Covid-19 Response: The ‘Goldilocks Balance’ For MSMEsBloombergQuintOpinion
It is a difficult time to be an economic policymaker with all sectors of the economy, from automobiles to hair salons, clamouring for relief in the context of the Covid-19 crisis. Steps announced now have to find the ‘Goldilocks balance’ – do enough to keep viable firms solvent until normalcy returns but not so much that there is rampant moral hazard and targeting failures. The U.S. Paycheck Protection Programme that provides a conditional grant to small businesses, for instance, has consumed more than $650 billion of funding in less than a month while battling criticisms of allocations to big businesses and venture-funded startups.
To do a quick recap of the financing landscape to Indian micro, small and medium enterprises, the total formal credit outstanding to MSMEs is around Rs 15 lakh crore. Banks account for 90 percent of this and NBFCs for the remaining 10 percent. Of the Rs 15 lakh crore, about a third is in loans of less than Rs 1 crore each. This segment has also exhibited the lowest non-performing assets of 4-8 percent, while at the upper end, NPAs are as high as 15-18 percent. So, MSMEs represent a mixed bag of over 6 crore firms, registered and unregistered with very different levels of profitability and resilience. Only a small fraction of these have GST numbers and are tax-paying. How then to define the policy objectives and relief measures for this segment? Doing so is critical because of the link to employment—with 11+ crore employed—and their role in making sure various supply chains function well as we seek to revive growth in the country.
We must recognise is that some firms will fail. The NPA numbers in the previously discussed already suggest that the baseline risk in these sectors is high. The magnitude of the economic shock is such that a significant number of enterprises will cease to exist, particularly in the micro-segment, those in hard-hit segments such as food and beverages where demand revival may be some distance away, and those in ‘red zones’ across the country.
The policy goal cannot be eliminating all MSME failure as we simply don’t have the resources to provide that magnitude of a backstop.
However, we must aim to enable a quick recovery for the firms that are able to survive the short-term dislocation. Perhaps, we should think about orderly winding down for formal firms in negatively-affected sectors so that they can start afresh when circumstances improve.
First, the short-term considerations. To mitigate the cash-flow pressures, some of the measures that could be considered are
- Releasing all pending payments from various government departments to MSMEs on priority;
- Pausing statutory payments such as provident fund and Employees' State Insurance contributions for say, six months;
- Paying back into workers’ accounts ESIC contributions that have been unclaimed and instead, extend coverage under PMJAY to all registered MSME workers.
Given that micro-enterprises are often subsistence activities for low-income households—and 90 percent of the MSME sector is micro—the right intervention here in the short-term may be cash transfers rather than additional credit. Factoring the targeting difficulties, all bank and NBFC borrowers with KYC details whose last-sanctioned credit facility is... say, less than Rs 10 lakh, may be provided a cash transfer to tide over expenses for three months.
Further Out On The Horizon
In the medium to long-term, the response of the banking system to MSMEs is going to be critical for a speedy recovery.
Here, the fundamental challenge is that banks face significant uncertainty on the credit quality of the firms given the altered business environment that they face. Many commentators have been right to point out that the issue for banks is not one of liquidity but rather risk appetite. In this context, we need a mechanism that will absorb much of the uncertainty while retaining “skin in the game” for the lender.
A time-bound, government-backed program that covers all lenders to MSME accounts (banks and non-banks) by providing a ‘First-Loss Default Guarantee’ protection for new loans/pass-through certificates to the extent of say, 40 percent of the portfolio may be worth considering. This is double the expected loss at the upper band of MSME lending in normal times and is, therefore, substantive cover for the average MSME loan.
If we estimate fresh loans of say Rs 5 lakh crore in the next few months, the implied guarantee amount is around Rs 2 lakh crore, reasonably within the resource envelope of the government.
The guarantees must be priced fairly so that is viable for both parties.
Finally concerning the orderly failure of MSME firms. This is relevant only for registered firms, a small proportion of the total. The IBBI has been working on rules for insolvency, bankruptcy, and a fresh start for individuals, partnerships, and sole proprietorships. There have been concerns about the implementation capacity and moral hazard. However, this may be an interesting window to test the efficacy of the proposed rules, particularly for the sub-set of registered MSME firms in the negative sectors and regions.
It is a long and tough road ahead for MSMEs but timely and substantive policy interventions that address the root cause of uncertainty is the need of the hour.
Bindu Ananth is Chair of Dvara Research. The author thanks members of the 2019 RBI MSME Committee (Chair: UK Sinha), Ananth Narayan, Nachiket Mor and colleagues at Dvara Research for conversations toward this article.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.