Mumbai: Credit growth in the micro, small and medium enterprise (MSME) sector, which had started slowing even before demonetisation, declined further during the demonetisation phase, a Reserve Bank of India (RBI) study said on Friday.

However, bank credit to MSMEs increased on average by 8.5% year on year during the June quarter of fiscal year 2018-19, mirroring the level of growth seen during April-June of FY16, it said.

By contrast, the rollout of the goods and services tax (GST) does not seem to have had any significant impact on credit, RBI’s Mint Street Memo ‘How have MSME Sector Credit and Exports Fared?’ said.

According to a separate set of RBI data, as of 25 November 2016— just over two weeks after the 8 November announcement of demonetisation—bank credit to MSMEs had fallen by 3.4% year-on-year. By December 2016, this had plummeted further by 4.3% year-on-year.

“The MSME sector has witnessed two major recent shocks—demonetisation and introduction of GST. Contractual labour in both the wearing apparel and gems and jewellery sectors reportedly suffered as payments from employers became constrained after demonetisation. Similarly, the introduction of GST led to increase in compliance costs and other operating costs for MSMEs as most of them were brought into the tax net," the study explained.

MSMEs, the RBI study said, face constraints in accessing credit through formal channels because about 97% of them operate in the informal sector.

“A large number of these firms depend on informal channels because of easy accessibility and availability of credit without any documentation hassles and mortgages, though the rate of interest on such loans may be very high. The challenges faced by MSMEs in accessing finance are due to lack of comprehensive formal documentation relating to accounts, income and business transactions," said the latest Mint Street Memo, brief reports on topical subjects.

Loans are provided to the MSMEs mainly through appraisal of collaterals rather than an assessment of their true business potential. “Further, banks do not trust start-ups, view such loans as risky and thus do not prefer extending finance to MSMEs," it added.

In the formal financial sector, MSMEs receive loans mainly from banks (around 90%). The study found that the share of credit provided by banks has declined since September 2016 partly reflecting the risk aversion of banks due to a deterioration in their asset quality. “In contrast, loans extended by non-banking financial companies (NBFCs) to MSMEs grew strongly at an annual average rate of 35% during the same period and their share in total credit almost doubled from around 5.5% in December 2015 to around 10% by March 2018. Lower non-performing assets (NPAs) of NBFCs in MSME credit might have helped them in extending credit to the sector," the study said.

It said the share of credit extended to MSMEs in overall bank credit had declined to around 14% by end-March 2018 from about 17% in 2007 which could partly be due to over-lending to large corporates in the second half of the 2000s.

Bad loans of both public sector banks and private banks pertaining to the MSME sector have increased over time, with the level being much higher in the case of PSBs.

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