Small businesses need easy financing
Leopold Kohr’s ‘Small is Beautiful’ phrase is often used to champion small, appropriate technologies that are believed to empower people more. With this focus on mind, India’s entrepreneurs of Micro, Small and Medium Enterprises (MSMEs) start their new small venture but more often than not their dreams and aspirations don’t turn out be that beautiful.
MSMEs sector in India is reeling under stress. This could be partly attributed to the present economic scenario which is beyond dim. But largely it is a fault of our own making.
It is well documented that MSMEs are unable to access bank credit because of the financial documentation and collateral requirements for obtaining a loan; high-interest rates; and long loan approval procedures, among others.
Since the past two decades or so, Banks as also Micro Finance Institutions (MFIs) providing credit to MSMEs through various mechanisms. These mechanisms were eventually collated in a 2015, when the Central Government launched the much publicized Pradhan Mantri Mudra Yojana (PMMY) commonly referred to as MUDRA scheme. The primary objective of this policy was to refinance banks and MFIs so that they can lent easily to MSMEs.
Before going into further details of the MUDRA scheme, it is important to understand the economic value of the MSME sector for the Indian economy.
RBI’s UK Sinha Committee Report[1] states that MSMEs have played a critical role in India’s economic transition away from agriculture and allied activities towards growth in the non-farm sector.
· The Micro, Small and Medium Enterprises (MSMEs) sector contributes in a significant way to the growth of the Indian economy with a vast network of about 63.38 million enterprises.
· The sector contributes about 45 per cent to manufacturing output, more than 40 per cent of exports, over 28 per cent of the GDP while creating employment for about 111 million people, which in terms of volume stands next to agricultural sector.
· An overwhelming majority of MSMEs are tiny and informal — 96 per cent of them were sole proprietorships — usually located within or just outside the owner’s household premises.
· Own-account enterprises (comprising 84 per cent of all enterprises) are those run by a single household member without paid workers and are often only one of multiple income sources for low-income households.
· Only 31 per cent are registered with any industry and trade association or development board, indicating the in- formal and unorganized nature of their operations.
· About 20 per cent of the MSMEs are based out of rural areas, which indicate the deployment of significant rural workforce in the MSME sector and is a testimony to the importance of these enterprises in promoting sustainable and inclusive development as well as generating large-scale employment, especially in the rural areas.
The MUDRA scheme provides non-farm income-generating loans up to Rs10 lakh by existing government and private sector banks, and other financial institutions. The scheme is designed to offer unsecured loans for MSMEs requiring credit for investments in existing businesses, as well as for new startups. MUDRA loan interest rates for 1–5 years range from 11.20% to as high as 20%[2].
Loans upto Rs. 50,000 are categorized as Shishu, from Rs. 50,000 upto Rs. 5 lakhs as Kishor and further up to Rs. 10 lakhs as Tarun loans.
Following inferences can be drawn from Table 1:-
· The loan size for more than 86% of MUDRA loans is just Rs 27,143.
· Kishore loans which are supposed to provide credit for upto Rs 5 lakhs, cannot provide credit of even Rs 1.5 lakhs, on an average.
· Tarun loans which are stated to provide credit to MSMEs for upto Rs 10 lakhs, provide credit to not even 3% of the beneficiaries and provide only 40% of their stated amount.
To understand why the average size of the loan and the high interest rates are an impediment in fulfilling the very objective of the MUDRA loans, let us consider a small example of a typical Shishu loan worth Rs 28,000.
The microenterprise is likely to be in trading (such as a Kirana shop, or a street vendor), or in repairs (two-wheeler, mobile phones, consumer durables) or in services like tea-shops, ready-to-eat snack shops, tailors, barbers, cobblers, etc. Of the Rs 28,000 loan, the micro- entrepreneur will normally invest a large part, at least Rs 20,000 in working capital to buy supplies of raw material or goods to be sold, paying wages and paying for rent and electricity.
Now, with a MUDRA loan, this micro enterprise has to make a periodic (monthly or quarterly) payment of a principal instalment and interest. For a loan of Rs 28,000 repayable monthly over 36 months, that could be as much as Rs 1000 per month. As we know, a vast majority of loans go into trading activities, and if we assume that the sales turnover was four times of the loan amount, it would be Rs 1.12 lakh.
Even if assume 15 per cent margin, on the higher side, the gross income will be Rs 16,800 in the year. The net income from the microenterprise is unlikely to be more than Rs 1400 per month, which means the monthly instalment is 70 per cent of the incremental income, leaving behind a mere Rs 400 per month.
This is bound to be drawn out by the micro-entrepreneur to meet household needs. If in some months due to contingencies such as illness in the family, if the micro-entrepreneur draws out more money, she/he will end up skipping instalments, which may eventually lead to a default.
Even if assume that the micro-entrepreneur has other cash flow to meet their personal needs, they will still be able to save only about Rs 400 per month, which in 36 months will add up to Rs 14,400, and is just about half of the loan taken. In the meanwhile, three years have passed and if anything, the working capital requirement would only have increased beyond Rs 28,000. This example explicates why MUDRA loans will not work to improve things for most of the micro-entrepreneurs, except temporary relief for the first one or two years.
There are various policy solutions that have been suggested to simplify the credit to MSMEs and remove these structural bottlenecks. Reserve Bank of India set up the U K Sinha Committee which proposed various solutions, some of which look viable.
· Ministry of MSME may consider setting up of a Non-Profit Special Purpose Vehicle (SPV) to support crowd sourcing of investments by various agencies particularly to pave the way for conducive business ecosystem for MSMEs. Crowd sourcing of innovative Start-ups is a global phenomenon now with platforms like ‘Kickstarter’, ‘Indiegogo’, ‘Crowd Supply’ and many other platforms providing the requisite financial impetus to small businesses.
· The Committee recommends for the creation of a Distressed Asset Fund, with a corpus of Rs 5000 crore, structured to assist units in clusters where a change in the external environment… has led to a large number of MSMEs becoming NPA.
· With the increased availability of data from several sources, including GSTN, Income Tax, Credit Bureaus, Fraud Registry, etc., it is now possible to do most of the due diligence online and appraise the MSME loan proposals expeditiously. It is recommended that banks should have access to such surrogate data for speedier and robust credit underwriting standards.
Apart from the ones, which the U K Sinha Committee, there are some more solutions which could be implemented.
· The interest rates of MUDRA loans need reduction and rationalization. Different banks charge different rates ranging from 11.2% to even 20%. A standard rate of interest could be way forward. The Government must incentivize MSMEs — specially the Shishu micro enterprises which form the bulk of MUDRA loan disbursal. A separate fund could be mooted for this purpose.
· The Prime Minister’s Task Force on Micro, Small and Medium Enterprises has also proposed the creation of a separate fund with SIDBI, using the shortfalls, if any, against the MSE credit targets set for the commercial banks. This fund named ‘Special Fund for Micro Enterprises’ should be utilized exclusively for lending to the micro enterprises.
· Credit choking of MSMEs is also because of multiple compliances and weak outreach of the state. Generally Government cronies and people close to the ruling political party and its eco system benefits from these loans. This entire process of availing the MUDRA loan, though merit based is often flouted by banks. Transparent digital methods are the need of the hour. With GST, AADHAAR and the KYC mechanisms, paper work can be reduced and clearances of the loans should be made easy. Banks should also be penalized in case if they provide out-of-turn loans to enterprises.
[1] Expert Committee on Micro, Small and Medium Enterprises, Chair Mr UK Sinha, Reserve Bank of India,
2019| https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=924
[2] Bank Bazaar | https://www.bankbazaar.com/personal-loan/mudra-loan-interest-rates.html
