Startups need a liquidity lifeline

April 16, 2020 3:00 AM

Monetisation of GST and income tax refunds will help create a liquidity cushion to India’s startups and MSMEs. This will also be amongst the largest tax reforms in terms of ease of doing business

To which, one Indian entrepreneur snarkily remarked, “and India’s first response would be to defer GST filing dates”.To which, one Indian entrepreneur snarkily remarked, “and India’s first response would be to defer GST filing dates”.

By Siddarth Pai & TV Mohandas Pai

A sense of humour is a major defence against minor troubles. Nobody has taken this to heart as much as entrepreneurs have during this COVID-19 crisis, especially as a commentary on the responses of various government bodies and regulators the world over. On Twitter, a user had remarked, “The one thing we’ve learned from this crisis is that if the Martians invaded earth, the US’s first response would be to lower interest rates”. To which, one Indian entrepreneur snarkily remarked, “and India’s first response would be to defer GST filing dates”. A few days later, India did indeed defer the GST filing, and other such compliance dates.

But, dry wit is no salve to the liquidity crisis that India is in the midst of. Ever since the IL&FS debacle in September 2018, the Indian economy has been tottering along, starved of liquidity. It caused a retraction of credit lines across the Indian economy as NBFCs, once heralded as the champions of last-mile credit, began to fall out of favour. Inaction during the incipience stage, the interim budget, and the elections compounded the festering of the crisis until it fulminated in mid-2019. The July Budget in 2019 saw the introduction of the “super-rich surcharge”—and its associated “collateral kind of consequence”, as one government official put it—which saw Rs 12 lakh crore of market capitalisation wiped out in a month. Even the historic corporate tax cuts couldn’t revive investments and spending before the double-whammy of the Yes Bank crisis and COVID-19 brought the Indian economy to its knees.

RBI’s arsenal, which has been wielded with full force at various times, failed to stem the liquidity drought owing to the transmission loss. It also failed to yield the reduction in long-term rates that were required to bring relief to businesses. The recent bazooka of TLTRO and reduction in the CRR has seen the effects of the failure of transmission come to the forefront. The liquid fund market has also dried up, with a flight to the safety of overnight funds crashing their rates. After the spike brought about the RBI measures, a rush of redemptions saw liquid funds lose as much as 20% of their AUMs since February. Some schemes have seen a cash/call ratio of -17.7%, causing them to borrow funds to honour redemptions. In a falling market, the first one to panic is usually the one who makes it out alive.

RBI, too, has acknowledged this failure in its March 27 policy statement, “Despite ample liquidity in the system, its distribution is highly asymmetrical across the financial system, and starkly so within the banking system.” Larger private sector banks have seen between 15-25% rise in their deposits, but credit growth has nearly stalled across the banking ecosystem. Even those with existing facilities struggle to get a top-up, and the loan rate cuts haven’t cascaded through the system, leading to a toxic macro-miasma of high rates, low income, and low growth. The liquid fund rout has been one of the drivers of this migration of money through the financial system.

The Centre’s finances reflect this economic emaciation as well. While countries like the US, Germany, and Japan have spent between 10-20% of their GDP in the form of economic stimuli and relief measures, the measures announced by India are only at 0.85% of the GDP. The only country with a lower measure, so far, is Russia at 0.3%. With oil at the lowest prices this century, Indian consumers haven’t seen oil prices fall commensurately as the government has raised the excise to shore up its finances. The relief measures so far have been around ensuring that India’s vulnerable population has the essentials they need to tide through the lockdown. This is a noble and much-needed move, but businesses are still waiting for relief.

On being asked about relief for MSMEs during the announcement of the economic package, the finance minister dourly responded, “We will look into it.” But, in the two weeks since the announcement, businesses are yet to find said relief. This habit of policy announcements through a thousand press conferences instead of at once leads to uncertainty in unstable times, which exacerbates conditions for the already beaten-down entrepreneur. While packages such as those offered by the US to its businesses—loans to maintain payroll that would be waived so long as employees aren’t retrenched, 30-year loans at 3.75% to businesses—may be out of the Indian government’s scope, even the easiest measure, in the form of refunds, hasn’t been tackled.

The measure of releasing all GST refunds will help alleviate the liquidity crunch faced by businesses. Thus, the lack of the same response for income tax refunds is confounding. Capping the refunds for income tax at Rs 5 lakh is a move aimed at a segment of the long-tail of India’s overburdened taxpayer. A tax refund isn’t a relief measure or a sop—it is the return of the taxpayer’s own money. The condition of Rs 5 lakh, in the business context, presupposes a revenue of up to Rs 50 lakh for those in the services space (this is due to the TDS rate of 10% for those under section 194J). The TDS rate of 10% presupposes a net profit margin of 45.45% for businesses and 33.33% for others, which is ludicrous in any business scenario except a pure monopoly. Compounded by the lack of profits in the MSME/startup space, this high TDS rate has resulted in most businesses and startups staring at huge income tax refunds, which keep piling up over time. From the beginning of the financial year in April to the tax filings in September of the subsequent year, money locked up as TDS refunds take around 20-30 months to get credited back to their accounts.

This excessive TDS, and breakdown of the refund mechanism due to the government’s fiscal situation, results in startups and MSMEs giving the government a two-year loan at 6% interest! Meanwhile, Sidbi announced a relief package of emergency loans that come at 10.5%, with a 1% processing fee, and payments in 24 instalments with the added extra of share warrants—a fine line between relief and rapacious. Furthermore, startups below `50 lakh of historic revenue, and those above Rs 10 crore have some liquidity due from either the tax refunds or Sidbi’s scheme; those in between, who grew this year, are left starved for liquidity. This “culling by conditions” approach is counterproductive to the growth of India’s startup ecosystem as up to a quarter of its fraternity—inordinately those in the early stage—become victims of the economic fallout of COVID-19.

But, modern problems require modern solutions. India’s cocktail of high systemic liquidity, low credit growth, high amount of refunds, with a stressed fiscal solution presents an answer within its own constraints. MSMEs and startups lack access to credit lines due to their size, but always have large balances with the government in the form of income tax and GST refunds. Banks don’t entertain startup loans due to their lack of collateral, and when they do, their pricing models factor in an extremely high interest rate to compensate for the risk. Meanwhile, the government’s finances don’t allow for the refund of tax dues upon computation. As a way to ensure businesses get the liquidity they require while helping kickstart lending by banks, the government should announce the following scheme:

Banks must have a scheme wherein startups have an overdraft account at 6% (the rate attached to refunds under the GST and Income Tax Act) up to 100% of their GST, and income tax refunds
These loans can be secured by the tax refunds, which can be paid into the overdraft account
Once the refund is released by the government, the loans can be squared off immediately

The monetisation of refunds will help create a liquidity cushion that India’s startups and MSMEs desperately crave. The tax of 6% makes the rate economically neutral for the startup while ensuring that liquidity is available at will. These facilities won’t end up being NPAs since they are directly linked to the tax refunds due from the government. This will also give the government relief in terms of its fiscal situation, and will be amongst the largest tax reforms for businesses in terms of ease of doing business. It will also give the finance ministry room to create a meaningful package to ensure the survival of businesses and startups. In this global age, many entrepreneurs cite the lack of support and complex frameworks as a reason to shift their headquarters overseas, making India a land of back-offices, and subsidiaries.

When COVID-19 passes—and this too shall pass—we shall see the emergence of a new global architecture. Startups and innovative businesses will drive the economy after this reset as the models they have been pioneering become the global norm. But, for India not to lose the gains made over the past few years under prime minister Narendra Modi, India’s startups need to be offered tangible relief that isn’t handicapped by excessive red-tape and conditions.

Siddarth Pai is Managing Partner, 3one4 Capital & Mohandas Pai is Chairman, Aarin Capital. Views are personal

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