SME sector: in search of an exit policy for unviable units

Updated: Jan 28 2008, 05:35am hrs
It is Budget time and there are lots of expectations from several sections of the population. But there are not many articulate chambers to champion the cause of the SME sector. The FM in his 2005-06 Budget gave lot of fillip to the sector by setting some sensible goals for the financial sector and announcing measures that have put the sector on a globally competitive map. But one thing that has missed his attention are measures to clean up the sector. After all, measures cannot be taken up all at a time.

About a third of small industries at the all India level are classified as sick. According to the third All India Census of SSIs 2001-02, 11 States of the 35 States and Union Territories share among themselves 89% of the sick and incipient units and 9 among them have 69% of the units closed. The states that take prominent rankings among sickness are: Kerala, Tamil Nadu, Karnataka, Andhra Pradesh, Punjab, West Bengal and Maharashtra. Sub-sectors face specific problems to a lesser or greater degree and vulnerability to global competition also varies significantly across sub-sectors. These numbers speak of the units that have entered the books of the financing institutions. There are many who did not borrow but fell sick. They have assets like the land and machinery, which are locked for decades without remedy. A rough estimate of such assets in the industrial estates alone would be 5-6% of the GDP!!

The acknowledged problems common to small enterprises as a whole persisting for over four decades include: lack of demand, lack of access to finance, non-availability of raw material, inadequate and high cost infrastructure, low capability for technological up-gradation again for want of financial support, marketing, and meeting international quality standards and lack of information about several of these aspects. Information asymmetry and adverse selection stare at both the bankers and entrepreneurs in equal measure.

The direct intervention in the credit market did some good, no doubt. But it has also engendered the growth of unhealthy species due to the banks queueing up for lending to some sectors that lead to avoidable portfolio risks. Banks carry the heavy baggage of as much as 30-35% in the unacknowledged sick industries portfolio. RBI Annual Reports on sickness and rehabilitation, despite redefining sickness and reformulating guidelines for rehabilitation, indicate that the banks are averse to take on rehabilitation.

While there were number of studies in the past and limited attempts on the part of the RBI resulting in formulation of certain guidelines for reviving the sick but potentially viable enterprises, they all remained largely on paper. The banks, in the meantime, as part of the reform process, have moved to revised asset classification according to which the units that fall in arrears of payment of either principal or interest for 90 days or more will be treated as NPAs. The definition of sickness in terms of the Kohli Committee lost its relevance thereafter.

The MSME Development Act 2006 and the agenda for development unleashed by the Finance Minister left an unfinished agenda that lay in tackling the sickness among the MSEs. At a time when the economy is in upswing with 9.1% growth during the current year and manufacturing sector growing at around 11-12% per annum, it would make lot of sense to base policies on solid foundations.

First, an ABC analysis of sickness should be done with treatment for the chronic sickness dealt with as incurable through legal proceedings and treatment on the basis of administrative exigencies.

The second category is one that is potentially viable and with the pumping in of oxygen for retrieval, should not be a problem. But the solution should be found within reasonable time the how and why of it should be dealt with.

The third category should be in the bracket of incipient sickness. This category should be considered for solutions that are appropriate for the unit both by the Government and the financing institutions together and the delivery of solutions should again be time-bound

Assets locked up in sick SEs should be released within the quickest possible time after identifying them as sick or potentially viable so that the factor productivity does not become negative. This is the reason for our examining the prospect of a sound exit policy with a proper regulatory framework for implementation.

Therefore, the future policy focus has to be not merely on certain key issues for sustained growth like raising total factor productivity and price competitiveness, ensuring quality standards and facilitating export growth, but also on providing a safe exit route for unviable enterprises. This calls for:

1. Basic recognition that enterprises have their inevitable failures (even the top 500 companies in the world were never the same every year)

2. The failed entrepreneurs have an urge to restart their enterprises with a new agenda or in a new shape after drawing lessons from their failure

3. It is imperative to ensure their sickness does not assume epidemic proportions; and

4. Legally, bankruptcies among the SEs would need recognition to facilitate exit route.

All developed nations have bankruptcy laws that define exit rules giving honor and dignity to failed entrepreneurs to make an honorable living. Hopefully, the Budget 2008-09 would unleash some policy initiatives in this direction from a Finance Minister who is keen to promote healthy growth of SME sector as a strong foundation for sustainable economic reform agenda.

Yerram Raju is a leading SME Consultant and Regional Director, PRMIA, Hyderabad Chapter. Reach him at or