The policy announcements of 2004 in the Budget, the setting up of SMERA in 2004, enacting MSME Development Act in 2006, and unleashing of the SME Development Fund in 2007 could not boost the credit markets in the SME sector, as the percentage of credit to SMEs declined from 10.76% (2001-02) to 6.34% (2006-07), despite a decline in the NPAs generated in the sector from about 21% to 5.58% between 2002 and 2007.
The sector that contributes to 39% of the manufacturing output and 34% of exports, employing 29.5 million persons through 400 SME clusters, 2,000 artisan clusters and nearly 12 million enterprises of all hues and sizes, has been worrying RBI.
There wasn’t much realisation that the risks that SMEs face, lie foremost in the choice of their business organisation and partners; marketing-domestic, international, branding, co-branding, timeliness; technology-both inappropriateness and inadequacies; pricing; and lastly, financial, in that order.
Not many working groups or committees set up by the Reserve Bank of India in regard to the priority sectors or SSI sector during the last five decades gave such a consummate treatment to the subject as the latest one set up under the chairmanship of KC Chakrabarty, chairman and managing director, Punjab National Bank, dealing with all these above-mentioned risks SMEs face. It is a different issue if they did not cite references to earlier works on the subject that contained quite a few suggestions mentioned in the report.
Asymmetric information, low economies of scale for lenders, high demand for collaterals, high risk perception towards small enterprises have been cited as reasons for poor credit flow from the formal sector to SMEs. These aspects were brought out time and again. But the admission that ?the banks are not adequately geared to new ideas and new businesses?; and that ?it is indeed difficult for banks to assess the capacity of the enterprise to repay?, in the backdrop of poor accounting standards and practices of the latter, lies the foundation for finding the right solutions to the problems for growth and exit. What more could be done would be discussed at the end.
Credit is one of the many factors that deserved the most comprehensive attention of the group. Discussing credit issues, the group came to the conclusion that many PSBs still do not honour the guidelines of RBI in credit assessment of SMEs on the basis of the Nayak Committee recommendations. For all loans below Rs 5 crore, 20% of the projected annual turnover could be lent towards working capital as the minimum without insisting on CMA data or the operating statement, balance sheet, etc. Post Basel-II preparations, banks started pricing loans on the basis of risk perception. The SME sector, viewed as a high-risk portfolio, irrespective of the value of collateral security offered, carried the highest interest rates for borrowers.
This ‘risk pricing’ ranging from 12.5%-14.5% with a guarantee fee of 0.75-1% for loans up to Rs 50 lakh, not to speak of processing fees, service charges for remittances, guarantees, letters of credit and bill payments, turned the SME sector up front uncompetitive but most sought after for banks.
It is surprising that the group has not chosen to recommend a credit risk insurance mechanism as obtained in all developed countries, where SMEs are thriving; e.g., the US, Japan, Germany, the Netherlands, Australia, Denmark, Italy, where the insurance agency takes the responsibility of not just the loan default but also the political risks, sovereign risks, and recovery of the defaulted loans for the lending agencies.
The premium is to be shared by the government, banks and the enterprise in rational proportion. It is also surprising that the group that found logic for retaining the freedom to charge interest to the banks argued for reduction of the 0.75 or 1% premium payable to the guarantee organisation. It is also common knowledge that under risk-based pricing, where the loan is guaranteed or collateralised, the rate of interest is dependent on the nature of guarantee or the value of collateral. Unfortunately, banks want to retain the cake and eat it too. The best-rated enterprises should carry a lower rate of interest in addition. These aspects have been omitted in such a comprehensive report.
The treatment of sick enterprises and the ameliorative measures suggested also mark a significant departure from the present pattern of the Kohli Committee recommendations, where it displayed its urge for a clean portfolio in the SME sector.
However, the government has to enact a suitable bankruptcy law sooner than later, so that enterprise health at all levels would enhance the country rating at the global level.
A single-window concept for deciding the sacrifices of government agencies, power and water utilities is a welcome move and banks could also be part of it. The SLIIC committee, which has served no purpose so far, could be wound up and the Empowered Committee of the RBI should take decisions in this regard.
Further, the state level and district level committees should be such that they conform to the timing of the decisions recommended in this report. Another important scoring point that requires a different treatment is the delayed payments.
A sickness cannot be cured by diagnosing the disease but by administering the right medicine at the right time. It is hoped that the government and RBI would arrive at action points quickly and implement the recommendations of the group, as also consider some of the additional suggestions made in this article. The entrepreneurs, both existing and prospective, would do well to pick up many otherwise indigestible materials for their sustenance and growth.
The author is an economist