Micro, Small and Medium Enterprises, or MSMEs, have been struggling for well over a decade now. The clampdown on economic activity due to the spread of COVID-19 has left its impact on all sectors of the economy but nowhere is the hurt as much as the MSME sector of India. MSMEs have been forced to become largely reliant on banks and new loans to tide over this unending crisis. They are currently living on the breadline with banks unwilling to lend to borrowers, whose payments are behind schedule as unpaid dues pile up and economic activity ran aground due to the lockdown.

Unfortunately, most of the measures announced by the RBI earlier have not had the desired effect. Despite the huge quantum of cheap funds being made available, they haven’t been seeing a lot of improvement. Just reducing the cost of funds had no impact on the volume and cost of the credit they provided due to the heightened risk aversion in banks. During this time MSMEs are facing lots of problems which resulted in layoffs, losses, and shut down. It becomes a huge point of concern for India as the MSMEs in India play a crucial role by providing large employment opportunities.

To address this issue and also to combat the further impact of coronavirus on MSMEs, Finance Minister Nirmala Sitharaman announced a series of measures under the Rs 20 lakh crore Atmanirbhar Bharat package to provide credit support to the MSME sector. Our Prime Minister, Narendra Modi, also asked Indians to be more vocal for the local which means using our made in India products to promote our Indian industry.

The first tranche of relief package had some substantive benefits for the MSMEs – Rs. 3 lakh crores loan package, Rs. 20,000 crores subordinate debt, Rs. 50,000 crores equity infusion, revised MSME definition, global tenders disallowed up to Rs. 200 crores and e- linkage to the market are provided to the MSME sector by the government to boost our Indian companies and enable them to stand out and compete in the global market. Let’s analyze these benefits one by one.

  1. Rs 3 lakh crore collateral-free loans for MSMEs – Due to restriction on economic activity during the lockdown, all MSMEs have lost their working capital. This loan facility will surely help them resume their business activities and sustain jobs in the market by infusing the much-needed working capital. As the government will also provide a 100% credit guarantee cover to banks and NBFCs on principal and interest, it will not expose the banking sector to any risk. As such, this amounts to the government paying the banks after the borrower has defaulted. As the government does not have the fiscal space to pay MSMEs Rs 3 lakh crore today, it is giving money through banks and will pay back these banks in the future. Banks are not lending much today, so they can implement this package.

    These loans will be for four years and do not have to be repaid in the first 12 months. Therefore, this credit guarantee is not going to impact the fiscal deficit, at least for a couple of years. Certainly, there will be some defaults that will start impacting after a couple of years but by then the economy and taxes would have recovered allowing the government fiscal space to spend money for its guarantee. Hence, given the current constraints, this seems to be the choice based on maximum benefit with the least evil.

  1. Rs 20,000 crore subordinated loan package will benefit around two lakh MSMEs which are under financial stress due to COVID-19 induced lockdown. Although this is not going to result in any immediate benefit as the process for evaluation and prioritization will be full of complexities.
  2. Rs 50,000 crore fund for investing in the capital of MSMEs, with a corpus of Rs 10,000 crore being provided by the government, is a well-intentioned scheme. As losses incurred during the current pandemic are depleting risk capital, it becomes important to replenish the working capital of MSMEs to restore the working and sustain jobs. However, given by the past examples, it’s an extremely tedious process to identify the right investment opportunity. The success of this scheme will depend on its implementation, which will neither be easy nor immediate.
  3. The definition of MSMEs has been revised to remove any differentiation between manufacturing and service sector enterprises. The investment limit, which defined MSMEs, has been revised upwards to allow MSMEs to grow in size and continue to get benefits. From now on, any company with an investment of up to INR 1 crore and a turnover of INR 5 crore will be a micro company. Similarly, a company with an investment of up to INR 10 crore and turnover of INR 50 crore has been defined as a small company and a company with an investment of up to INR 20 crore and turnover of INR 100 crore has been defined as a medium company.
  4. No global tender below Rs 200 crore – Indian MSMEs have often faced unfair competition from foreign companies. To protect the Indian Industry from unfair global competition, the government will not be allowed to procure global tenders up to INR 200 crore. However, the way global tenders are contested and won, this policy change may not in reality have any economic impact or help MSMEs.
  5. Rs 30,000 crore liquidity scheme for NBFCs with an investment-grade credit rating. The move is expected to provide liquidity support for NBFCs and mutual funds and create confidence in the market. The problem of the NBFC sector in India lies in its fragmented structure of the bottom 90% of the NBFCs. They provide the reach but have an unreliable balance sheet. Therefore, finding enough NBFCs out of this lot with an investment-grade credit rating will not be easy.

The way every scheme in the first tranche of the package is structured, it will not impact the fiscal deficit of the current year. All will be through the banking system as loan and bulk of it would be guaranteed by the government. The message is clear – fiscal deficit and protecting sovereign credit rating remains the top of the mind concern for the government.

However, one must question, is there anything in this MSME Atmanirbhar Bharat package which is going to make India self-reliant. The package might help MSMEs to restart after the lockdown, but they will continue to struggle and slowly become irrelevant. The package fails to drive a structural change – the problem facing the Indian businesses in general and MSMEs, in particular, is – to have a viable, profitable business model. As the MSMEs walk out of COVID, the burden of this additional loan will be a further drag.

The package misses the opportunity to address the main issues related to MSME credit. The 100% sovereign guarantee provided by the government for uncollateralized, automatic MSME loans will encourage both banks and borrowers to never return the money and to become defaulters. It will further discourage banks from willingly lending to these MSMEs in the future.

Before ushering reforms in the Indian MSME sector, one needs to have a clear understanding of the role this sector can play through – job creation for millions, unleashing entrepreneurs to fulfill their ambitions to build businesses and development of the indigenous goods. Once such role clarity is evolved, then only policy interventions can help to create an effective business environment, and then regulations may support correcting imbalances in the system, solely liquidity injections will not help to build a strong MSME sector. The economic damage caused by the lockdown on all sectors of the economy is already much larger than the measures undertaken so far. Hence, to prevent the country from macroeconomic instability in the near future, a continued focus on reforms and strong government intervention will be required.

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