How green finance can strengthen the MSME sector

Updated on: Aug 15, 2022


The efforts of governments and financial institutions are crucial to be able to tap the endless opportunities in this field

India’s micro, small and medium enterprises (MSMEs), like in most developing countries, are the cornerstone of economic development, with their leading role in providing large-scale employment and strengthening the complex supply chain of goods and services.

Approximately 6.5 crore MSMEs in India contribute close to 30 per cent of the GDP of the world’s fifth-largest economy, employing around 11 crore people and with a share in its exports of nearly 40 per cent.

Given the sheer size and impact of the sector, active participation of MSMEs is critical to India achieving an inclusive, low-carbon economic transition, especially at a time when the Indian economy has unequivocally aligned itself to the global sustainable development agenda, led by the UN Sustainable Development Goals and the Paris Agreement.

To put things in perspective, given its size, the sector has a significant carbon footprint of its own. For example, studies reveal that there are over 200 energy-intensive manufacturing clusters in the country, consuming an estimated 50 million metric tonnes of oil annually. At the same time, however, India’s MSME sector is also disproportionately more vulnerable to climate change-related risks, including both physical risks as well as transition risks, largely because of their limited capacity to respond adequately to them, relative to their larger peers.

Physical risks to the sector may include aspects such as damage to their physical infrastructure and personnel, and disruption in their upstream or downstream supply chains, while transition risks may include changes in regulations within India and export markets or shifts in consumer preferences and technology.

The capacity of MSMEs to adequately cope with such climate-related vulnerabilities will depend on addressing the barriers that currently exist. These barriers may be in the form of lack of finance, technology or market access, access to relevant information, insufficient knowledge about climate risks, weaker capability to evaluate the cost to benefit of adaptation and mitigation measurements, and inadequate supporting policies and regulations. Each of these gaps can potentially be an opportunity for green financing to address.

Supporting MSMEs transition into the green economy

Simply put, green financing is any investment, such as a bank loan, made towards ‘green’ sectors such as renewable energy or ‘green’ activities, such as purchasing environment-friendly goods and services.

There is a clear green transition visible across sectors globally as well as in India, with significant public and private investments flowing into it. For example, the power sector in the country is transitioning from thermal power to renewables, with ambitious targets taken at the country level, policy actions being taken at the national and State levels, and increasing credit inflow from the Indian Financial Institutions. MSMEs in the fossil fuel-based power sector value chain would need to shift their capabilities as well as their capacities to be able to transition successfully, which will require capital as well as access to market opportunities. Green financing can support such a transition.

At the same time, there is also an opportunity and pressing need to help MSMEs recognise how the green transition itself, such as through the adoption of greener technologies, can also strengthen their financial performance, lower operational risks and improve operational efficiency.

Anaemic financing flow is a well-recognised and well-entrenched issue for the MSME sector. Data suggests that only about 14 per cent of the loan accounts at scheduled commercial banks in India were of MSMEs, accounting for only 16 per cent of the overall credit flow outstanding, as of March 2021. A recent study (NIRDPR, 2021) showed that nine out of 10 MSMEs depend on informal sources (mostly unsecured loans) for their working capital and term loans. Even alarming is the fact that a significant portion of MSMEs in India still have no access to external finance and depend wholly on self-financing.

A mismatch between the higher risk profile of MSMEs and the conservative risk appetite of commercial banking has been a prominent reason for the less-than-ideal credit inflow into the sector. One of the viable solutions to address this gap and make MSMEs more bankable could be ‘blended finance’, or the use of public or philanthropic funds to share the risk of private sector lending.

While technology adoption is not readily associated as a focus for green financing, there is no denying that inadequate adoption of technology remains one of the top challenges for Indian MSMEs.

Modern technologies such as AI-based tooling and machinery, ERP planning, and inventory management have been shown to significantly enhance productivity, efficiency, and competitiveness; yet, evidence also suggests that SME entrepreneurs, especially those in semi-urban and rural areas, may not even be fully aware of the wide variety of pertinent technology and software solutions available to them. Green financing can be a viable channel to enable MSMEs to invest in new technologies and innovations.

Private green capital can also play a role in augmenting the government’s efforts to incentivise the sector to upgrade their obsolete equipment and adopt advanced technologies and solutions, such as the Special Credit Linked Capital Subsidy Scheme for MSMEs in the services sector, which provides for 25 per cent subsidy for procurement of technologically advanced service equipment through institutional credit.

Green financing can also support closing the considerable skill deficit in the MSME sector. In many cases, there is a considerable gap between the requirements of the industry and the skilling its workforce receives. For example, a recent NSSO survey revealed that as many as 20 high-growth sectors, such as construction, hospitality, automobiles, healthcare and logistics, lacked adequate training facilities. This skill gap further weighs down due to the lack of awareness among entrepreneurs towards modern, digital solutions. While many government-led and private-led skill development and capacity-building programs exist, notable among them being the Pradhan Mantri Kaushal Vikas Yojana, there remains considerable scope for green financing to help fill the gap.

There has been significant growth in the availability of green financing globally and there is a deep interest among international green investors in the India growth story, which presents a significant opportunity for Indian MSMEs. India’s regulators and financial institutions must work towards enabling MSMEs to tap green capital from both domestic and global sources.

As India’s regulatory environment evolves further, much thought would go into expanding the scope of new or existing regulations to accommodate MSMEs’ green transition. For example, the government may consider carving out portions of the proposed domestic green bond for MSMEs financing or expanding the ECGLS scheme to support climate-related investments as well as protect MSMEs from climate-related risks.

The possibilities for green financing to support Indian MSMEs’ sustainable transition are endless, but it will only be through the concerted efforts of governments, financial institutions and the MSMEs themselves that we will be able to tap this opportunity to its fullest.

The writer is Deputy Managing Director, Axis Bank

Published on August 15, 2022
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