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Opinion | The big funding challenge that small businesses face

Their credit lines get cut off, especially in crises, and they need policy support to keep funds flowing

The present pandemic-induced lockdown has exposed the vulnerability of a large part of India’s labour force. These are the daily wage earners and workers in the informal sector. Their livelihoods are precarious, earnings barely enough to make ends meet, and they do not have financial savings to fall back on. Unlike in developed economies, they do not even have social security to bank on. They may be just above the poverty line, but switch off the economy even for a week, and they fall below it. What is true for this large class of workers is also true for micro, small and medium enterprises (MSMEs). India has an estimated 63 million of them. Their existence is not hand-to-mouth, like that of workers, but in many ways their predicament is the same. If their revenue stops for a month or two, their viability is imperilled. Typically, their enterprise involves securing inputs (or finished products, if they are traders), and selling their output against credit. Thus, most of them have to pay upfront for their inputs, as also for salaries, but wait to receive payments. This is their working capital cycle. A large number of MSMEs are suppliers to large corporations and the government. In times of stress, they face delays in getting paid. This adds to their cash flow problems. In circumstances like the present lockdown, these can get worse because their customers also run out of cash.

The challenge of providing adequate finance to small and medium enterprises (SMEs) is an age-old one, faced not just by India. Apart from delayed payments, and managing cash flow mismatches, their other challenge is to secure funding for business, both in the form of equity and debt. A U.K.-Sinha-headed committee comprehensively captured their funding challenges and proposed solutions in a report that it submitted to the Reserve Bank of India (RBI) last year. However, this is not the first such report, nor will it be the last one. India has grappled with this challenge for several decades. One has only to read the speeches of past RBI governors to find recurrent mentions of it. Their main challenge, however, is not the cost of credit, but access to it. Sometimes, it is simply not forthcoming. This may be due to the classic problem of “adverse selection" and risk perceptions, or because of lazy banking that only chases fat cat borrowers and ignores the rest.

Over the years, several reforms have been introduced, including a mandatory quota for “priority sector loans" to SMEs. We now also have a bankruptcy law that empowers small creditors by allowing them to move the courts if payments are delayed. Newer methods of providing loans based on credit scores, receivables or social media profiles have been tried. Some banks and non-bank lenders have formed unique templates for retail lending. We also have a stock exchange exclusively for SMEs with a lighter disclosure burden to enable easier equity funding. But their challenge remains.

Three recent examples illustrate the problem, and why it is such a tough nut to crack. As part of its monetary stimulus, RBI introduced long-term repo operations (LTRO), through which it provides banks cheap funding for long periods. The idea was to get credit flowing to needy SMEs that were already facing a crunch thanks to the non-banking sector crisis following the IL&FS fiasco. So what happened? The funds allegedly got cornered by large corporates, including public sector entities, some of which probably refinanced their more expensive term loans with cheaper LTRO funds. Thus, RBI was forced to come out with another LTRO window that specified sub-quotas to be lent to small borrowers. The success of this micro-management remains to be seen. You can take a horse to the water, but can you make it drink? Extreme risk aversion sets in during a recession, and it is usually SMEs that are worst affected and need the most assistance. Unthinkable as it may sound, RBI may have to take the credit risk of SME loans upon itself to get funds flowing.

Another example is that of the Trade Receivables Electronic Discounting System (TREDS), a platform for discounting bills. An SME facing a payment delay can put up its receivables for sale, and someone else could acquire this asset by paying, say, 90% of its face value. But despite what was practically a diktat issued by the government to use this platform, it has only met with limited success. There was news recently of defaults on some receivables, which has made TREDS participants wary of picking up discounted bills. So SMEs are once again stuck with an unhelpful reform.

A third example is of a portal organized by the Tamil Nadu state government, which puts large companies delaying payments under a broader gaze. An SME creditor is expected to list a pending payment on this portal, so that the matter gets “escalated" upward, in a manner of speaking. It is a de facto “naming and shaming" tool. But which SME would want to earn the displeasure of a large and perhaps only customer? So this initiative too has met with limited success despite the best of intentions.

In the present unprecedented situation, the Centre should provide fiscal support. This could be either through a large interest rate subvention or a moratorium on working capital loan repayments, available to all SMEs, regardless of sector, as long as their loans are in good standing and where the amount is below a certain threshold (say, 5 crore). Such a measure might just help ease an old problem in these difficult times.

Ajit Ranade is an economist and a senior fellow at The Takshashila Institution

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