India’s micro, small and medium enterprises (MSME), viewed as the lifeblood of the Indian economy, contribute 30% to the gross domestic product (GDP) and, of these, micro-enterprises alone are estimated to employ 23% of India’s total workforce, according to the data of the Union ministry of MSME. Access to credit has been the most contentious issue discussed on public platforms. International Monetary Fund (IMF) estimated that only 23% of the total number of enterprises in this segment got formal access to credit.
Post-pandemic, the government of India has been laying considerable emphasis on the growth of MSMEs and extending incentives and products for easing the conduct of their business. In her usual meetings with the bankers, the Union finance minister draws her untiring attention to the need for an increase in credit to these enterprises. Banks, on their part, do not lose the opportunity to exhibit their fancy to lend to such enterprises.
Trust deficit was the major contributory factor from the lenders’ perspective. It is, therefore, considered expedient to look at the risk profile of such enterprises and see the possible mitigating factors.
Latest Profile of the Sector
Interestingly, TransUnion CIBIL-SIDBI MSME Pulse Report for July-September presents a very hopeful perspective presenting a growth of 24% year-on-year (y-o-y). Credit to ‘micro’, viewed as an unmoving window of banks for five continuous years since 2017 and even on the negative window, reported a 13% growth in credit outstanding y-o-y as of September 2022 versus 10.6% y-o-y for all the MSMEs y-o-y. Growth in disbursements for MSMEs had been at 54%, 23%, and 9%, respectively, during the period.
According to RBI’s Financial Access Survey, 72.83% of MSME credit is concentrated in 10 states: Maharashtra, Gujarat, Tamil Nadu & Pondicherry, Uttar Pradesh, Delhi, Karnataka, Rajasthan, West Bengal, Telangana and Haryana. Maharashtra takes the major slice of 26.19%. This obviously means that government assistance to the sector also reached these states in a significant measure, at least proportionately viewed.
The very small (with aggregate credit exposure not exceeding Rs10 lakh), micro1 (with aggregate credit exposure between Rs10 lakh-Rs50 lakh) and micro2 (with aggregate credit exposure between Rs50 lakh-Rs1 crore) experienced growth of 20%, 15% and 11% y-o-y, respectively, showing a sudden spurt in micro-lending, which is not just a post-pandemic bounce back, it added.
Delinquency rates dropped y-o-y across all three lender categories: public sector banks (PSBs), private sector banks (PVBs) and non-banking financial companies (NBFCs); the highest drop was in the PVBs segment (from 2.8% in Q2FY21-22 to 1.5% in Q2FY22-23). Street vendors’ financing programme, MUDRA loans (Rs3.4 crore sanctioned during FY21-22), and the 59-minute loan programme for MSMEs contributed to the steady uptick that was presented, apart from the Union finance minister dinning into the ears of bankers that credit to MSMEs has been sluggish. There was pressure on the banks to perform.
This positive vibration whittles down suddenly when we hear the Union minister of state for MSME submits to the Parliament, duly reported in the Financial Express dated 23.02.23: “The number of Udyam-registered MSMEs closed in the current financial year has nearly doubled from the last financial year’s count, showed official data. From 6,222 MSMEs shut during FY22, the count has jumped to 12,307 as of March 9 in FY23 while only 175 units were closed between July 1 (when the Udyam portal was launched) and March 31 in FY21, taking the total number of MSMEs closed to an all-time high of 18,704. Maharashtra had the highest number of casualties with 4,871 Udyam-registered MSMEs shut since July 2020 followed by Tamil Nadu (2,326), Uttar Pradesh (1,568), Gujarat (1,558), Rajasthan (1,297), Bihar (1,075), and more.”
Gross non-performing assets ratio (the ratio of total gross NPAs to the total advances made during a particular period by the lender) in MSME loans in FY22-23 stood at 7.6%, 7.3% in FY21-22 and 8.9% in FY20-21.
Resilience and sustainability of industrial growth are inextricably linked to the healthy growth of the MSMEs which happens to front-end the supply chains of the industry at large. The data and analysis of the Transunion report does not provide information on the share of growth of manufacturing MSEs. September 2022 PMI data shows that industrial growth has not kept pace with the overall growth of the economy. The growth obviously occurred in the services sector, due to the digitisation of the highest scale, entry of fintechs, formalisation of the MSMEs, widely dispersed 200-odd incentive schemes from the Union ministry of MSME, and the unique success of the unified payment interface system (UPI).
Despite the UK Sinha committee report calling for cash flow-based lending of working capital to the MSMEs, RBI creating a public credit registry and pushing the banks to move to data-based lending instead of security-based lending, MSMEs did not catch the eye of the banks. Hence, risk profiling of the MSMEs would be necessary to understand the reasons for the trust deficit in the manufacturing sector.
Definitional Risk: Manufacturing and services have been combined in the way the MSMEs are defined. The changes to the definition adopting the twin criteria of investment and turnover to redefine them have given an escape window for the banks to keep at bay the MSMEs with investments below Rs1 crore (Rs10 million). The turnover threshold for such enterprises is five times the investment level—Rs5 crore per annum. While this definition, coupled with the insistence of any new enterprise to register on Udyog-Aadhar portal of the government of India, has enabled only the organised to have access to credit and incentives, it is yet to bring many unorganised MSMEs into the organised fold. Lenders still have their own definition—micro enterprises are those that have outstanding credit of less than Rs1 crore. The law of proportionality demands that the micro enterprises be brought under a separate statute so that the benefits meant for them reach without infringement.
By nature, micro-manufacturing enterprises are owner-led proprietary or family partnerships. They do not distinguish their firm expenditure from family expenditure. Their books of accounts are also not well organised. Their maintenance of record of stocks of raw materials and finished products is less systematic than that of their counterparts in the small and medium enterprises even. They are mostly sub-contractors as their scale of production does not permit them to participate in private or public tenders directly. But their working capital cycle accommodates this unorganised way of running their enterprises. They lack counselling and guidance from their lenders as the latter have little time for these large numbers in their books of accounts that tend to slip to non-performance at the drop of the hat. Thus, these enterprises have origination risks. Information asymmetry and adverse selection, the two factors that adversely affect credit risk, need mitigation.
Covenant Risks: These MSMEs, in their eagerness to borrow money, sign on the dotted line before their lender. They do not understand the implications of the covenants to which they are agreeing. Earlier, they were not aware of even the rates of interest. At least now, thanks to the widely publicised monetary policy interventions periodically, they know the interest rates. But they are ignorant of the insurance clauses and their implications. They do not, in many a case, know that their machinery and stocks are jointly insured with the lender and the premium is directly deducted annually from their working capital account. The extent of insurability is least known to them. Such insurance is invariably made with the insurance arm of the bank that lends the enterprise. But the covenants of the policy are little known to them as the banks do not share a copy of the insurance policy. This is a grey area.
Compliance Risk: MSMEs fail to comply with the regulations relating to products, processes and finance more out of ignorance than out of their own volition. Neither the regulatory institutions nor the financial institutions spare time to explain the implications of non-compliance with the rules and regulations. Environmental regulations and financial regulations are the most breached. The labour code, which has four components, is least explained to the MSMEs. It is not uncommon to find that these enterprises fail to maintain even a muster roll and—even where maintained—it does not agree with the reality. The number of persons actually engaged and the number in the roll rarely tally. There is a cost involved in compliance and such a cost is considered onerous by the micro manufacturers. When the cost of compliance is more than the cost of avoidance, they prefer the latter. Transparency in the cost of compliance is also found wanting. These are areas of immediate correction to take these enterprises to globally competitive levels.
Human Resource Risks: MSMEs employ an average of eight to ten workers including the owners. They invariably depend on migratory labour instead of labour because of the low wages they demand and reliability. Many studies have indicated that they spend little resources on skilling, re-skilling, and up-skilling as the cost of such human resources development is beyond their capacity to absorb. In fact, these MSMEs act as providers of skilled persons to the small and medium enterprises as the labour learn their art of working on the machine duly trained by the proprietors. Some states have insisted on engaging locally available skills and their experience with such persons on the production front has become counter-productive and costly. They cannot afford to train their labour in reputed institutions. They require peripatetic trainers who are rarely available.
Product Risk: According to a number of studies, 60%-70% of the MSMEs may conform to the quality of the product requirements but fail in packing and forwarding requirements. This puts the buyers at risk and, therefore, the related payments.
Pricing Risks: Several manufacturing MSEs adopt neighbourhood pricing of their products as they would not like to lose out in competition with their peers. They lack abilities to cost their products. They also do not properly understand the leakages that occur in their supply chains. The product is not priced cost plus. Since debt is their major source of capital, they always look to loan swaps and interest subsidies as major sources to beat the pricing competition.
Technology Risks: While several enterprises are aware that new technologies have the potential to increase their efficiency, their ability to finance those new technologies is very limited. Many are scared to approach their lenders as they would have been in arrears already either of the interest or principal payment. They must have already availed one or two ostensible restructuring of their loans. Their ability to calculate return on investment in technology is also extremely limited. Banks hardly find the time to spend with the entrepreneur to guide him.
Payment Risk: Global Alliance for Mass Entrepreneurship (GAME) estimated that the problem of delayed payments to MSMEs is in the magnitude of Rs10.7 lakh crore, with 80% of this being attributable to delays to micro and small enterprises (MSEs). The problem of delayed payments is exacerbated by the lack of credit, specifically working capital facilities, that are available to these businesses. Reports such as the IFC’s 2018 Financing India’s MSMEs estimate that the total addressable debt requirement of MSEs was Rs24 lakh crore in 2018, with an estimated 70% attributable to the elevated working capital needs of these businesses.
Sovereign Risk: Industrial policies, budgetary announcements, export-import policies, trade policies and the not-so-enriching interface between various government departments that deal with the MSMEs and the Union ministry of finance, and inter-state coordination issues are the various factors that impinge on sovereign risk. Enterprises have to adjust themselves and accommodate to the changes in the way they function rather than seeking instantaneous remedies to their business dealings.
Policy formulation for the MSMEs is at risk because of lack of reliable data. There has been no census of the units since 2004, the year of the last census. The data on the Union ministry of MSME portal is that of 2012. While the data on Udyam registration is captured in isolation, its integration with the existing data did not take place. There is no data on mortality in the figure of 60mn (million)-odd enterprises mentioned on the website.
While several state governments and the Union government announce a host of incentives, the reach is suspect due to a variety of constraints: 1. Expediency decides the allocated budget for release to the sector and the first hit is the MSMEs, the most vulnerable. 2. There is invariably a lack of information relating to the cost of securing these incentives – in terms of the number of visits the entrepreneur has to make to the concerned department; the cumbersome approach to the person who actually decides on the sanction and release of the incentives. 3. Weak negotiating ability of the industrial associations over the incentive releases, etc.
Digitalisation of enterprises, account aggregators (yet to mature in its access and use), open credit enablement network (OCEN), co-lending with NBFCs, factoring, trade-related exchange system (TReDs), have lately entered the risk mitigation instrumentality. Yet, the ability of the MSMEs to take advantage of these mitigants is way behind in terms of awareness and skills.
Therefore, there is a need for developing a separate framework for the MSMEs and a broad-based ecosystem involving policy-makers, institutions that act as policy instruments, RBI, Indian Banks Association, NBFCs, the ministry of agriculture and cooperation, ministry of electronics and information technology, ministry of environment, ministry of energy of the Union government and the ten state governments that have the major share in MSMEs. This framework should be discussed with the stakeholders in the leading ten states before firming up. A separate line of the budget should be provided to meet the announced incentives and institutions like the NIMSME, NIRD, central universities and those that are licensed to run technology hubs should monitor the working of the framework.
(Dr B Yerram Raju is an economist, risk management and SME turnaround specialist.)
