The micro, small and medium enterprises [MSMEs] occupy a pivotal position in the Indian economy. The sector consists of a total of 63 million units which employ around 111 million people. It contributes about 30 per cent to the GDP, accounts for 45 per cent of manufacturing output and about 40 per cent of total exports.
Considering its huge job creating potential [next only to agriculture and allied activities] and the power to increase income across a wide spectrum of the populace, it fits well into the inclusive development agenda of Modi. The best way to fully leverage the demographic dividend [65% of India’s population is below 35 years] is to create opportunities for growth in MSMEs.
The health and growth of the sector is also vital from the perspective of making a success of the ‘Make in India’ initiative under which the government intends to increase the share of manufacturing sector in the GDP from existing low of 15% to 25% by 2025. It is crucial to maintaining macro-economic stability given its role in increasing exports and sobering effect on current account.
A major factor constraining growth of MSMEs [97% operate in the ‘informal’ sector] is their lack of access and timely availability of credit from institutional sources such as commercial banks, non-bank financial companies [NBFC] etc. This in turn, is due to their inability to comply with documentation relating to accounts, income and business transactions and collateral/security insisted by the latter.
This forces them to depend on informal sources viz. money lenders, traders, middlemen etc who don’t insist on comprehensive documentation and process of taking loans is hassle free. But, the the rate of interest on such loans is very high. This affects the competitiveness of their businesses and many a times, these enterprises are pushed into a debt trap.
The MSMEs operating in the ‘formal’ sector [a miniscule 3%] who have no issues in compliance with procedures and offering collateral take loans from institutional sources. Around 90% of these enterprises borrow funds from the banks.
All through, MSMEs have been on low priority in the overall lending by banks. According to a study by Reserve Bank of India [RBI], the share of credit extended to MSMEs in overall bank credit declined from an already low of 17% in 2007 to around 14% by end-March 2018 – a good part of this happening after the demonetization on November 8, 2016. As of 25 November 2016 – just two weeks thereafter bank credit to MSMEs had fallen by 3.4% year-on-year. By December 2016, it plummeted further by 4.3% year-on-year.
In contrast, loans extended by NBFCs to MSMEs grew strongly at an annual average rate of 35% during the same period and their share in total credit almost doubled from around 5.5% in December 2015 to around 10% by March 2018.
In the past, MSMEs – both in the informal or formal sector – were doing transactions mostly in cash. In this backdrop, the sudden demonetization led to a cash crunch on the owners who were unable to make payment to their workers [industries such as wearing apparel and jewellery employing contract labor were the worst affected]. Many of the enterprises – especially those who were not conducting business through banking channels at all – had closed down
The launch of Goods and Services Tax [GST] w.e.f. July 1, 2017 within 6 months of the note-ban may have added to the woes of enterprises due to the new set of requirements under GST. For the entities closed in the aftermath of note ban, resumption of operations under the new tax regime [that requires ‘honesty’ and ‘transparency’] could be a bigger challenge; particularly for those not used to paying taxes under the erstwhile dispensation.
With these ‘structural’ and ‘disruptive’ reforms leading to suspensions/closures and delayed resumption of operations, the decline in bank credit to the MSME sector was not entirely unexpected. But, their role in combating the generic ailments afflicting the sector including the ‘inaccessibility’ and ‘non-availability’ of credit from institutions cannot be glossed over.
The demonetization has forced the black money lying dormant with the hoarders to be deposited in banks thereby contributing to the pool of lendable resources with the banks. This has also led to manifold increase in the number of tax payers and buoyancy in tax collections. That augments the capacity of the government to infuse more capital to public sector banks [PSBs] helping them lend more.
The GST by bringing in all businessmen under a seamless single tax gives them legitimacy and helps in securing the much needed documentation. Once an entity uploads the sales data on the GST network [GSTN], the return is automatically generated. This together with bank statement equips a micro/small enterprise with necessary papers to comply with the requirement for accessing credit from the banks.
Having got over the initial teething trouble in adjusting to the new regime and GSTN more or less stabilized, already, there are signs of recovery in credit off-take from the banks. During the first quarter of current year ending June 30, 2018, the bank credit to MSMEs increased by 8.5% over the corresponding period last year. This level of growth was last seen during the first quarter of 2015-16.
Going forward, the pace of banks giving loan to MSMEs should gain momentum. The real boost is going to come from the formalization of the informal sector made possible by the two path breaking reforms viz. demonetization and GST. Even if 1/4th of these enterprises in informal sector graduate to formalized way of doing business, we will have 15 million entities having access to bank credit.
If, they can get loans at rates much lower than the interest rate they currently pay [to informal sources], this will lead to huge gains in enhancing their competitiveness, increasing exports and creating jobs.
To sum up, while the government has done its bit to give the necessary policy reforms push, it is time for banks to live up to the challenge.