In this Moneycontrol Deep Dive podcast. we examine whether the 59-minute loan sanction for small businesses is a gimmick or a masterstroke.
The frenetic election season will bring with it controversies, sops, slogans, rallies and a lot more and media platforms will as always struggle to keep up with it all.
From the time the government reached out to Micro, Small and Medium Enterprises (MSMEs) with overtures to boost their growth, analysts have tried to understand not just the reasons and the implications of the move but the fine print underscoring it.
In this Moneycontrol Deep Dive podcast. we examine whether the 59-minute loan sanction for small businesses is a gimmick or a masterstroke.
On November 6, Debabrata Das, wrote a piece in Fortune India with this headline, " With an eye on elections, government gives boost to MSME sector."
The article exhibited a pattern of inquiry that is essential to make sense of sweeping economic decisions. It is after all still hard to completely deconstruct the reasons and outcomes of demonetisation. Or successfully evaluate the management of the goods and services tax (GST). Or even to foretell the impact of Reserve Bank of India's (RBI) directives that are currently causing panic among ATM operators. But we must try, right? If only, because such complex ideas have the potential of affecting citizenry in a far-reaching manner.
And in retrospect, demonetisation and GST impositions did adversely impact among other things, small and medium businesses. And hence economic policy makers must think of not just the immediate returns of a momentous announcement but also how it will pan out in the future, in real time, when implemented.
And that is why it is important that the MSME goody bag is examined in its entirety. Especially because there has been an unprecedented tension between RBI and the central government over the liquidity issues pertaining to easing credit availability to micro, small and medium enterprises. And as always there is that unavoidable question. Why now?
What about the timing?
As Debabrata wrote in the Fortune piece, "At a time when the talk of a liquidity crunch in the Indian financial system is rife, it seems odd that micro, small, and medium enterprises (MSMEs) have been promised that loans below Rs 1 crore would be sanctioned in less than an hour. But when you put it in the context of a general election next spring, the government’s efforts to pacify the MSME sector, which been through the wringer in the past two years, starts to make sense.
For nearly two years, the MSME sector has borne the brunt of the government’s policy measures. With demonetisation first and then the haphazard implementation of the goods and services tax (GST), the MSME sector had been left cash-strapped." Unquote.
The author cites MSME Pulse report from TransUnion CIBIL and the Small Industries Development Bank of India (SIDBI) to report how the percentage of non-performing assets in the loans given to the sector grew to 17.2 percent this June, from 14 percent in December 2016. According to the report, he says, the total credit exposure in India to the MSME sector is Rs 22.8 lakh crore.
Adding to the woes of the sector was the fact that loans were tough to come by. This was , says the author, because 11 of the 21 public sector banks are facing lending restrictions as they are under the Reserve Bank of India’s prompt corrective action (PCA) framework.
"With a financing requirement of nearly Rs 4.5 lakh crore over the next two year, it was assumed that the non-banking financial companies (NBFCs) will step up into the space left vacant. However, in the aftermath of the meltdown of the biggest NBFC in the country, Infrastructure Leasing & Financial Services (IL&FS), the entire industry is strapped for cash."
A political decision?
As expected , says the piece, traditional support base among MSMEs for the ruling party was getting increasingly antagonised but things took a swift turn when a large support package was announced for the sector.
As the piece elucidates, "Prime amongst the measures was the promise of loans of less than Rs 1 crore being sanctioned in less than an hour. These loans can be accessed through a link on the GST portal. Further, all GST-registered MSMEs would get a 2 percent interest subvention for fresh and incremental loans. And for exporters who receive loans in the pre-shipment and post-shipment period, there would be an increase in interest rebate to 5 percent from the existing 3 percent.
MSMEs with a turnover above Rs 500 crore would be brought on to the Trade Receivables e-Discounting System (TReDS) where entrepreneurs would be able to access credit from banks based on their upcoming receivables." Unquote.
Additionally, as the piece informs, public sector companies have been asked to procure 25 percent of their total purchases from MSMEs and of this 3 percent should be from MSMEs promoted by women entrepreneurs. We quote, "To improve the ease of doing business for MSMEs, clusters would be formed, initially for pharmaceutical sector MSMEs; regulations with regard to labour laws have been relaxed; inspections would be done through a computerised random allotment; and environmental clearance has been simplified." Unquote.
Vinod Parmar, global head of sales and marketing at Vayana Network is cited and he opines that linking loan approvals to GST returns will encourage more and more MSMEs to become a part of the formalised economy. Besides, any platform which can reduce friction and give convenient access to finance to the MSMEs will see rapid adoption, according to him.
What will be the big gain?
The bigger question is IF the growth of MSMEs will benefit from these measures. It goes without saying as the piece suggests, that the well-being of 65 million MSMEs in the country that employ 120 million people, will impact which way the election results swing in 2019. As the author says, "Disruption in credit to the sector could affect both jobs and the MSME entrepreneurs. Prime Minister Narendra Modi has a penchant for making mega announcements near the festival of Diwali. This year, the focus clearly is on the elections, which is why the traders who form the BJP’s traditional support base have a lot to cheer about." Unquote.
The larger picture
On November 6, Ravi Krishnan wrote a Moneycontrol piece that also went beyond the optics of the sops to convey that an inordinate price should not be paid for a short -term gain. The central argument being, "It is important that MSMEs get access to credit, but it should not come at the cost of banking sector's health."
The piece concedes that access to formal credit is a serious issue for most micro, small and medium firms in India. And on the surface, it seems that the government is seeking to fill this gap with its 12-point programme announced on November 2.
The slip between the cup and lip as far as lending to this sector goes, can be attributed to the fact that about 97 per cent of MSMEs operate in the informal sector and without formal documentation and records, loans are hard to come by.
We quote, "Bank credit has been slow in recent years. Although it picked up recently, banks have ceded space to NBFCs or Non Banking Financial Companies who have doubled their share in MSME credit from 5.5 per cent in December 2015 to around 10 per cent by March 2018. That’s why when a liquidity crunch is feared to hit NBFC lending, the government has been pushing the central bank to open a special window for such firms and also be lenient in recognising MSME defaults." Unquote.
But even good intentions must consider how much they will cost.
As the author says, "While an attempt to help out the MSME sector is commendable, sanctioning a loan of Rs 1 crore in just 59 minutes looks like a gimmick that can have unintended consequences. It could mean subtly putting pressure on state-owned banks to lend to this sector. Public sector banks would do well not to relax their credit appraisal and assessment in a rush to meet this artificial deadline. As it is, in a sector that is reeling from demonetisation and the imposition of Goods and Services Tax (GST), the level of delinquent loans is pretty high. According to SIDBI's MSME Pulse, the non-performing assets ratio ranges from 8.7 percent to 19.5 percent depending on the size of the loan taken." Unquote.
It is now an established fact that public sector banks have been hit badly with about 15. 2 percent of their MSME loans turned sour at the end of June 2018 compared to 5 percent for NBFCs and 3.9 percent for private banks.
Says the author, "Unbridled, forced lending to the sector could reverse the gains made by banks in recognizing and resolving their bad loans. Thus, the government would do well to take steps to help MSMEs beyond opening credit channels. Indeed, some of this has already been done. Asking companies with a turnover above Rs 500 crore to register themselves on the Trade Receivables Discounting System (TReDS) receivables platform will help MSMEs tackle cash flow problems and enhance their access to credit, since banks will have greater security (and documentation) in extending loans.
Indeed, the larger question policymakers should ask is why do MSMEs remain small and operate in the informal economy. The answer lies in complex regulations and lack of infrastructure. The GST, which is supposed to help ease the tax burden, is a case in point." Unquote.
It is of course important to recognise the unrealised potential of MSMEs as they contribute to a fifth of the country’s labour force, about 45 per cent of manufacturing output and 40 percent of India’s exports.
However, to help them thrive, improving infrastructure and ease of doing business are a must. Some steps that have been announced must be lauded as checking unwarranted inspections of factories, simplifying penalties for minor offences under the Companies Act etc but as the piece points out, more such measures are needed rather than directed lending.
What could go wrong with populist measures like indiscriminate lending? Well, plenty. The MSME package promises loan clearances in 59 minutes flat, disbursal within 10 days and concessional interest rates on borrowings. It was a great idea, but a flawed decision, says consulting editor RN Bhaskar in a Moneycontrol piece on November 22. We quote, "The Banks are already weakened by bad loans. Concessional interest rates and forcing them to increase their allocation of funds to MSMEs from the existing 20-25 percent is not a wise way of strengthening the banking sector. " Unquote.
The article recognises the importance of the MSMEs in the organised sector work force and cites The Ministry of Micro, Small and Medium Enterprises' annual report for 2017-18 which pointed out that this sector accounted for Rs 39 lakh crore of gross value added (GVA), or about 31.6 percent of the country’s GVA.
And of the jobs they provide, about five crore are in rural areas, making its support crucial during elections in states like Uttar Pradesh, which accounts for 14 percent of all MSMEs.
But the author points out that the only dark cloud is that the rate at which they have been growing has been declining consistently. We quote, "They grew by 15 percent in 2012-13, 12.3 percent in each of the two following years, and only 7.62 percent in 2015-16.
Clearly, they needed incentives and a bit of prodding to accelerate their growth rate. Demonetisation had hit them very hard and so did the Goods & Services Tax (GST). The latter has increased their need for working capital because GST must be paid at the time of invoicing, even before the money comes into their kitty.
Still, there is no denying that many MSMEs have been weighing down the list of non-performing assets (NPAs) in India. They have become riskier for banks to lend money. Worse, the risk is growing each month. And that is why the idea of giving them loans at subsidised rates of interest is terribly bad."
The piece points out how easy it is to forget, that interest rate is a reflection of the risk that the borrower poses. Says the author, "The riskier the borrower becomes (either because of the industry, markets, or personal downturn in fortunes) the more will the interest rate climb. This is the market’s way to ensure that money is used carefully and all prudential lending is based on this principle. Violate this norm and you will end up creating a mess in the financial sector.
Just go back to the times before the 1990s when long term lending carried a lower interest rate and vice-versa. Any college student would have told you this was insane. Long term borrowing poses more risks than short term lending. " Unquote.
The piece recalls the the pre-1990 era, when the interest rate structure was such that businessmen often borrowed for long term projects and then diverted the money for short term use. Banking was turned on its head. This was rampant and hurt banks terribly. Mercifully, this practice was ended, says the author and adds, "Risk is the reason why, with other things being equal, long term borrowing always carries a higher rate of interest than short term.
That is also why riskier loans command a higher interest rate than less riskier loans. The trouble with interest concessions is that many businesses will spawn MSMEs, borrow money against them and divert money to non-MSME uses. Hence, interest rates for MSMEs should be determined by the risk they pose to the lender." Unquote.
It is easy to see that banks will find it tough to monitor end-use because the numbers of MSMEs are huge and this could adversely impact the banks and the rest of the economy.
A more reasonable way out
But of course, MSMEs must be helped. The question is just how.
Suggests the author, "First, give them a tax break. Reduction of GST rates would be one good way. The government did toy with this idea in August, but gave it up because nobody could decide on the amount that should be borne by the state and how much by the Centre.
But that was an academic issue. Eventually, this is paid for by common taxpayers like you and me. But there is one difference. Since GST is paid on the basis of production of goods and services, there can be no diversion of funds. Lower interest charges actually encourage people to cheat. Hence, the reduced GST pinches taxpayers less severely than concessional interest rates." Unquote.
Another way would be to encourage MSMEs to go in for credit ratings. This way, he says, they learn how to reduce their risk profile. The point being the financial burden on MSMEs can be reduced without adversely affecting the health of the economy and that of the banking sector.
A step backwards?
Is restructuring of MSME loans a 'step backwards' ? Yes, if Fitch Ratings Director (Financial Institutions) Saswata Guha is to be believed. He believes the risks to the banking sector will manifest in 6-9 months.
In an interview to PTI, he said, that given the past record, it is unlikely that banks would exercise prudence while restructuring loans of micro, small and medium enterprises.
As we reported in a piece last week, the tension between the government and the RBI resulted in a meeting where the board of the Reserve Bank advised the RBI to consider a scheme for restructuring of stressed assets of MSME borrowers with aggregate credit facilities of up to Rs 25 crore, subject to conditions necessary for ensuring financial stability.
However Guha said that in one way, it is a step backwards given RBI's previous stance to do away with all restructuring and added that relaxation of lending norms to spur growth is "never a good strategy". Also, the legacy problem loans will continue to be a bigger drag on the MSME sector's asset quality until March 2019.
He said and we quote, "There is adequate evidence in the form of USD 140 billion of NPL (non-performing loan) stock that the sector is currently grappling with, which, in my opinion, is a direct result of the unbridled lending of the past," Unquote.
On the RBI board's decision to defer the timeline for implementing capital adequacy norms (Basel III) by the banks, Guha told PTI that the move is "certainly credit negative" as it reflects the sector's poor capitalisation, particularly that of state-owned banks, and their inability to meet minimum regulatory requirements.
To repeat once again, there was a stand-off between the RBI and the Finance Ministry over several issues, including easier funding norms for the MSME sector, implementation of the capital adequacy norms among other things.
On November 19, as multiple news sources reported, the RBI Board directed the Reserve Bank to restructure loans for the MSME sector, extend the timeline for implementation of Basel III norms and also set up an expert committee to deliberate on economic capital framework.
But coming back to Guha, he has stated that non-banking finance companies (NBFCs) continue to remain a risk as a result of their aggressive lending, especially to real estate and MSME, in the past.
"We may see slippages from the latter sectors (real estate, SMEs) in the near-term if challenges in terms of liquidity continue. However, better rated non-banks with good track record and market reputation face much lower rollover risk as compared to ones where risks are elevated although funding costs have risen across the board."
On November 20, Mint had cited a person with knowledge of the discussions within the RBI board who has shared this under condition of anonymity, "“The government thinks that demonetisation and the goods and services tax (GST) have negatively affected the MSME sector and squeezing credit to them at this time may put them in further trouble. The government is also worried that squeezing of liquidity at a time of ongoing elections in five states and ahead of general election in early 2019 may dent it politically."
The Mint report put together by Asit Ranjan Mishra and Gireesh Chandra Prasad also cited Chandrakant Salunkhe, founder and president of SME Chamber of India to serve a reminder that the latest liquidity crunch faced by MSMEs started with the unearthing of the PNB fraud after which banks turned reluctant to offer trade finance to small businesses.
You will remember that this ₹13,000 crore fraud at the Punjab National Bank in Mumbai, featured Nirav Modi and his uncle Mehul Choksi as the prime accused .
Worse was to follow and we quote, "Non-banking financial companies (NBFCs), a key source of funds for small businesses, saw their liquidity drying up after debt-laden Infrastructure Leasing and Financial Services (IL&FS) started defaulting on loan repayments, leading to the government superseding its board in early October.
Industry representatives say the latest cash crunch covers trade finance, working capital requirements and investments into plant and machinery." Unquote.
According to Salunkhe, about 900,000 MSMEs have closed down over the last couple of years since demonetisation in November 2016. The subsequent sops are in a way , offering them a way out. The situation is dire. As Salunkhe says,
“Out of the 15 lakh (incorporated) companies in the country, 15,000 are medium-sized ones. If the liquidity crisis is not resolved, none of these will graduate into larger companies in the next few years." Unquote.
Will the recent measures help them out? The jury is out on that one.
As expected, along with the media and the financial pundits, political naysayers too have stepped into the controversy to do their bit. On November 23, 2018, Dr. Amit Mitra , Minister of Finance Govt West Bengal addressed a press conference in Delhi and said that the central government’s inability to manage elite institutions like RBI and CBI was “symptom of a disease."
And the disease he said was an incapacity to govern. He also said that the 59-minute loan sanction for small businesses was a gimmick.As for now, the die has been cast and with elections looming large on the horizon, there is probably more in the sop box that will be pulled out in the near future to win over the electorate.