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Re-imagining finance for MSMEs to transform the Indian economy

“Every business starts small.”

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Our small businesses are the growth engines of the Indian economy, contributing 30% of the GDP. However, they are facing the most trying times during this pandemic.

At least 10% of micro-enterprises, 99% of India’s enterprise base, shut shop permanently post lockdown. Widespread informality and limited access to formal credit among India’s ~70 million enterprises has meant that less than 7% of India’s enterprises will benefit from the Government of India’s well-intentioned Emergency Credit Line Guarantee Scheme (ECLGS), a fully guaranteed and subsidized top loan for existing formal borrowers. Soon to be deployed schemes – fund of funds and distressed asset funds – are much smaller in scale and will likely support a creamy layer and well-established set of enterprises.

Lack of formal finance is one constraint. IFC’s report on the MSME credit gap in India suggests 70% of credit demand remains unmet among MSMEs. This gap means that entrepreneurs are unable to expand inventory, invest in machinery or upgradation. While entrepreneurs consistently speak about the impossible conditions, onerous procedures, paperwork and delays to source credit, bankers complain that many business owners are just not ‘finance ready’. This stalemate persists, and despite a significant push from the government, MSME lending remains below 20% of a typical bank’s portfolio. A whopping 65% of micro-entrepreneurs relied on family and friends for credit or grants through Covid, with many dipping into personal savings of up to a lakh to ensure business survival.

‘I borrow money from friends to purchase stock and taken gold loans to pay bills and salaries; only 20% of my customers pay immediately and over 80% purchase everything on credit’ – Small grocer in Thiruvallur, Tamil Nadu

Another structural challenge, exacerbated by Covid, is delayed receivables. Hailed as the ‘biggest problem faced by Indian MSMEs’, over 5 lakh crores, amounting to a third of MSME sales, is stuck in delayed payments from state and central public sector companies and large private companies. Low bargaining power and delays in the judicial system mean that MSMEs are essentially stuck with 17% of them writing off up to 20% of their receivables.

Amid this doom and gloom, however, age-old solutions have received a significant boost. Gromor Finance, an upcoming NBFC, for example, has partnered with deAsra Foundation, an entrepreneurship support organization, to launch a Covid recovery loan product.

“A major reason for the stalemate between banks and nano and micro-entrepreneurs is information asymmetry. While many of ~1000 entrepreneurs Gromor reached out to qualified for the ‘Sahayata loan’, many were rejected because of basic documentation – address proof, UPI enabled bank accounts etc.” – Shailesh Dixit, Co-Founder, Gromor Finance

According to Gromor at least 50-60% of rejected loan applications were because of basic documentation. NBFCs and FinTech players such as Gromor have a window of opportunity and are most likely to drive a virtuous cycle of formalization – formal credit – job growth among India’s MSMEs.

FinTech and NBFCs contribute to ~40% of new to credit borrowers, twice as much as private and public sector banks. Hence, unlocking credit flow to these ‘new age’ players is a national imperative. However, many unrated or low rated NBFCs, who typically serve nano and micro-entrepreneurs customers, and are at the forefront of India’s movement towards formal entrepreneurship, are unable to serve customers at full capacity. Therefore, both the central and state governments are only able to support a fraction of MSMEs. Several financial innovations are leading the charge in bringing many more MSMEs to the formal fold. Cluster-based financing is one example. By assessing the credit worthiness of MSMEs at a cluster level (e.g. shoe manufacturers), financiers can build a profile of ‘thin file’ enterprises through a deep understanding of cash flows, business cycles, and industry trends. NBFCs such as Aye Finance and FinTech players such as Credochain, Svakarma leverage cluster-based financing to keep acquisition costs and default rates lower.

Factoring and supply chain financing are game changers for delayed receivables. TReDS, a digital factoring platform, has over 12000 MSMEs and has cleared invoices worth 22,000 crores in the last 3 years. The ecosystem of buyers, sellers, and financiers offers a robust mechanism for MSMEs to get payment on time. However, the platform requires reform to boost the number of financiers, MSMEs, and large buyers on the platform.

A final unlock for MSMEs will be insurance. With Covid, ‘business break’ insurance has become a topic of conversation in policy and corporate circles. Given the complexity of the MSME landscape, a bundled product which starts from a universal no-frills product to add-ons that MSMEs can pay for basis their unique context will help. IRDAI recently announced that two products for MSMEs are in the works and as an ecosystem, we need to help strengthen and mainstream these offerings.

India has immense entrepreneurial potential that continues to remain underleveraged. While finance is one element to build a dynamic biosphere of entrepreneurship, the Covid crisis has brought in unprecedented urgency to reach and support MSMEs and create a comprehensive, integrated policy to promote skill development and liquidity.

Source: The Times of India

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