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Modi govt’s Rs 20 lakh crore package is a missed opportunity for MSME credit reform

Govt’s 100% sovereign guarantee for uncollateralised MSME loans will encourage borrowers to never pay back, discourage banks from lending to them in future.

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It is a relief that the first tranche of the Narendra Modi government’s Rs 20 lakh crore economic package to kickstart the Indian economy has a very small impact on the fiscal deficit and government borrowing this year. However, it is a missed opportunity for deeper reform of small business credit in India.

Small firms are the biggest employers in India. The present package is an attempt to give people back their jobs by reviving firms when the lockdown is being eased. It is clear that India cannot afford to keep the lockdown in place, while doing fiscal transfers to the vulnerable. The end of the three-month period, for which fiscal transfers had initially been announced, is approaching soon.

Last week the government announced an increase in its borrowing programme from Rs 7.8 lakh crore, as estimated in the budget, to Rs 12 lakh crore. The additional Rs 4.2 lakh crore were barely sufficient to make up for the first Covid-19 fiscal package, the shortfall in tax revenue this fiscal year, and the shortfall in disinvestment revenue expected this year.

With limited fiscal space, the government did not announce large fiscal transfer package for the jobless based on more borrowing. Instead, it has tried to kickstart the economy by pushing money into MSMEs.

Also read: Modi govt just needs to fire more fiscal bullets, it can take aim later

100% guaranteed loan is effectively a fiscal transfer

The key focus of the first tranche of the package, announced by Finance Minister Nirmala Sitharaman, is to address the problem of liquidity being faced by MSMEs due to the lockdown.

However, the package misses the opportunity to address structural issues related to MSME credit. If anything, the 100 per cent sovereign guarantee for uncollateralised, automatic MSME loans will encourage both banks and borrowers to never return the money and to become defaulters. It will discourage banks from willingly lending to these MSMEs in the future.

Rs 3 lakh crore credit will be provided to MSMEs as automatic collateral-free loans. These loans will be for four years and do not have to be repaid in the first 12 months. In other words, defaults will happen in future fiscal years, by when the economy and taxes would have recovered allowing the government fiscal space to spend money for its guarantee.

With a 100 per cent government guarantee, the bank will not bother to chase the borrower. As such, this amounts to the government paying the banks after the borrower has defaulted. As the government does not have the fiscal space to pay MSMEs Rs 3 lakh crore today, it is giving money through banks, and will pay back these banks in the future. Banks are not lending much today, so they have the ability to implement this package. This poses no risks to them.

Alternatively, the government could have borrowed money and then directly given money to MSMEs through government departments. This would have meant a higher fiscal deficit and more government borrowing, and would have had administrative issues. In essence, it would be no different.

Also read: Modi govt stimulus should’ve focused on boosting demand, not just liquidity, analysts say

Structural issues in MSME credit

To address the structural issue of MSME credit, there need to be two key changes in the way banks lend to them. First, small businesses should be given uncollateralised loans, not just now, but also in the future. It should become a part of the way banks function. Second, they should look for good borrowers based on credit history — within their own bank, as well as with others.

In today’s situation of limited resources and limited credit availability, it is even more important that money goes to firms that are going to use it well. Banks should not want to give credit to borrowers who are expected to default. While India has focused on large wilful defaulters, it is equally important not to give loans to small defaulters — whether wilful, or even those that do not have a business plan to use money efficiently.

The first steps towards this change could have been made in the present package. First, to encourage banks to find good borrowers, the guarantee should not have been 100 per cent. Banks are risk averse today because of the fear of investigation agencies. They are not giving loans despite the liquidity being provided to them by RBI, and despite the fall in reverse repo rates that make it unprofitable for banks not to lend.

But going to 100 per cent guarantee and eliminating all incentives for banks to give loans to good borrowers is the other extreme.

Also read: India’s young people can be the corona-warriors who’ll put the economy back on track

Reforms needed

How should the present package be tweaked? First, by allowing banks to suffer some losses and assuring no investigations against them, incentives can be changed. The sovereign guarantee can be say, 50 per cent of the total MSME lending by the bank under this scheme. This way, banks have the incentive to give loans to better firms.

Second, the loans should be linked to the credit history of the borrower, and banks should be encouraged to give uncollateralised loans based on this credit history in the future. This way, the borrower has the incentive to repay the loan. If the borrower repays the loan, it prepares the ground for getting more loans later.

In addition to this, the problem of low MSME credit needs financial sector reforms. It requires the development of a bond market which can cater to the financing needs of larger firms. It requires a competitive banking sector in which banks chase borrowers to borrow, based on their ability to repay rather than public sector banks being mandated to give Mudra loans.

It requires a Resolution Authority which can monitor and sell off a badly managed bank before it collapses, causing pain to its depositors, borrowers and some hapless public sector bank that is forced to buy it.

Hopefully, the government will use the present adversity as an opportunity to bring these deeper structural reforms back to the table. As it is sometimes said, never let a crisis go to waste.

Also read: Why India’s rural economy stands to gain after the lockdown is lifted


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  1. Sir, mai bank mai gaya tha lekin muje bola ki 20 lakh ka sabhi tak kuch nhi aya hai to kab tha sir ……Kya kare hm log kuch nhi path raha bank nhi lon

  2. I am the poor and migrated people…now i want to some money…due to family maintanance

  3. I have a question. How do banks finance large industries? Do they insist on collateral security for a part or complete loan amount? The Author is quite correct in the matter of MSMEs. But what about big borrowers?

  4. There are few more issues & ways around that too.

    The money could flow back to the ruling dispensation through the political donation bonds. A % leak there and no pay back – even if it is 10% of borrowers is huge. And total lack of who donates what in the political donation bonds is definitely an issue.

    Second, a totally gov guaranteed loan is not even necessary. If has to be done, the gov could have said atleast 50% of monies can be used only or salary and thus put money in the hands of consumers (and multiplier effect) rather than all go to capital expenditure; and the other investments have to come from promoters pockets. Or give a equity to the employees of such MSME in some way or fashion to get them a skin in the game and incentivise the workers to strive.

    Whats the definition of the capital/turnover – over what time frame? Invest 1 c over 2 years? in 6 months? 1Q? The devil is in details.

    How do you prevent a big corporation – Reliance or TVS group of Bajajss from floating multip,le MSME and pocketing money?? What are the checks and balances to ensure that it is genuine MSME and not multiple MSMEs of a big holding corporation?

    For traceability of the money is a concern and definitely a concern because of wilful transfer, personal expenditures masquerading as investments (foreign travel as partner visit for example), etc. make it all a app based – each MSME to install an app – if ArogyaSetu can be mandated, why no this – and remove any f2f interactions for favoritism etc. Then mandate that all disbursals of this money should be electronic via UPI. Trace each and every rupee . Go digital completely for this quantum of money.

    Mandate that they should go to private or public equity marker in 2-3 years to prove to market and generate equity to pay back the loacan. If not some other alternative.

    Mandate that one of the core family member of the MSME promoters always have to be India till loans are repaid?

  5. But Ila, I am sure if the Government wants it will have enough elbow room to recover the loans from those MSMEs who can pay….MSMEs still file annual reports, GST returns…etc…… a going concern can’t vanish into thin air. Ii is another matters if some MAMEs just want to eat away the loan and wind up….
    I think you are missing a point here..

  6. Govt’s 100% sovereign guarantee for uncollateralised MSME loans will encourage borrowers to never pay back, … this is not new, already happens in Agriculture (aka Loan mela)

    More importantly proprietors of MSME’s will just use the loan for consumption

    • MSMES are not undocumented farmer….MSMES are going concerns filing regular returns with the Government.

      Ii is another matters if some MAMEs just want to eat away the loan and wind up….
      I think you are missing a point here..

  7. Only thing that will work is what Rahul Said last elections. Give 6000 every month to the bottom 50% for two years. That is how demand will grow.

  8. It would be very unfortunate if small businesses – which often pay high rates of interest while borrowing from informal sources – treat this three trillion as a giveaway. Conditions in the economy are tough, something they are aware of while taking the loan. For their part, having an inventory of honest, credit worthy borrowers is part of any bank’s normal functioning. With or without government guarantee and even if the lending is directed in the form of MUDRA, the branch should conduct its due diligence.

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