First dose is liquidity; MSMEs get mega guaranteeApprox Read Time: 7 minutes
In News: First dose is liquidity; MSMEs get mega guarantee
- The Union Finance Minister has announced an economic relief plan with primary focus on addressing the distress in the MSME sector.
- The MSME sector lies at the heart of the Indian industrial ecosystem and employs an estimated 11 crore persons.
- The announcement follows the Prime Minister’s announcement of a Rs 20-lakh-crore plan (almost 10 per cent of the GDP) to deal with the impact of Covid-19.
- The measures are targeted at avoiding large-scale business closures, which could impact the financial system systemically and disrupt supply chains in the coming days.
- However, the success of the scheme depends on these measures working as a multiplier to improve the lending in the banking system and induce fresh funding of distressed smaller firms.
Change in MSME definition:
- The government has also decided to expand the definition of MSMEs, which will enable a larger number of enterprises to be classified as MSMEs and, therefore, be able to avail of the benefits.
- There has always been a fear, among successful MSMEs, that if they outgrow the size of what has been defined as an MSME, they will lose their entitled benefits. This is why MSMEs like to remain within the definition rather than grow.
- The revised parameters come almost two years after the Centre first brought the MSME Development (Amendment) Bill, which aimed to change the definition purely on the basis of turnover. However, following opposition from some sections, the Bill was put aside.
- As per the proposal, micro enterprises will be those with investment of up to Rs 1 crore and turnover of up to Rs 5 crore.
- The earlier definition classified investments of up to Rs 25 lakh for manufacturing and up to Rs 10 lakh for services.
- For small enterprises, the classification covers up to Rs 10 crore in investment and Rs 50 crore in turnover.
- The earlier classification involved investment of up to Rs 5 crore in manufacturing and up to Rs 2 crore in services.
- For medium enterprises, the investment limit has been doubled for manufacturing enterprises from Rs 10 crore to Rs 20 crore and quadrupled for services from Rs 5 crore to Rs 20 crore, in addition to the turnover criteria of up to Rs 100 crore for both sectors in this size.
Measures announced for MSMEs:
- A ‘fund of funds’ with a corpus of Rs 10,000 crore will be created for infusing about Rs 50,000 cr as equity into MSMEs. The government intends to put in Rs 10,000 crore and get others, possibly institutions like LIC and SBI, to fund the remaining amount.
- The Fund of Funds will be operated through a mother fund and a few daughter funds.
- The government will provide equity funding for MSMEs with growth potential and viability.
- The fund structure will help leverage Rs 50,000 crore at daughter-fund levels.
- This will benefit those MSMEs who have the potential and are viable.
- The government has disallowed global companies from participating in tenders up to Rs 200 crore, reserving that space exclusively for Indian companies. This will be a step towards Self-Reliant India and will also be able to serve Make in India.
- Post-COVID, trade fairs and exhibitions will be difficult so e-market linkage will be provided for MSMEs so that they will be able to find their market.
- Also the government and central public sector enterprises will release all funds due to MSMEs within 45 days.
Emergency credit line for standard MSMEs:
- Banks and NBFCs can provide emergency credit lines to MSMEs up to 20 per cent of their outstanding credit as on February 2, 2020.
- These loans will have a 4-year tenor, a 12-month moratorium (payment holiday) on principal payments, and a cap on interest costs.
- A total of Rs 3 lakh crore is projected to be disbursed under this scheme that will be open until October 31, 2020.
- Borrowers with up Rs 25 crore outstanding and Rs 100 crore turnover are eligible, which could help nearly 45 lakh units to resume business activity.
- Further, borrowers will not be required to provide any fresh collateral and guarantee fee against these loans.
Partial credit guarantee for stressed MSMEs:
- While full credit guarantee is being provided to MSME whose loans are standard, stressed small companies whose loans have been classified as NPA (non-performing assets) will be given subordinate debt by banks against a partial credit guarantee provided by the government.
- The Centre will provide Rs 4,000 crore as funding support to CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises) — which will help in facilitating Rs 20,000 crore of subordinate debt to nearly 2 lakh enterprises.
- While a partial credit guarantee reduces the credit risk for the lenders, the effectiveness of this measure will depend upon their appraisal.
- The main thrust of the current announcements was a relief to MSMEs in the form of a massive increase in credit guarantees to them.
- In other words, instead of directly infusing money into the economy or giving it directly to MSMEs in terms of a bailout package, the government has resorted to taking over the credit risk of MSMEs should they want to remain in business.
- Loans to MSMEs are mostly given against property (as collateral) because often there isn’t a strong cash flow analysis available. However, in times of crisis, property prices fall and this interferes with the ability of MSMEs to seek loans.
- A credit guarantee by the government helps as it assures the bank that its loan will be repaid by the government in case the MSMEs fails to do so.
- For ex., if the government provides say a 100% credit guarantee up to an amount of Rs 1 crore to a firm, it means that a bank can lend Rs 1 crore to that firm; in case the firm fails to pay back, the government will make good all of Rs 1 crore. If this guarantee was for the first 20% of the loan, then the government would guarantee to pay back only Rs 20 lakh.
The need for credit guarantees:
- During the Covid pandemic, the RBI and government have initiated measures to push liquidity into the market via the banks.
- However, the measures so far have not helped because banks simply do not want to lend any new money. Banks fear that any new loans will only add to their growing mountain of non-performing assets (NPAs).
- As a result, the government faced the odd problem of banks having money but not willing to lend to the credit-starved sections of the economy.
- Thus the government has now resorted to the credit guarantee scheme in order to balance the conflicting positions in the economy and address the lack of liquidity.
Benefits of the announcements:
- The Rs 3 lakh crore credit guarantee is the most substantive announcement as it will most likely have a significant impact in helping MSMEs pay salaries and continue to operate even as the economy slows down.
- This measure will help as many as 45 lakh MSMEs. While this is a small proportion (about 0.5%) of the overall number of MSMEs, these are likely to be the enterprises, which employ almost 40% of all employees.
- The change in definition of MSMEs will also help because “turnover” is the more efficient way to identify an MSME and it also allows a lot of firms, especially in the services sector like mid-sized hospitals, hotels and diagnostic centres to be eligible for benefits as an MSME.
- The redefinition will assist the MSME sector in growing and emerging as a vibrant and dynamic sector, contributing to self-reliance and employment in a big way.
Issues with the announcements:
- There is a risk of deteriorating credit culture as bankers would have no liability, which may lead to an increase in adhoc disbursement of loans.
- A 100% credit guarantee leaves no incentive for either borrower to pay back — he has nothing to lose — or for the lender — as the banker is assured of payback from the government.
- As a result, it is quite likely that the government will have to start paying money to cover these loans in the next financial year when MSME NPAs rise once the moratorium is over.