Improving. The Financial Ecosystem of. Indian MSMEs

Transcription

1 Improving The Financial Ecosystem of Indian MSMEs

2 Introduction A vibrant entrepreneurial ecosystem constitutes a failsafe route to a nation s economic development. Prime Minister Narendra Modi s Make in India initiative, which seeks to beef up manufacturing productivity and transform India into an economic force, is seen as a prime driver of entrepreneurial innovation. The Micro, Small and Medium Enterprise (MSME) segment, which is the cornerstone of any economy, has enormous potential to unlock India s entrepreneurial power, create employment opportunities and fuel global competitiveness. The biggest differentiator for MSMEs is their competitive business model, which focuses on the use of cost-effective and homegrown resources, capital, processes as well as labor. This ensures a rapid and a robust Return on Investment (ROI). However, to leverage their USP and ensure that they explore opportunities to the fullest, Indian MSMEs need timely and unhindered access to funds - which has traditionally been a severe constraint. This paper takes a closer look at the MSME sector today, and assesses the gaps in financing MSMEs. It also explores potential solutions to address these deficits and enhance the financial ecosystem in which the MSME operate.

3 03 Current Definition of MSMEs by MSMED Act (2006), Government of India The MSMED Act (2006) by Government of India gives the following definition for micro, small & medium enterprises: Enterprises engaged in the manufacture or production, processing or preservation of goods (investment in plant and machinery) Micro enterprise: Does not exceed Rs. 25 lakh Small enterprise: More than Rs. 25 lakh but does not exceed Rs. 5 crore Medium enterprise: More than Rs.5 crore but does not exceed Rs.10 crore Enterprises engaged in providing or rendering of services (investment in equipment) Micro enterprise: Does not exceed Rs. 10 lakh Small enterprise: More than Rs.10 lakh but does not exceed Rs. 2 crore Medium enterprise: More than Rs. 2 crore but does not exceed Rs. 5 crore (Source: Ministry of MSME s Annual Report )

4 04 Current State of the Indian MSME Sector According to Ministry of MSME s Annual Report for , an estimated 46 million MSMEs in India manufacture more than 6,000 products, contribute 8 percent of gross domestic product (GDP), 45 percent of industrial output, 40 percent of exports, and employ nearly 106 million people. Although 94 percent of MSMEs are unregistered, the contribution of the sector to India's GDP has been growing steadily at 11.5 percent annually, which is higher than the overall GDP growth of 8 percent MSMEs in millions (Source: 4th ALL INDIA CENSUS OF MSME, EDITION: APRIL 2011, CII Report on MSME Conclave 2014 ) Like other economies, the Indian MSME sector has the potential to increase its contribution to employment to over 50 percent over the next decade. In addition, as per an industry report NASSCOM Perspective 2020: Transform Business, Transform India, the MSME segment has the potential to build 2,500 large-scale businesses. These businesses could clock in revenues of Rs10 lakh crore ($200 billion) a significant contribution to GDP and creation of employment at the same time.

5 05 Employment generated by MSME as a percentage of overall employment globally US UK INDIA GERMANY FRANCE BRAZIL Non SME SME (Source:CII-KPMG report on The New Wave Indian MSME 2014) However, there are major roadblocks that inhibit the growth of MSMEs in India. The MSME sector is constantly battling the odds to stay competitive in the global marketplace. Among the challenges that the MSME sector faces, access to timely and unrestricted credit remains the most critical, according to the FirstBiz-Greyhound Knowledge Group MSME Survey Major Challenges Faced By MSMEs Dearth Of Easy Finance and Credit Instrruments Limiting Regulatory Policies Non Availibilty Of Modern Technology Lack of Infrastructure Facilities Absence of Marketing Platforms Lack of Skilled Labour (Source: FirstBiz-GreyHound Knowledge Group MSME Survey 2014)

6 06 Inflexible lending guidelines and the risk-averse nature of financial institutions force many MSMEs to depend on informal sources of capital (borrowing from relatives or moneylenders) and the unorganized market for their financial needs. a. Financial source (all figures in millions): 1. No finance/ Self Finance: (87.23%) 2. Finance through Institutional sources: (10.87%) 3. Finance through non-institutional sources: (1.05%) 4. Finance through both Institutional & non-institutional sources: (0.84%) Finance Source wise (in milllion units) No/Self Finance Institutional sources Non Institutional Both (Source: 4thAll India Census of MSME)

7 07 Credit Demand of MSME Sector There is a total finance requirement of INR 32.5 trillion ($650 billion) in the MSME sector, which comprises INR 26 trillion ($520 billion) of debt demand and INR 6.5 trillion ($130 billion) of equity demand. Total Demand For Finance (In INR Trillion) Debt 0 Total Finance Demand Debt Equity Ratio Equity (Source: 4th MSME Census, Intellecap IFC Research report 2013 on MSME sector) According to the Financial Intellecap-IFC Research Report 2013 on the MSME sector, financial bodies consider major part of this debt demand as unrealistic because of factors like high-risk perception and lack of availability of immovable collateral. An estimated 37 percent of the overall debt demand is unviable for financial institutions. Also, nearly 25 percent of total demand is from micro enterprises, which have higher preference of debt from the informal sector. Hence, only 38 percent of the total debt demand is considered addressable by formal financial institutions. Sick enterprises in default New enterprises (in operation for less than 1 year) Rejected by formal financial institutions Voluntary exclusion by micro enterprises Total (Source: 4th MSME Census, Intellecap IFC Research report 2013 on MSME sector) 13% 23% 1% 25% 62%

8 08 Financial Gap in the MSME Sector Despite banks adopting a more progressive outlook in lending to MSMEs, there is still a significant financial gap of INR 20.9[9] trillion ($418 billion, according to MSME census and RBI data, ). After exclusions in the debt demand (62 percent of the overall demand) and the equity demand (from MSMEs structured as proprietorship or partnership), there is still a demand-supply gap of INR 3.57 trillion ($71.4 billion), which formal financial institutions can finance in the near term. This is the demand-supply gap for approximately 11.3 million enterprises. While a large number of these already receive some form of formal finance, they are significantly underserved with only percent of their demand currently being met. The micro, small, and medium enterprise segments respectively account for INR 2.25 trillion ($45 billion), INR 0.5 trillion ($10 billion) and INR 0.18 trillion ($3.6 billion), of the debt gap that is viable and can be addressed by financial institutions in the near term. Micro and small enterprises together account for 97 percent of the viable debt gap that can be addressed by financial institutions in the near term.

9 09 Sources of Credit Finance for MSME Sector Financial institutions providing credit finance to MSMEs in India: 1. Commercial/Regional/ Rural/ Co-operative Banks 2. SIDBI: Small Industries Development Bank of India (refinance and direct lending) 3. SFCs/SIDCs: State Financial Corporations/State Industrial Development Corporations 4. NBFCs/ VCs: Non Banking Financial Companies/ Venture Capitalists Institution-wise Distribution of Debt Supply to MSME Sector Share of MSMEs with formal debt supply (banking or institutional financing channel): 33% Share of banking institutions: 92% (* bank lending driven by priority sector lending policy) Share of non banking institution: 8% Formal Debt Supply 20% Banking Non Banking Institutions 98% (Source: RBI Data , Ministry of MSME Annual Report )

10 10 Challenges Bank Face in Lending to MSMEs When MSMEs opt for formal channels, they generally choose a bank as the main source of funding. However, banks are often hesitant and resist lending to MSMEs for many reasons, which include: The information asymmetry that comes from MSMEs i.e., lack of financial information and standardized financial statement -in a nutshell, the casual, non-systematized approach projected by the MSME The major risks involved in lending to MSMEs, which may have little or no assets that can be used as collateral, high failure rates, low capitalization and vulnerability to market risks The bank s incapability to figure out whether MSMEs possesses the technical, managerial and marketing skills to generate adequate revenue and service the loan because small businesses try to limit their establishment overheads to present a stronger business model

11 11 Reserve Bank of India Guidelines Recognizing the importance of the MSME sector, the Reserve Bank of India (RBI) has issued the following guidelines to: 1. Ensure credit to the MSME sector as part of the priority sector lending by banks 2. Earmark credit for microenterprises within overall lending to micro and small enterprises. 3. Open specialized SME branches 4. Enhance the limit for computation of the aggregate working capital requirements on the basis of minimum 20 percent of the projected annual turnover 5. Adopt a cluster-based approach for SME financing by banks 6. Review the progress in achieving at least 20 percent year-on-year growth in credit to SMEs by the boards of banks MSME credit also allows banks to build a granular diversified portfolio, which helps in risk to ease risk. Government Schemes The Centre has undertaken major initiatives to help MSMEs improve their access to funding. These measures include: 1. Restructuring existing regulatory shackles: This involves streamlining accounting processes or formalizing processes for SMEs. It could also mean cutting down capital needs in Basel Committee s norms for MSME portfolios. Basel III" is a comprehensive set of reform measures developed by the Basel Committee on Banking Supervision, to strengthen the regulation, supervision and risk management of the banking sector. These measures aim to: improve the banking sector's ability to absorb shocks arising from financial and economic stress, whatever the source improve risk management and governance strengthen transparency and disclosures in banking

12 12 2. Developing financial markets for MSMEs 3. Entering the market directly: Direct government intervention in the banking markets includes direct lending through government-owned institutions and directed credit programmes, where the government provides capital to banks specifically for lending to MSMEs. This has also stimulated banks to lend more. 4. Guaranteeing SME loans for which the Government shares a portion of the credit risk. The Government operates through NABARD and SIDBI, which run major schemes like: a. Credit Guarantee Trust for Micro and Small Enterprises: The credit facilities, which are eligible to be covered under the scheme, are both term loans and working capital facility, extended by banks up to Rs.100 lakh per borrowing unit, without any collateral security or third party guarantee, to new or existing micro and small enterprises, and guaranteed by the Trust up to75% b. Credit Linked Capital Subsidy Scheme: 15% Back End Capital Subsidy, capped at Rs.100 crore for technology upgradation. The Government also offers support to MSMEs engaged in foreign trade through the Export Credit Guarantee Corporation (ECGC). It provides services which offer risk cover and guarantees, to protect exporters and banks from inherent risks associated with the sale of goods The Government also offers support to MSMEs engaged in foreign trade through the ECGC. It provides services which offer risk cover and guarantees, to protect exporters and banks from inherent risks associated with the sale of goods and services to foreign buyers

13 13 Possible Measures to Help MSMEs Improve Access to Finance While there have been significant efforts by the Centre and financial bodies to develop and implement numerous support mechanisms for the MSME segment, we, at Power2SME, feel that the following efforts can be undertaken to further improve the MSME financing issue. Enhance debt access to non-banking finance companies focused on these units and give perks for participation in the sector Create an IT-enabled platform to track MSME receivables to facilitate securitization of these trade receivables Give credit guarantee support for MSME finance to non-banking finance companies Delayed payments increases the working capital needs of MSMEs and tightens their financial position. Mechanisms to leverage other sources such as factoring can potentially help MSMEs liquidate receivables faster, and possibly afford them an opportunity to leverage their creditworthiness to avail financing Endorse establishments to syndicate finance and give advisory support to MSMEs in rural and semi-urban areas Embark on further research activities to have better understanding of financing patterns of services enterprises in the MSME sector Bolster the MSME credit information bureau and expand the scope of the information bureau to collate and process important transaction data

14 14 Conclusion The financing requirement varies across sub-categories in the MSME sector. There is a strong need for financial bodies to shed their risk-averse mindset and come out with innovative financial management mechanisms to ensure smooth flow of credit to the MSME sector. Meanwhile, MSME units too need to continue innovating to sustain the growth traction.