MSMEs are an important sector contributing 8% of countrys GDP, 45% of manufacturing output and 40% of exports, according to the inter-ministerial committee on MSMEs (September 2013). It is estimated that 3 crore MSMEs providing employment to 7 crore persons are manufacturing more than 6,000 products. And the growth in the sector has been slowing down in recent years. Hence, there is a need to think out of the box to ensure flow of credit to MSMEs.
But first, some facts about the highly heterogeneous MSME sector where 94% of units are unregistered. MSMEs are mainly classified as manufacturing and service enterprises. There is a specific stipulated limit on investment in plant and machinery for each of the respective micro, small and medium segments in manufacturing with a maximum limit of R10 crore, and for equipment in service enterprises with a maximum limit of R5 crore.
The government has been making consistent efforts since 1948 to encourage MSMEs in India. The Office of Development Commissioner for MSMEs, operational since 1954, has 70 offices and 21 autonomous bodies spread across the country. The government has initiated various measures over the years such as cluster approach, special economic zones and MSMED Act, 2006, to encourage the sector. In fact, the government of India has a dedicated ministry for MSMEs since 1999. The Small Industries Development Bank of India (SIDBI), established in 1990, is the principal financial institution for promotion, financing and development of the MSMEs. Commercial banks, especially through the priority sector lending, play an important role. At the state level, state financial corporations and state industrial development corporations are the main sources of long-term finance for the sector.
Nearly 93% of units in the MSME sector are dependent on self-finance and do not get any financial support from the financial institutions. Issues related to credit such as adequacy, timely availability, cost and mortgages continue to be a concern. In India, a universally acknowledged reason for the reluctance of the commercial banks to lend to MSMEs is the lack of reliable information for banks to assess the creditworthiness of these units and their promoters and proprietors. The credit information companies (CIC) are attempting, since 2005, to collect and build information database. The CICs are in a nascent stage and the information base is still very limited. The progress is obviously slow for many reasons and RBI recently released a draft report on credit information for CICs seeking comments from the public. The dataset by CICs can only be prepared by official track of information which is not available for many units and certainly not for first timers. In India, with cash component of payments still substantial in transactions, establishing credit history would take a long time before business practices change and credit history is created. Again, collecting soft information on MSMEs and their proprietors and promoters would involve substantial effort, which would be expensive to collect and difficult to substantiate. Also, the ease with which these MSMEs can change their location, address and name of the promoter and proprietor, especially when most of them are in rural areas, and with most of them unregistered, makes it rather difficult to recover loans. Further, lack of transparency and fair bankruptcy process and legal provisions for the recovery of loans are lengthy and therefore cumbersome. In the current context of rising NPAs in case of all commercial banks, lending to MSMEs is considered rather risky and therefore the persistence in reluctance.
The government could consider a self-help group (SHG) approach to extend credit to the MSMEs, as SHGs, based on experience in the sector of microfinance, operate on collective wisdom and peer pressure to ensure end-use and repayment. A similar exercise, in spirit, by Bangalore in filing property tax for the Bruhat Bangalore Mahanagara Palike in 2008 has yielded positive results where taxpayers can see what they have paid compared with their neighbours (Isher Ahluwalia, 2014).
Given the demographic patterns in India, more jobs would have to be created outside the government sector. In this context, the role of MSMEs assumes great significance and needs to be strengthened. In addition to technological solutions, which would generally take a long time to implement and fructify, the banking system could use a time-tested approach exemplified in SHGs to extend credit to MSMEs. A strong and flourishing MSME sector would contribute to growth and higher exports.
The author is RBI Chair Professor of Economics, IIM Bangalore.
Views are personal