Friday, December 30, 2011

MSMEs financing bottlenecks!

The markets are in jittery, and for valid reasons. The rupee has hit an all-time low of 53 and macroeconomic indicators of the economy are sagging. Industrial production is on a downward spiral. Policymaking is ground to an apparent halt, and the rollback of the decision to open up multi-brand retail has sapped investor confidence. The negative growth registered in industrial production in October, a sharp 5.1% decline, and shows that industrial productivity is slowing far more rapidly than expected.

All these pose greater risks for overall economic growth in 2011-12, already watered down to 7.6%, with further downward revision on the cards. For now, slowdown worries take their toll on capital goods and companies stocks. Its impact is going to be more severe on micro, small and medium enterprises (MSMEs), which have been already running through bad time a rough patch, affected with huge financing gap and consistent decline in global demand for their products.

Despite being hamstrung by these, MSMEs rely on open market for their business finance, as internal mobilisation through informal sources makes the business more vulnerable. Though the socioeconomic importance of MSMEs is well recognised in academic and policy circles, they are starved of funds, with little interest shown by institutional investors. The priority sector lending policy outlines that 40%of net bank credit of public and private sector banks must be earmarked for those sectors, which include MSMEs. The policy stipulates 32%of net bank credit of foreign banks for the priority sectors, of which 10%is allocated to MSMEs. But barring regional rural banks, how many banks comply with this criterion? In the absence of proper channelisation, the mandated allocation hardly makes a difference to the business of the firms get financed by them.

Here, it’s imperative to keep in mind that the MSME sector is not homogenous, but is constituted by three different sub-sectors. These sub-sectors need to be serviced separately. For micro enterprises, access to credit is priority. For small enterprises, access to credit is relatively easy, though limited, and therefore remains important along with cost. For medium enterprises, access to institutional finance is easy though the cost incurred on credit is quite high. Collateral based lending offered by banks and financing companies is normally made up of a combination of asset-based finance, contribution-based finance and factoring-based finance using reliable debtors and guarantors. Substantial numbers of MSMEs are falling short on collateralised security needed for bank loans, and lack the prospect of high returns to attract formal venture capitalists and other risk investors like private equity funds. Moreover, market is also suffering from deficient information, diluting the effectiveness of financial statement based lending and credit scoring.

The sector expects that the government will take the decision to earmark 20%share in public procurement (wherein it will procure 25-30%of its needs from MSMEs), a proposal which is hanging fire for quite some time. Anil Bhardwaj, secretary-general of Federation on Indian Small and Medium Enterprises (FISME), observes that “this will work as lifeline in ongoing slowdown. To ramp exports, FISME has suggested the need to take up export promotion in urgency to enhance MSME participation in export from 0.5% to 5% in next 10 years”. For this to happen, the prevailing support mechanism, which heavily rely on Export Promotion Council for exposing MSME s to export market, has to be discarded. FISME also has valid reasons to criticise the RBI’s indifferent approach on MSME finance, but their demand for separate financial regulator for MSME seems not practical. Because, it alone wouldn’t ensure the micro centric approaches of new regulator on these small businesses, also after a certain point, policy must be shaped with optmising the interests of industries involved and its end consumers. So, basic idea should be at the ground to address the odds, which restraining the finances of this segment of industries.

James Carville, who advised US President Bill Clinton, once remarked that for being ecstatic on bond markets, “I used to think that if there was reincarnation, I wanted to comeback as President or the Pope or as a 400 baseball hitter. But now I would like to come as bond market, you can intimidate anybody.” Such is the negativism about the bond market even in western economies, but surprisingly that hardly directs the saving towards financing MSMEs worldwide.

Venture capital, as financial intermediary, also not providing viability to MSMEs for better engagement; the basic proposition could be found through their working model, that being able to secure finance is critical and most difficult for any business. It’s applicable to startups seeking venture fund or mid-size companies that need cash to grow up. So venture capital is most suitable for business with large up-front capital requirements which can’t be financed by cheaper alternative such as debt. Another financing option, private equity shows explicit interest s in typical leveraged transaction, where it buys majority control of a growing or mature firm. This works different from a venture capital or growth capital investment fund in which the investors invest in young business and rarely bids for decisive control. Beyond these lesser suitable options, bank remains the most appropriate route for bridging the gap of financing for MSMEs. So, it’s essential, bank come forward for effective partnership with MSMEs which is the engine of growth.
Atul Kumar Thakur
December 15, 2011, Wednesday, New Delhi

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