Credit to MSMEs – A never ending saga
Reserve Bank of India (RBI) Governor Shaktikanta Das speaking on monetary policy recently said: “The key to calibrating monetary policy lies in understanding the drivers of inflation: disruptions in global supply chain, Ukraine-Russia war, external value of the rupiah, social regimes in the name of fairness providing less than compatible goods and services, ballooning current account deficit, etc.
The effect of inflation on these already disrupted supply chains is compounded by rate hikes to contain inflation. Credit instantly becomes more expensive as banks and financial institutions are quick to pass on higher rates to borrowers, with a disproportionate delay for depositors. The study of credit flows is constrained by authentic data. The RBI and the State Level Bankers’ Committees (SLBCs) only report the stock represented by outstanding credit available on the RBI Annual Reports, Monthly Bulletins, Economic and Political Weekly and CMIE data. Our study therefore presents this limitation for the interpretation of the data.
It reminds me of what Keynes said: “It would be foolish, in forming our expectations, to attach great weight to questions which are uncertain. In his Currency Treaty, he argued that “certain categories of investments are governed by the average expectations of those who trade on the stock exchange, as revealed by stock prices, rather than the true expectations of the professional entrepreneur”.
He made it clear that this does not apply to categories of businesses that are not readily tradable or to which no tradable title closely matches. The categories falling under this category are quite extensive – micro and small manufacturing enterprises in the current connotation. (EWG, Ch.12, p.151)
Rate fluctuations impacting the marginal efficiency of capital indicate that new investments will not be very disproportionate to the evolution of the return on capital, while the marginal propensity to consume would not be seriously impacted, through the rate static employment and the rising growth of Gross Domestic Product (GDP).
I looked at the changes in gross bank credit to industry versus credit to micro and small manufacturing enterprises.
The analysis of developments is constrained by the unavailability of the flow of credit, in terms of disbursements month by month or quarter by quarter and the number of companies. The data gives an idea of credit stock or outstanding credit which includes interest, inspection fees, insurance payments, guarantee fees and SMS messages and sometimes unspecified debits on customer accounts .
RBI bank rates have been constant ranging from 4.25% to 4.65% since the pandemic broke out, and this goes to the RBI’s credit for maintaining financial stability by ensuring that the liquidity of the system is not affected by the injection of more than sufficient capital into the banks.
The Union government has announced Atma Nirbhar Bharat Abhiyan to push businesses on the margin, get extra credit to stay in business. When we see the data for outstanding loans to micro and small manufacturing enterprises (MSEs) in the chart, “not all flavors can sweeten little hands.” Outstanding credit in this sector reflects banks’ risk aversion.
Thus, these two primary variables remaining uniform, it was not expected to find that outstanding credit at the level of MSEs fluctuated exceptionally.
Source: RBI Monthly Reports
From the table above, it can be clearly deduced that the 2 quarters in 2020 and 2021 were negatively affected. As Gross Bank Credit (GBC) flows in a linear fashion, the expected outcome for the MSE sector must be in line with GBC levels, as they are at the frontline of the medium and large industry supply chains. But with the glaring negative results, it projects a completely different picture.
It would appear that the stock of credit to MSEs has been a flat blue line. If the banks had extended the Atma Nirbhar Bharat Yojana incentive for moratorium and incremental credit during the period June 2020-June 2022 even to those who deserved it (more than 60% as revealed by some studies), the share of MSEs in GBCs should have been impressive instead of a wild fluctuation in outstanding credit.
The gradual increase in outstanding credit was impressive in the year 2020-21 while in the very next year the huge increase in the first quarter of 2021-22 fades to a negative of 2.584%. The jump in the very following quarters must be attributed to the reclassification by banks of MSEs according to the new definition announced in June 2020 and to the new units registered under the Udyam Aadhar portal.
While outstanding credit in the first quarter of 2021-22 increased by 5.307%, in the first quarter of 2022-23 it was only 0.596%. Such a large drop only indicates the persistence of banks’ risk aversion. The chart below showing the month-to-month change clearly indicates the very wild swings in the stock of credit to MSEs versus the mid-sized sector.
While the mid-sized sector’s credit stock peaked between November 2021 and January 2022, it plunged in March 2022. Banks have had to pressure businesses to reduce outstanding credit to manage their provisions balance sheet.
It is therefore desirable that these MSEs, presented as incubators for job creation and engines of growth, be seen from a different angle with a view to integration into the economy and not as exiting players. Another blatant and naked proof is their presence in the start-up category.
Manufacturing MSEs represent less than 10% of the total number of start-ups. Over the past two decades, their ability to compete with service sector companies in paying wages and salaries to their employees has made them depressed and highly uncompetitive.
Human resource management for MSEs has not captured as much government attention as digitalization.
Perverse incentives and untimely delivery of incentives at the other end also added fuel to the fire. A growing economy, which promises to reach the third place of the world economies, must pay more attention to the ecosystem of MSEs which form the front-end of the supply chains of large and medium industry.
Credit is an important part of the process but not a sufficient condition for growth. MSE manufacturing has a competitive advantage in the agribusiness sector, even on a global scale when the cluster food processing chain and logistics are supported by appropriate incentives in packaging, branding and export.
The focus should be on how MSEs can be empowered to build equity over time and how they can be helped to grow. The RBI and GoI should evolve their management information system to periodically obtain data on the number of businesses financed and credit disbursed and not just outstanding credit which includes interest, SMS charges, inspection fees and compound interest.
Incentivizing them for digitalization and cultivating them for regulatory compliance are worthwhile investments in MSEs to ensure their sustainability and resilience.
(The author is the founding director of Telangana Industrial Health Clinic Ltd and an economist with three decades of experience as a banker. He is grateful to Ramya Bhavani for statistical support.)