Micro & small enterprises produce about 8,000 products, contribute 40% to industrial output and offer the largest employment after agriculture. The sector, therefore, presents an opportunity to harness local competitive advantage to achieve global dominance in industrial production and provide even greater employment. Government policy as well as credit policy has so far concentrated on manufacturing units in the small-scale sector.

The lowering of trade barriers across the globe has increased the minimum viable scale of enterprises. The technology employed for firms to be globally competitive is now of a higher order. So, the definition of small-scale sector has been revisited with the introduction of the Micro, Small & Medium Enterprises Development Act, 2006, which includes medium enterprises with micro & small enterprises.

The challenges faced by micro, small & medium enterprises (MSMEs) includes inadequate access to finance due to the lack of information and non-formal business practices, fragmented markets for inputs and products, lack of easy access to inter-state and international markets, limited access to technology and product innovation and lack of awareness of global best practices. They also face considerable delays in the settlement of dues and payment of bills by large buyers.

With deregulation of the financial sector, the ability of banks to service the credit requirements of MSMEs depends on underlying transaction costs, efficient recovery processes and available security. There is an immediate need for the banking sector to focus on the credit and finance requirements of MSMEs.

The Union finance minister on August 10, 2005 announced a policy package for stepping up credit to SMEs. One of the salient features of the policy package included allowing banks to fix their own targets to achieve a minimum 20% year-on-year growth in credit to SMEs. The objective was to double the flow of credit to the SME sector from Rs 67,600 crore in 2004-05 to Rs 1,35,200 crore by 2009-10, ie, within a period of 5 years.

The package also suggested rationalising the cost of loans to the SME sector by adopting a transparent rating system with cost of credit linked to the rating of an enterprise.

RBI has also initiated a number of measures to increase credit flow to the MSME sector which, inter alia, includes asking all banks to make a concerted effort to provide credit cover to at least five new SMEs, speedy disposal of loan applications of small-scale units, introduction of a debt restructuring mechanism to nurse sick SME units back to health and a one-time settlement scheme for sick small NPA accounts, specialised SME branches in an identified cluster or centre, and periodic review of the flow of credit to SMEs.

While formulating its lending policy to the priority sector, RBI has included only those sectors that impact large sections of the population, weaker sections and sectors that are employment-intensive such as agriculture, micro and small enterprises. It can be seen that credit flow to the SME sector is primarily regulated and covered under priority sector lending. However, there is no specific target for credit flow to the SME sector under priority-sector lending, which inhibits increased credit flow.

State-run National Small Industries Corporation (NSIC) has initiated certain innovative measures to increase credit flow to the MSME sector, aligned with the policy package announced by finance minister. These initiatives include tie-ups with banks to meet the credit needs of small enterprises. In this direction, NSIC launched a new scheme to facilitate the sanction of loans for small enterprises by commercial banks. Under this arrangement, NSIC mobilises and forwards the credit proposals to banks for their consideration.

Despite their dominant numbers and importance in job creation, small enterprises have traditionally faced difficulty in obtaining formal credit or equity. Small enterprises are regarded by creditors and investors as high-risk borrowers due to insufficient assets and low capitalisation, vulnerability to market fluctuations and high mortality rates, information asymmetry arising from a lack of accounting records, and inadequate financial statements and business plans.

All this makes it difficult to assess the creditworthiness of potential small unit proposals. To address this problem, NSIC has a performance and credit rating scheme for small enterprises. This external credit rating is a useful instrument to assess the creditworthiness of small enterprises, create greater transparency between financial institutions and small businesses, and helps define a small enterprises position in the marketplace. This scheme is operated by NSIC through accredited rating agencies and the fee for the rating is subsidised by the government to the extent of 75%.

With the policy interventions of the government and the initiatives taken by RBI and other government bodies, it is expected that the credit flow to the MSME sector will definitely improve during the 11th Five-year Plan.

?The author is chairman & managing director, National Small Industries Corporation