The importance of the micro, small and medium enterprises (MSME) sector can be understood by data that shows about 63 million units were contributing nearly 45% of the country’s manufacturing output, more than 40% of the country’s exports, over 28% of the gross domestic product and were providing about 111 million jobs. This data is published by the expert committee on MSMEs appointed in June 2019 by the Reserve Bank of India (RBI) and chaired by UK Sinha.
In view of its major role, successive governments have been encouraging the sector by introducing schemes incorporating subsidies, incentives, interest concessions, bank loans with easy terms and credit guarantees. The RBI as the banking regulator has also been issuing periodic guidelines to the banks with a view to encouraging them to lend liberally to such enterprises. In the latest economic stimulus package announced by the Union finance minister a relief estimated to be worth Rs3 lakh crore has been earmarked for this sector alone. So far so good. But what is the reality?
My personal interactions with three young entrepreneurs over a period of two years reveal the wide gap between the intents of the policy makers and the ground reality. A wide array of bottlenecks at every stage makes it a herculean job to survive the challenges for a start-up unit and is highly frustrating for the survivor. Let me first narrate the cases briefly.
The live cases:
Kripa’s Dental Clinic:
After practising with a renowned dentist for a decade, in June 2019, Kripa* decided to be on her own. She negotiated with a retiring dentist to buy his premises. His old equipment needed replacement and interiors were to be refurbished. Her application for bank loan was kept pending by the manager of a public sector bank (PSB) for five months. It was only with the help of a VIP that she could get her proposal moving.
When the credit was actually sanctioned it was only to buy the premises. She needed new dental chairs, X-ray machine, furniture and consumables for a month. She did not know that these could also be acquired from bank funds. The bank manager did not ask her either. From her own savings, she bought these expensive materials. With some money she had saved earlier, she managed to start the clinic by December 2019 and because of her reputation was able to pick up the practice in two months.
With COVID-19 lock-down, she had to close the clinic in late-March. When the lock-down was partially lifted late in May, she started attending the clinic. But the new protocol issued by the Indian Dental Association (IDA) required her to take additional safety precautions, which needed money. When I visited her in late May she was anxious to know if the relief package announced by the government of India (GoI) would help her to tide over her financial constraints. A little of probing was a revelation to me, as a former banker.
She herself did not know the differences between term loan and working capital loan and the purposes for which the banks would give finance. Neither the chartered accountant (CA), who prepared her project report nor the bank manager had explained to her these concepts. She had thought that the bank loan would be only for the purchase of the premises. The manager had not cared to visit her proposed clinic either.
I assured her that I would get back to her with the details and the possible alternatives for her after consulting my banker-colleagues.
Devindar’s Photo Framing Unit:
Devindar* started a micro enterprise in 2007, manufacturing wooden photo frames, articles of straw, and laminboard. Quickly he built a reputation and expanded his unit. A PSB provided him with credit facilities. He was happy.
In 2018, he applied for a term loan of Rs12 lakh to expand his business. His firm was eligible for a subsidy of 15% of the loan under the credit linked capital subsidy scheme for MSMEs introduced by the GoI. For almost two years, he did not get the subsidy.
When he checked with the local nodal agency (NA) for the MSME, he learnt that the bank had not submitted the claim at all. He had to approach them to submit the claim through the NA for onward transmission to GoI. The NA assured that despite the delay, the GoI would consider releasing the subsidy. The claim was submitted in early February 2020. Till May, the firm had not got a response from the GoI.
Shreevani’s Hospitality Services:
In the third case, the government and, to a lesser extent, the banker are to be blamed. I will limit my comments only on the latter.
A young lady, Shreevani* who was working for an multi-national company (MNC) decided to start a hospitality service unit to provide pre-cooked food to employees of large establishments. After a comprehensive market survey, she saw that there was enough space for a new unit. Taking a calculated risk, she set up a kitchen in rented premises, hired a dozen staff and entered into agreements with a few establishments to supply breakfast, lunch and dinner to their employees in their campuses. She also contracted with a small transport operator to deliver the food at the campuses. Her brother, who was in that line elsewhere, joined her to help her in managing the kitchen; she would take care of the outdoor work.
Two PSBs were not inclined even to study her project, let alone giving finance. The third one was more helpful. It took two months to process and after some ‘wires’ were pulled, sanctioned a term loan and a working capital limit. The project went on stream early September 2016.
Two months later, in November 2016 came the first major blow: the sudden demonetisation of high-value currency notes created problems. Most of her suppliers would provide materials on cash-and-carry basis only. The workers were being paid in cash once a week. She had to hold a large volume of cash on hand. With the note ban it was no more feasible.
A few months of struggling, she was able to weather the storm, her business picked up and she expected to reach her projected break-even level of turnover. She was buoyant that she would succeed in her maiden venture.
Then came the tornado: the new goods and services tax (GST) regime in 2017. Its impact was debilitating.
Her services attracted a GST of 18%. The agreement to provide the service was at a fixed rate; the newly levied GST burden could not be passed on to the clients. In the pre-GST regime, her services attracted a lower sales or service tax and these were loaded on her quote. Further because of their commanding position, the clients would insist on a month-long billing cycle although in reality they would take their own sweet time to settle her claims.
Second, she had also to pay GST on her purchases. There was a provision to get the refund of the tax paid on the inputs for which claims were to be filed before the authorities. She took the help of a CA to file the claims and do the follow-up which involved additional expenses. The refunds would not come smoothly.
A substantial part of her working funds got locked up in the form of GST already paid with a prolonged waiting time to get the refund.
Weeks went on without cashflow, whereas staff, suppliers and interest on the bank loan plus instalment of loan were to be paid. How long could this continue?
Without cashflow, purchase of fresh supplies was impossible and ensuring the committed supply to the clients was a losing proposition. Finally, she took a call to shut down.
She advised the staff to find alternative employments, borrowed from her relatives and friends to clear the outstanding liabilities to the vendors, terminated her contracts with the clients and surrendered the premises, which would otherwise create a recurring burden of rent on her already fragile finance.
When she approached the bank to give an update, the manager questioned her: how could she close down without informing the bank. She had not submitted her stock statements and audited financial accounts for the two years. She said she was not aware of these requirements. The manager said they were in the loan sanction letter. A copy of this was not given to her at all. The manager had never, even once, visited her premises.
It's Not Just Credit that Matters:
I do not wish to clutter the essay with more live cases. The examples cited here speak about what is required for the MSMEs: it is not just credit and government subsidy.
At every stage starting from planning a unit, a new entrepreneur needs timely guidance and appropriate advice. She will be ‘illiterate’ in the area of finance, like Kripa: the banker has to educate her about the different purposes for which bank finance is available and what the advantages of such facilities are. Had she been informed about the availability of finance for different components of capital expenditure and for consumables, there would have been no need for fresh financial assistance. Can’t the bank manager who is in the know of things guide the borrower?
A large company will have plenty of personnel on their pay roll to prepare the loan proposal or the bank would do it for the company. Expecting a new small entrepreneur to be familiar with the nitty-gritty of loan proposal and its terms is unrealistic.
Second, why do bank managers take a long time to process the loan papers and take a decision to sanction or reject? Why do they keep the proposals pending and act ONLY when there is pressure from ‘above’ or ‘outside’?
Third, it always pays to get familiar with the borrower and her line of activity, the equipment and machinery she may need, the kind of premises she intends to acquire on lease or purchase, and visiting it.
I had an interesting case of a huge furniture firm’s new showroom being inaugurated by a senior officer of the bank, which financed their manufacturing facility in the outskirts of the small town I live. When he asked the manager of the lending branch, he did not know where it was located. In the normal circumstances it does not matter. But a regular visit by bank officials to the unit helps both the bank and the borrower: the bank can watch the unit’s activities and the borrower feels that the banker has an interest in his success.
Fourth, when the finance is granted it is necessary to be completely transparent. Giving a copy of the sanction letter along with the terms and conditions is the first step. It is critical to advise the borrower about the kind of discipline she is expected to comply with regarding stock statements, auditing, compliance with the laws of the land and so on.
On the face of it, these are very ordinary measures required and expected of bankers. While a borrower will be more than happy when she gets the money she asks for, she will gain greater confidence on the banker when he acts as a friend, philosopher and guide to her. That attitude will go a long way in enabling her to develop confidence in her own ability to face adversities.
Bankers need a new orientation to meet this expectation, going much beyond the standard reports of meeting targets for sanction and disbursements.
(*Names have been changed)