India’s small firms need cheaper loans, not just an interest holiday

India’s small businesses get the costliest loans next only to unsecured personal loans, notwithstanding their assets and employment creation for the economy.

The weighted average lending rate for micro, small and medium enterprises (MSMEs) was 11.24% in February, the second highest among different segments, according to the Reserve Bank of India (RBI).

The benefit of deep policy rate cuts have clearly not reached small firms, owing to the credit spread banks add in lieu of the risk perception of their businesses.

Policymakers need to fix the cost of credit, else small firms would remain under pain even after normalcy returns once the lockdown is gradually lifted.

One way to do this is to encourage credit guarantees by the Small Industries Development Bank India (Sidbi). “Credit flow to MSMEs could be augmented through additional refinancing facilities to banks and other financial institutions such as SIDBI, which are focused on these enterprises,” analysts at Delloitte Touche Tohmatsu India Llp said in a 1 April note. Top-up loans for payment of salaries could also be considered, they added.

Sidbi has already announced a concessional rate of 5% for MSME loans under its emergency covid-19 package. Present credit guarantee schemes may also be strengthened.

Nevertheless, the importance of the temporary relief measures cannot be overstressed. At RBI’s behest, banks have started opening up emergency credit lines to businesses for meeting their immediate requirements. Interest payment on working capital lines have been deferred for three months. These were necessary for MSMEs to survive in the wake of revenue streams disappearing due to the lockdown.

All these measures will ensure that MSMEs survive. But beyond the lockdown, for firms to get back on their feet and to even strengthen their balance sheet, they would require cheap credit.

MSMEs contribute to roughly 30% of gross domestic product (GDP). While the blow to GDP during the lockdown cannot be wished away, the economy badly needs small firms to stay in business and bounce back when things start becoming normal. If small firms crumble under the weight of interest payments, it will defeat the impact of relief measures given so far.