Battered by Lockdown, MSMEs Are Up Against a Wall

The COVID-19 pandemic has left micro, small, and medium enterprise (MSME) sector gasping for air. With the nationwide lockdown extended to May 17th, the MSME’s fight for survival has become more severe. Making the core of our $2.7 trillion economy, the MSME sector constitutes nearly 30 percent of India’s GDP, 31 percent of GVA, and 48 percent of India’s total export. The MSME sector comprising of 63 million enterprises is also a major employer, providing employment to approximately 21 percent of the country’s workforce. However, with the lockdown in effect and the economy at a standstill, the nation is experiencing a huge loss in output, revenue, and jobs. The Centre for Monitoring Indian Economy (CMIE) reports that during the third week of April, the unemployment rate in the country skyrocketed to 26.2 percent, rendering almost 14 crore people without jobs. The economy has been on a complete shutdown for almost 40 days (barring essential services). Though restrictions are being lifted in a phased manner, the disruptions caused to the economy is most likely to persist. Hence, there is an immediate need to safeguard the ailing MSME sector, which forms the bedrock of the Indian economy.

Interestingly, the micro-units account for almost 95 percent of the 63 million (approx.) enterprises in the MSME sector. Besides, a major chunk of these units is located in the informal economy. Consequently, the sector is often characterized by its small scale of operations encompassing a high level of personal interaction and limited resources, especially in terms of liquidity and access to credit. Moreover, MSME units do not possess adequate infrastructural setup in terms of IT (information technology) resources to adapt to a work from the home framework, a policy taken up by many large domestic and multinational firms. Given that the MSMEs sector is most likely to be the worst hit by the pandemic, it becomes crucial for policymakers to intervene and foster a supper system for the sustenance and revival of the MSME sector.

Major Bottlenecks

A perennial problem besetting the MSME sector is the access to institutional finance, a notion resonated by several studies and, most recently, the UK Sinha Committee appointed by the RBI. To put this in perspective, the Economic Census 2013 highlights that 93 percent of the enterprises are affected by the unavailability of institutional or non-institutional sources of finance. Moreover, Patnaik and Pandey (2019) highlights that micro and small enterprises received a mere 6 percent of the bank credit. To improve upon the gloomy circumstances faced by MSMEs, the Prime Minister’s Task Force on MSMEs recommended banks to achieve the target of 20 percent credit growth (year-on-year terms) to micro and small enterprises. However, the 2.6 percent credit growth achieved as of Feb 2020, is well below the recommended target. A major reason for the limited credit extended to MSMEs is the rise in non-performing assets (NPA), which restricts the ability of the banks to extend credit to MSMEs, wherein the risk of default is much higher. The report of the high-level committee appointed under the chairmanship of U K Sinha also cites the inability or unwillingness of MSMEs to repay as a key factor leading to NPAs. Consequently, banks are more inclined to lending to sectors with a lower insolvency risk. However, the lack of ability to pay is not the only factor impeding MSMEs access to finance. A recent report by the Confederation of Indian Industry highlights that the lengthier loan process and insufficient level of loan extended are factors restricting MSMEs access to formal finance. Based on our estimates from the World Bank Enterprise Survey (WBES) data, MSMEs which are financially constrained report high interest rates, collateral requirement, and smaller loan size as factors impeding their access to institutional credit. Moreover, the estimated credit mismatch of around ₹20-25 trillion for the sector only drives MSME units towards informal sources of finance.

Another problem plaguing the MSME sector, even before the onset of the pandemic, is that of delayed payments. Interestingly, most MSME units participate in supply chains as suppliers of intermediate goods and services, which results in low bargaining power. Further, these MSMEs are often suppliers to large corporates who, in turn, operate on a credit basis, hence delay in payments hinders MSMEs’ ability to make wage payments and repay loans. The UK Sinha committee point out that 41 percent of distressed loans in the MSME sector is due to delayed payments. Further, the committee also highlights that during 2017, the average time taken to realize the payment from the buyer stood at 220 days.

Though access to formal finance and the issue of delayed payments remains a pressing concern for the MSME sector. The fact that the MSME units are informal in nature remains a major hurdle from the policy perspective. These enterprises face proportionately greater financial obstacles, and with the nationwide lockdown in effect, for some of these micro-enterprises, it becomes a question of survival. To revive these units, any stimulus in the form of tax relief may not be effective, since most of these enterprises do not fall under the tax net. In this regard, the 67th and 73rd round of informal enterprise surveys conducted by the National Sample Survey Organization (NSSO) highlight that close to one-fifth of the firms report access to finance as a major obstacle to growth.  Further, only 14.2 percent of all informal units have access to the formal source of finance, with majority resorting to non-institutional sources for meeting finance requirements. The surveys further provide some key insights into the financial constraints faced by the informal MSME units. Almost 65 percent of financially constrained informal enterprises in 2015-16 were owner-operated units (employing only family labour). When we look at the credit allocation, it is not surprising that 60 percent of enterprises using hired labour (large firms) obtained external funds. The COVID-19 has gravely aggravated the pre-existing concerns. With sources of revenue and cash buffers all vanished, the situation gets only gloomier for the MSME sector. According to a survey conducted by All India Manufacturers’ Organisation (AIMO) on 5000 MSME units reports that 71 percent of these units were unable to make wage payments for March. Already into May, such firms would have exhausted their reservoirs of cash and now stand on the verge of exit. Therefore, in the hour of crisis, the owner operated enterprises are likely to bear greater brunt. Given the fact that these enterprises face greater financial exclusion, a blanket policy for the MSME sector may be of limited relevance.

The Way Ahead

As the sector awaits an MSME specific stimulus package, some policy actions are already in action. At present, the government has allowed for deferment in GST payments until June 2020. In addition, the RBI has also made similar provision for interest payments on working capital loans for the coming three months and payment of loans till June. Further, the introduction of Long-Term Repo Operations (LTRO) worth ₹100,000 crores is more likely to aid the MSME units through cheaper rates of borrowing. Similarly, the Small Industries Development Bank of India (SIBDI) has also announced concessional interest rate loans for MSMEs. In this regard, most public sector banks have also established a COVID-19 Emergency Credit Line (CECL) to ease the liquidity crunch faced by the sector. Besides, as we approach the eleventh hour, the economic stimulus seems imminent.

Though all the existing policy interventions aimed at mitigating the immediate liquidity concerns of MSMEs are steps in the right direction, more insightful and long-term oriented policy initiatives are needed for safeguarding the sustenance of the sector. In this regard, the issue of delayed payment should be at the top of the policy agenda. As per a statement made by the Union MSME minister, almost ₹40,000-50,000 crore worth credit is held up in due payments to MSMEs. Hence, it becomes imperative to address the issue of delayed payments, which results in uncertain cash flow cycles and in turn, impeding the operational efficiency of the MSME sector. To establish a timely flow of payments to MSMEs, the RBI already established the Trade Receivables Discounting System (TReDS) for MSMEs in March 2014. However, the TReDS systems have limited impact since such a facility may be mostly used by the small and medium firms.

Recently many initiatives are undertaken to address the delay payments problem. However, overlapping nature of these initiatives further leads to a higher cost of operations and confusion among the beneficiaries. Hence, there is a need for a clear directive in explaining the aim, scope, application procedure, and key differences among these schemes that would guide MSMEs in the right direction. Further, the COVID-19 pandemic provides the government with avenues to promote digitization and, at the same time, widen the base of FinTech (financial technology) services. As mentioned earlier, the prominence of micro-enterprises and the informal nature of business of operations imply that most of these units do not have established credit history or collateral for obtaining formal sources of finance. In this regard, FinTech services offer innovative solutions. These services evaluate the repayment ability of the unit through using technology to understand the time cycle involved in an MSME unit to generate cash through its operation (from the time it receives investment to the time taken to make the sale of goods and services). This, in turn, provides an assessment of the repayment ability and the default risk of the firm. For instance, Capital Float, an NBFC, asses risk profiles of enterprises in real-time using data from PayTM and analyzing the MSME cash flow data. Authenticating via e-KYC, the company confirms loan agreement via a mobile-based app. The loan is then credited to the firm’s account on the same day with zero paperwork. Such innovative technology enables MSMEs to seize opportunities and have access to formal sources of finance.

With the supply chains disrupted and cash pockets empty, resuming economic activity after the restrictions are lifted may not be that straightforward. With depressed demand, the government would have to intervene to ease the pressure. At present, PSUs and other government bodies are required to procure at least 20 percent of their input requirements from MSMEs. We suggest that the government could increase the share to at least 25 percent for the next three-year cycle to cater to the loss in demand and output facing MSMEs. Moreover, the pandemic rightly highlights the inability of MSMEs to cope with a situation like natural calamities, there is an urgent need for the government to extend insurance coverage to MSME employees through Pradhan Mantri Suraksha Bima Yojana, and Pradhan Mantri Jeevan Jyoti Bima Yojana schemes – a recommendation put forth by the UK Sinha committee. Besides, tackling such unprecedented outbreaks and other natural calamities calls for setting up an ‘emergency fund’ in line with the model employed by Korea and Malaysia to aid the micro segment of the MSME sector. In addition, at present the Shishu scheme under the MUDRA Yojana provides a loan of ₹50,000 to micro units. Therefore, another possibility is enhancing the amount to ₹1,00,000, which would considerably benefit the micro units. The pandemic has brought to light some of the structural issues crippling the MSME sector. Hence, policy measures must be not only focused on relieving the stress of the lockdown but also bring about long-term structural reforms.

(The authors’ views are personal)

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