The Prime Minister’s dream of a $5-trillion Indian economy by 2025 along with effective financial inclusion and sustainable economic outcomes is premised on investment from both domestic and foreign investors. Government expenditure can only provide a stimulus, but cannot alone take India to PM’s goal.
For domestic private investments to happen, the role of timely, adequate and quality (low cost) credit cannot be overstated, particularly during the current times when Covid induced stress is maximum on almost all industries. With the recent change in the definition, more than 95 per cent of Indian companies are bought under the definition of MSMEs.
So what ails the MSME sector largely reflects the credit eco-system for more or less the entire industry in this country. The large corporate and top business houses have had any difficulty in accessing credit.
Access to credit
Most of the MSMEs are in rural and semi-urban areas where access to credit is extremely limited. They are vulnerable to predatory moneylenders and often fall into a cycle of debt. Lack of access to finance and timely credit support in business has been a long-standing issue for these MSMEs.
Starting from difficulties faced in seeking loans and working capital from banks to delay in receiving government payments and tax refunds, most of the MSMEs are under severe debt.
As per an IFC study, there is an overall debt demand of ₹69.3 trillion of which 84 per cent is financed by informal sources such as moneylenders, family, friends, chit funds. Formal sources such as commercial banks, NBFCs and government institutions cater to a mere 16 per cent.
Out of these ₹10.9 trillion, ₹8.8 trillion is supplied by commercial banks while ₹1.5 trillion by NBFCs. The failure of traditional lending mechanisms to guide credit towards these MSMEs have led to a scenario where financing is often not reliable, and steady.
This has been particularly exacerbated by the pandemic, as well as the poor state of micro financing in the country, highlighted by India’s estimated credit gap of over $330 billion.
Further, when more these 80 per cent of these MSMEs are in the micro and small category and depending on informal sources of credit, the usefulness of the government’s emergency line credit, stressed asset relief, equity participation and fund of funds operation make very little meaning and contribution to the sector.
Banks employ various methods to limit risk by better assessment of the creditworthiness of individuals or firms, MSMEs included. To keep NPAs down, many credit worthy individuals are denied loans by banks.
While determining creditworthiness, there are two errors that are common — False Acceptance of a bad applicant and False Rejection of a good applicant. The former error is detrimental for banks and increases risk while the latter impacts financial inclusion and economic growth itself.
Many MSMEs have an existing barrier in terms of accessing credit. A false rejection of a good applicant paired with the existing structural issues relating to access to credit for this sector exacerbates the issue. While there are plethora of punitive actions prescribed against commissions of irregular loan financing, there is complete absence of punitive action against omissions of genuine credit financing of businesses, particularly the MSMEs.
Thus, there is no incentive for bank managers to take risks and finance genuine credit requirements.
This kind of approach to credit adversely impacts both growth and financial inclusion. However, recently the government sought a list of investment-grade companies denied emergency credit by banks in the backdrop of the Covid pandemic though what action the government took on the recalcitrant banks remains unknown.
Banks will have to move away from financing collateral to financing the business or the business plans.
Another issue is the lack of paperwork or digital footprint for small MSMEs, a factor which holds them back from being integrated into the formal economy and deprives the MSMEs to take advantage of the formal credit system.
They continue to gain access to credit against assets such as land, etc. when much of the MSME development has started to follow a digital model.
Recording transactional details such as utility payments, electricity bills, etc. would give insight into the financial behaviour of these entities that can aid in extending credit coverage to the unserved/underserved MSMEs.
The way forward
Focused regulatory and structural changes which will improve access, ease the transition to the formal sector and increase consumer education and protection are necessary.
In the long term, once these regulatory issues are addressed, sanctioned loans will be disbursed more easily and private investment will be boosted, creating a virtuous cycle for MSMEs in the country.
Finally, to minimise the false rejections of good applicants, routine audits of all loan applications on random sampling basis must be undertaken by RBI and administrative action taken against malafide omissions resulting in unethical denial of loans to deserving MSMEs.
The writer is a Member of Parliament, Rajya Sabha from Odisha and a former CAG bureaucrat. Views are personal