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What govt must do to fix credit infra, bankruptcy framework, payments for MSMEs to realize full potential

By R Narayan

With India’s ranking jumping 65 places in the World Bank’s ‘Ease of Doing Business Rankings’ in the last four years, it seems India is finally gaining acceptance as an ideal destination for setting up a business or a manufacturing base. The government has introduced a number of business-oriented reforms and cut red tape in the last few years that have allowed India to climb rapidly and break into the list of top 100 nations. The target from here on is to be a part of the coveted top 50. 

While this has been an exceptional feat achieved by a country as large as India, the ease of doing business for MSMEs largely remains elusive. Our credit infrastructure, bankruptcy framework, and payment mechanisms remain crucially handicapped and need to be addressed urgently if India’s MSMEs are to realize their full potential. 

India has the largest base of SMEs in the world after China. However, Indian SMEs contribute only 8-10 per cent to the GDP, compared to 60 per cent in China. If we are to make MSMEs a hotbed of entrepreneurial activity, we will have to focus on the concerns of the Indian MSME sector through some well-thought actionable measures. 

Tackling Issue of Delayed Payments 

MSMEs face a problem of delayed realisation of their bills and receivables, particularly from large corporate buyers and PSUs, leading to liquidity constraints—a key reason for many of them turning into non-performing assets (NPAs). Since payment delays can go up to 180 days, the impact on the MSME is large and can often be the reason for NPAs. Relooking at the NPA time frame and moving it to 180 from the current 90 days would help the MSMEs. 

It would be correct to state that the government has taken significant steps towards resolving the issue of delayed payments, launching MSME Samadhaan being one of them. Over 12,000 applications have been filed by micro and small units on the portals with over 600 of them being successfully disposed of. 

Despite the fact that the MSMED Act in 2006, was set up to deter buyers from defaulting on MSME payments the onus of raising these defaults rests with the MSMEs who are reluctant to report defaults for fear of losing out on business. 

In order to facilitate a sustainable ecosystem for the sector, the government would need to quickly work towards the efficient implementation of the existing frameworks meant to tackle the critical issue of delayed payments.  

Classifying NBFC Loans under Priority Sector Lending

According to the International Financial Corporation (IFC), the credit need of the Indian MSME sector stands at approximately Rs 32.5 trillion. Despite this huge demand, out of 63.3 million existing MSMEs across India, less than 5 million have access to formal credit. A dismal reality that can be changed provided MSME loans from NBFCs are re-classified under the Priority Sector Lending (PSL). 

While refinancing of NBFCs with a focus on SME loans was considered priority sector lending in the past, the Central Government changed this classification in 2011. This change has drastically impacted lending to the sector. Adding on to that, the NBFC liquidity crisis, which hit the economy in 2018 further worsened the credit flow to Indian MSMEs. The need of the hour is an intervention to eliminate these stumbling blocks by re-classifying NBFC lending to MSMEs under the PSL tag along with providing favourable refinancing eligibility norms for NBFCs. 

Rethinking IBC’s Waterfall Mechanism 

The Insolvency and Bankruptcy Code, introduced in 2016, has resulted in the consolidation of all existing insolvency-related laws. Since its introduction, it has brought about a radical shift in the relations between debtors and creditors by formalising the process of resolving insolvencies. However, it is yet to formalize rules for proprietorship and partnership firms. A very high percentage (above 90 per cent) of MSMEs thereby are excluded from this important reform and are excluded from any resolution or exit mechanism.

Further, the waterfall mechanism, which the proceedings follow for distribution of assets during liquidation, is highly disadvantageous to the MSMEs given that they are treated as unsecured creditors under this mechanism. 

Fifth in order of precedence for pay-out of funds, MSMEs get the meagre amount post the secured creditors and employees are paid. The primary supplier of goods and services to these big companies, MSMEs incur huge losses during insolvency proceedings that ultimately might result in their own bankruptcy. To foster a favourable environment of doing business, it has become imperative for the government to make the necessary changes for placing small operational creditors at a higher priority in bankruptcy proceedings. 

With the right support and policies, the MSME sector will help achieve the target proposed by the National Manufacturing Policy which aims to increase the pie of manufacturing sector in India’s GDP from the current 16 per cent to 25 per cent by the end of 2022. It would be fair to conclude that India’s dream to compete and triumph over the top 50 countries in the World Bank’s Ease of Doing Business Index would be spearheaded by its resilient and dynamic MSMEs. 

(R Narayan is the Senior Vice President at FICCI-CMSME and Founder & CEO at Power2SME. Views expressed are the author's own.)