The micro, small and medium enterprises (MSMEs), which contribute almost 45% to India’s gross domestic product (GDP), are suffering greatly because of both supply and demand side issues. The government of India and state governments need to move very fast because, MSMEs are fast losing their meagre reserves and cannot hope to survive this crisis, unless, substantial help comes their way immediately.
This is true for manufacturing, service and other kinds of MSMEs.
On the supply side, MSMEs face a reduced labour supply as workers are still unable to come to work due to lock-downs and restricted movement. Also, workers may have gone elsewhere, could be unwell and/or would need to look after their families—all these impact their availability. Without a doubt, measures to contain COVID, such as lock-downs and quarantines, while necessary, have led to further and more severe drops in labour availability and hence, capacity utilisation. That is a critical issue facing MSMEs. This apart, supply chains have also been disrupted leading to severe shortages of components as well as intermediate goods in many MSME clusters.
As far as the demand side is concerned, a sudden and significant loss of demand (and revenue as a consequence) for SMEs has crippled their ability to remain viable and going concerns. This loss of demand has also caused severe liquidity shortages as MSMEs are incurring costs, with virtually no production—paying salaries (in many cases), maintaining infrastructure and the like.
The demand shock is very severe because consumers themselves are experiencing several issues—income loss at the individual level in many cases, fear of infection and contagion and increased uncertainty about everything. All these have cascading effects and reduce consumption as well as spending. These effects have been exacerbated because in several instances, workers have been laid off en mass as large companies and some MSMEs have not been able to pay salaries, despite wanting to do so.
Some sectors, such as aviation, tourism, hospitality, travel and transportation, have been strongly affected, also contributing greatly to overall reduced business and consumer confidence. Without question, while ‘social (physical) distancing’ is a very necessary measure to combat COVID-19, SMEs are more vulnerable to this ‘social (physical) distancing’ than are other companies.
In terms of credit markets, the all-round uncertainty is not helping and bankers and financial institutions (FIs) are reluctant to lend, despite being flush with funds and I would not blame them. As in other crisis situations, someone has to underwrite their risk for they in many ways are protecting depositor funds, which is also very crucial. In general, the overall confidence is very low and despite, RBI’s measures of reducing interest rates and providing a small directed lending facility of Rs50,000 crore for refinancing by National Bank For Agriculture & Rural Development (NABARD), Small Industries Development Bank of India (SIDBI) and the National Housing Bank (NHB)—I say small from the perspective of India’s size and its diversity of sectors and companies including MSMEs—I am afraid the bankers and FIs would need a stronger push to actually lend in real time.
Overall, the impact of COVID on financial markets has been such that there is reduced confidence in lending and, therefore, a subsequent reduction of credit lines and the like.
While all of these various impacts affect both larger firms and MSMEs, the impact on MSMEs is especially severe due to their higher levels of vulnerability and lower resilience (because of their size and unique aspects).
So, what can be done?
The government of India has to think out of the box and try and help MSMEs immediately.
As a first step, all MSMEs should be provided a complete one-year tax holiday from direct as well as indirect taxes. This would go a long way towards restoring some confidence among MSMEs. Many countries have done this almost immediately, for varying periods of time and the impact is already being felt there.
Second, the RBI should immediately appoint a board member led national committee that ensures that banks and FIs fully pass on its interest rate cuts. This committee should also ensure that SIDBI fully and completely utilises its portion of the (small) directed lending facility of the RBI immediately, for the benefit of MSMEs. Remember, that the directed RBI refinance facility is for SIDBI, NABARD and NHB to lend to agriculture, MSMEs, microfinance and related sectors. Clearly, the earmarked funds for SIDBI (of the order of Rs15,000 crore) can only be partially used for direct support to MSMEs (especially, as refinancing of SIDBI’s microfinance institutions (MFIs) is also expected from this kitty). But that would be hardly enough for the large and attendant problems faced by India’s extensive MSME sector.
Third, given the huge magnitude of the demand and supply side shocks and the uncertainty surrounding them, SMEs will urgently need to be supported in a sustained manner and for longer periods for various aspects including digitization, practicing physical ‘social’ distancing, compulsory use of personal protective equipment and the like. All of these will increase fixed costs significantly.
The government of India should therefore immediately establish a specialised larger MSME refinance/investment facility (SME India Refinance and Investment Facility) for enabling quick emergency lending, that is, term loans and working capital support and quasi-equity investment in MSMEs.
Given the size and diversity of India’s SME sector, the facility must be of the order of at least Rs2 lakh crore.
The quasi equity facility is a provision to convert a portion of the debt (term loan) lent now as equity at a later date for MSMEs satisfying some minimum (performance) criteria at the time of conversion of debt to equity, which can be anywhere between three to five years from now. Multi-lateral and other private funds can be easily tapped for the same, especially for the Indian SME sector and if specific knowhow on tapping global funds is required, the same can be shared.
This facility must be used by bankers and FIs for refinancing their lending support to SMEs. Incidentally, bankers are flush with funds but given the overall uncertainty, I am not sure that they would be readily forthcoming to lend to MSMEs. They are extremely risk averse and therefore a refinance facility will work and work effectively.
I have personally been involved in such efforts globally in many such crisis-impacted environments and believe me, the bankers and FIs forget their risk aversion and readily lend, provided their lending is underwritten by someone (which in this case will be the government of India).
While all of the above are important to implement, time is of essence here and this calls for immediate operationalisation of the above. Perfection is the enemy of the good and it would be in the huge interest of MSMEs and India to see the above implemented immediately and in quick time as the future of India’s MSMEs and their very survival is what is at stake!
(Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years.