2022-23). As a thumb rule, commercial banks are less interested to serve smaller initiatives, which need finance the most and have less collateral to pledge. CGTMSE was floated by the government and SIDBI to break this deadlock. The trust extends up to an 85 percent guarantee to banks against MSME loans, subject to a ceiling of Rs 5 crore. It means banks can give loans to the identified segment with as low as 15 percent collateral support.

 Do a bit of ground survey and the beneficiaries are hard to find. The reason lies in simple math. According to National Sample Survey (NSS) 2015-16, India has 633 lakh MSMEs, 99.9 percent of which fall in micro and small categories, defined by turnover ranges of below Rs 5 crore and Rs 5-50 crore, respectively. Assuming an average loan requirement of Rs 50,000 a unit, the sector needs Rs 3.16 lakh crore of credit. It means on average CGTMSE guarantee can eliminate less than one-third of the collateral needs. The NSS data was collected before the government revised the definition of MSMEs in June 2020 and opened the Udyam registration portal for voluntary disclosures and certification. As of date, 2.04 crore MSMEs employing 12.32 crore people have registered on the portal. Of the total, 5.55 lakh enterprises are small. Assuming an average working capital requirement of Rs 1 crore, the sector needs Rs 5.55 lakh crore credit, five times the size of the CGTMSE approvals. Clearly, the institutional mechanism is insufficient. That explains why microenterprises rush to NBFCs and micro-finance institutions (MFI) for collateral-free loans of Rs 1 lakh at 15-24 percent interest as against 10 percent (prevailing) in banks.

On the flip side, such a high-cost loan is unsuitable for manufacturing MSMEs, operating at wafer-thin margins in the days of reverse auction. According to NSS, 31 percent of the 633 lakh MSMEs are into manufacturing. The situation is pathetic as you go down the value chain. Growth has already started putting pressure on supplies. Ironically enough, the stronger and longer the momentum, the more vulnerable to fail will be the supply chain. The government will be forced to allow imports, compromising job creation potential.

Stressed Supply Line 

A quick visit to India’s oldest engineering MSME hub in Howrah, West Bengal, will tell you where the shoe pinches. Micro-entrepreneur Bimal Das makes custom-made wooden dice of a large crane wheel or steel plant valve, based on an engineering drawing, with the help of one labour, from his 200 square feet rented space at Baltikri for a gross enterprise income of Rs 30,000-40,000 a month. This dice will be used by AJ Cast Alloys, which has a turnover of Rs 13.5 crore, to create the steel body of the wheel. The cast will land up with Bimal Dinda, who is operating from a shared shop floor, for machining. He will put the 600 kg wheel on a wooden pulley to create grooves and bends, using second-hand lathes, as per the drawing. Depending on the work, the rates may vary from 35 paise to Rs 2,000 apiece. Dinda’s net income (after paying for labour, rent etc) hovers around Rs 30,000 a month.

After one or two more stops, the wheel will land at Probal Roy Choudhury’s small enterprise, Fluid Control and Engineering Company, on a hand cart, for the final assembly and delivery to a large crane maker. Probal secures orders from large enterprises and outsources part of the work from Das, Dinda and AJ Cast.

Keeping in tune with the expansion rush in steel, cement, power, railways, defence, etc, both Fluid Control and AJ Cast are witnessing a two-fold rise in demand since the end of 2022-23. Both need more capital. Probal is an M-Tech from the Indian Institute of Technology, Kharagpur and is highly connected. His banker doubled the working capital limit at 50 percent collateral support. But AJ Cast was not as lucky. Stung by a lack of resources, AJ is either avoiding taking some orders or delaying the delivery for working capital management. Das and Dinda have no money to install new machines and pace up operations.

Pressure is felt by Probal, who withdrew from a major tender last week for fear of missing the delivery schedule. Surely someone else had taken it up. But that someone should face the same capacity constraint. “What is happening in the Indian economy is unprecedented. I have never seen such a strong flow of orders and, I guess it will only rise. I would have loved to optimise the opportunity but my ecosystem may not permit that,” Probal said.

Pratim Ranjan Bose is an independent columnist, researcher, and consultant. His Twitter handle is @pratimbose. Views are personal, and do not represent the stand of this publication.