Fight the good fight against Covid-19

The Economist in its latest edition titled ‘Dropping the Ball’ rightly mentions – “Talking down the issues is not winning strategy.” India with a population of about 130 crore has around 100 coronavirus cases and two deaths. The awareness created by the Union and State governments and the proactive prevention and curative measures, coupled with friendly hot weather in most parts of the country barring up-North, have stood in good stead.

But it is unfortunate for a slow-growth economy where inflation is down and IIP up that this new scare has caused market mayhem pulling it down to pre-1930 levels. Several weaklings and numerous of MSMEs could see the prospect of unpaid bills. It may be difficult for them to keep the labour engaged with obstructions to the moving machines, more particularly, the export-led ones. Time to seek way out is right now and not later.

Paid Sick Leave

Will it be possible for India to take the call of US democrats – notwithstanding its total unpreparedness and niggardly health system – “paid sick leave rules, expanded payments for programmes like unemployment insurance and the nutrition assistance, and guaranteed payment of all testing and out-of-pocket costs”?

In fact, McKinsey’s March 9, report, anticipates that the global GDP growth in 2020 could fall as deep as -1% to -1.5% even if socio-economic impacts get localised and effective and timely countermeasures are initiated.

A large number of NRI families in several countries — Middle East, UK, US, Canada, New Zealand just to cite a few — are all dependent on imports for their essential food requirements. China and India have been their source. Now that the flights have stopped; visas have been cancelled, and even local movements in several nations restricted, the information is that all big malls like Lulu, Walmart, etc, have even emptied their stocks!

Rising Unemployment

The 73rd NSS 2015-16 mentions that 110 million were employed in the MSME sector. This is despite the sector’s inhibition to disclose the actual number employed for saving regulatory costs and the countless contract labour engaged to keep themselves afloat in the market competitively. According to the RBI Governor, around 50% cent of the total MSMEs operate in rural areas and provide 45 per cent of total employment. Therefore, industrial hygiene needs to improve significantly.

Micro enterprises, which account for 97% of the total employment in the MSME sector, in the context of Covid -19, faces most of the heat. Even if banks have restructured or revived them in the recent past, they should be given further restructuring by way of reduced instalments elongated dues in their working capital accounts.

India is uniquely fortunate thanks to the hot climate catching up down the Vindhyas and in a month even the North would see about 30 degrees. Moreover, with adequate stocks of foodgrains, starvation will be afraid of staring at us unless we mismanage public distribution. Opportunity awaits the MSMEs but their preparedness needs unstinted support from the lenders – be it banks or NBFCs.

Active Banks

Banks cannot be sitting ducks talking of collateral security and failing to convert risk into reward at the right time. Industry associations should aggressively put their strategies in position and rebuild trust between their member entrepreneurs and lenders. The time is for more leg work; more buyer-seller meets; more enterprises must adopt affordable ERP and move to digital platforms because these platforms alone enable speed of transaction and delivery.

Second, they should also be handheld for capturing the local domestic market to the maximum extent by coordinating with the State government concerned under the public procurement policy. The unmoved stocks thus should be quickly turned into cash.

MSMEs should be made not merely preferred creditors under IBC and NCLT but should also get at least 75% of the pendency cleared within 30-60 days of accepting the case on merits. Third, the moratorium period for the new MSMEs and restructuring in manufacturing should be extended by six months to ward off project and cost overruns.

The MSMEs financed by the NBFCs and digital payment platforms should quickly reassess the status of the loans from a practical point of view by speaking to the entrepreneurs concerned to resolve any payments likely to get stuck due to Covid-19.

Worst Hit

The services sector, where the banks and NBFCs lent heavily under retail market and MSME (services) portfolios, would be worst hit. Training-led conferences and seminar-dedicated institutions, which run mostly on promised payments from their hosts, would renege on payments as they are either not held or least attended.

Here, along with the earlier manufacturing MSME credit, it is important that the RBI quickly takes corrective policy decisions and guide banks, financial institutions and NBFCs to postpone NPA thresholds to 120 days and review the position at the end of April, 2020.

Banks beleaguered as it is due to unsustainable NPA levels would be worst hit if Covid-19 impacts their assets right away. Globally, central banks are already ahead of the curve in providing relief to the financial sector both through the zero/least interest rates for bond and credit markets and even Basel may be moving in some unusual remedial stand.

“One scary thing facing us is demand contraction. People will buy only essential goods. New purchase orders will drop further. Payment cycles will get disrupted. Job losses are ahead. All this could be a possible fallout of coronavirus. Also, the loss of GDP may be equivalent to one month of GDP,” says Sameer Kochhar of Skoch Group. But production cannot stop if employment is to be preserved and future demand is to be adequately met.

‘When winter comes, can spring be far behind’? Next monetary policy, notwithstanding comfort on inflation headwinds, could see a rate cut. At least the Chief Economic Adviser asked for it!

MSMEs Need Cash Flow Based Finance

Cash Flow Based Finance to MSMEs:

The Need and the Deed

Access to finance is the Achilles Heel of the MSMEs not just in our country but entire world. U.K. Sinha Committee has recommended cash flow based finance (CFB) as the best possible way of resolving the working capital issues of the sector. The term simply means that the finance starts with cash-in to cash-out, normally referred to as the working capital cycle by the lenders.

This is a form of financing in which a loan is backed by a firm's existing and expected cash flow. This loan is very different from asset-backed loans where the collateral of the loan is based on business assets. The repayments are going to be based on business-projected cash flows. The debt covenants of these kinds of loans are focused on manageable levels of interest rates.

Charting the cash flow helps in entering the fixed costs, operating costs, accounts receivables and existing accounts payable into the future weeks/months realistically.

It is important to understand that financing cash flow is somewhat unique for each business depending on the industry, business size, stage of business, model size, owner's resources, among other factors. It is therefore important for each enterprise to assess its resources of financing cash flow: owner investment or equity; government incentives and remittances; inventory financing, trade financing, deposits on sale, receivable discounts, factoring, or purchase order finance etc.

Several MSMEs do not have uniform flow of cash for doing their business throughout the year. It is set with lows and highs in the stream. If they want to buy the raw material when it is available at low price, it needs storage space and lender’s tolerance for high stock. Unmoving stock is always viewed with suspicion. Whenever the turnover is low, the firm faces stress because it cannot afford the luxury of unloading the excess raw material.

Whenever the finished goods are not rolled out, it can be for a variety of reasons: either the buyer is not satisfied with the quality specified at the time of order; or the buyer is starved of resource to buy at the time of receipt of goods or he has himself shifted his line of activity and therefore, trying to find fault with the product somehow to escape his obligation. Payments get delayed. There are also number of cases where the payments are delayed even after acceptance of goods. If the goods are not returned within the specified period of contract, it will be deemed acceptance after that period is over.

If the contractual relationship between the buyer and seller that is invariably conditioned by the provisions of the Indian Contract Act, comes into dispute, the amount gets stuck under litigation. MSMED Act has provisions to tackle delayed payments under MSME Facilitation Council but has been ineffective. Therefore, at the tail end of production, where the sale occurs, the cash gets stuck.

E-marketing that is fast making inroads through institutions like Amazon, Flipkart, etc., and e-invoicing that is getting popularized through GEMS and TReDS are yet to significantly change the fate of manufacturing MSMEs.

Several MSMEs, pre-GST were indulging in buying raw material in cash and selling finished product in cash. This simply means that they have been bypassing the lenders’ books. This unorganized way of business is gradually transforming with GST introduction, notwithstanding several issues locked up in GST dispensation itself. It is expedient for an enterprise to have a revenue-based financing program to ensure that cash flows are not hurt for want of a loan from the bank/FI.

It is very easy to lend on cash flows for business enterprises right from the flower vendor or vegetable vendor to a trader dealing in gas cylinders or furniture. Same can’t be that easy if one would like to fund the cash flows of a manufacturing enterprise. This segment can also afford higher interest for their loans as they invariably pass on the interest to the buyer through sale price. If they want to offer competitive price, they indulge in discounts.

In other words, the cash conversion cycle (CCC) of MSMEs has many aspects for the lender to understand. This requires (1) change in mindset of the bank field staff, managers and (2) continuous follow up of the cash flows systemically with a consent-based ERP architecture. MoMSME that offers ZOHO ERP book free of cost to enterprises with turnover of Rs.1.5cr could increase the threshold to Rs.5cr. The initial cost of such shift could result in transforming 55-60 percent of the micro and small enterprises getting into organized finances when CFB lending becomes reliable data based and data monitored lending. Data itself will be the security. Its credit rating and collateral is either not required or based on movable short-term assets such as inventory, floating debentures (for limited companies), debtors etc.

Cash is the king. It is cash that repays the loan and not collateral as the latter takes enormous time, cost and effort to repay a facility. Documentation is also simple: in the form of invoices issued by the enterprise; sales records; supplier and customer references in addition to a thorough interview of the enterprise owner. It may be necessary to crosscheck with the suppliers the invoices provided. All this simply means that in CFB, banks should spend more time with the entrepreneur and they don’t have the wherewithal to do this now.

While the RBI has been working on Public Credit Registry the way it captures the data, the veracity and verifiability of the data it captures and ease with which it becomes accessible would make firm data itself as collateral for the banks and FIs.

The writer is author of ‘The Story of Indian MSMEs’. The views expressed are personal.

Published in the Hindu Business Line, 12.03.2020: www.thehindubusinessline.com

Hopes, Aspirations and Disappointments - Union Budget 2020

Hope, Aspirations and Disappointments

Nirmala Sitaraman starts on Aspirational Note. The two hour forty minute long budget speech creating record could perhaps prove the dictum: ‘if you fail in logic resort to rhetoric.’ Let me deal with the hopes and aspirations first and then with the disappointments later.

It has for first time addressed the farm sector comprehensively providing end-to-end solutions but leaves no assurance for income in the hands of the farmer. Allied activities get a boost. If a farmer were to hold a few animals in the backyard, a fishpond and a small poultry in addition to crop farming or horticulture, he has everything in the budget to cheer. There is every chance to cross-hold risks among the farming and allied activities.

States should follow the intent and modify the Agricultural Marketing laws to make way for the responsible aggregators and technology. Warehousing facilities in the Agriculture Market Yards and cold storage facilities would insulate the farmer from fluctuations in returns to the farm produce.

FM has announced Rs.15lakh farm credit amidst unwelcoming banker in the rural areas and banks that have learnt the art of showing up in figures that they do not deliver to the intended customers. It is heartening to see the push for Primary Agricultural Credit Societies that were almost forgotten for decades. NABARD that has half of its fleet serving Mumbai Headquarters should have been restructured for focused attention on farm credit. She should have forsaken tolerance for not achieving priority sector targets to take the RIDF window. This is a lost opportunity.

While the erstwhile lost focus on Education, Health and Hygiene has been regained with appropriate budget allocations and set a new direction through internships in higher education, unless infrastructure for primary education and teaching skills are enhanced the foundations will remain weak. Introducing internships in higher education has potential to make education fit the employment bill. We may hope for a correction through the National Education Policy the Government is planning to introduce.

The District Teaching Hospitals and para medical services planned will sow the seeds for sustainable health interventions. This just marks only a good beginning as the effect can be felt only after five years.

With the measly allocation for MNREGS and not linking it to the farm sector the budget left a void. It failed to kindle the appetite for consumption, the trigger for growth. The consumer is not left with much surpluses either for increased investment or consumption. Growth impulses are not generated significantly.

MSME sector has got a new direction with the introduction of sub-ordinated debt or equity funding but it remains to be seen whether the Banks that failed them in credit would meet the new equity route and help scaling up process. TReDs and GEMs are not new interventions to talk of. Unless all the government departments and PSUs enroll on these platforms, MSM|E vendors would not get their due. For those moving to organized way of doing business with just 5% in cash are exempt from audit up to Rs.5cr turnover.

In the last budget, the FM made a reference to U.K. Sinha Committee Report, but she skipped it now. Neither Distressed Asset Fund to ensure that no viable manufacturing MSME downs its shutters, nor Fund of Funds found allocation in the Budget. In a slowdown, it makes lot of sense to ensure that no viable manufacturing MSME exits so that the workforce engaged therein would not add to the unemployed. 

Economic Survey 2020 made a very detailed analysis of the banking in the financial sector. FM did not seem much worried over the increase in frauds and poor credit risk of the Banks. Although it is heartening to see that no further capital allocation is made cutting into taxpayer’s purse, it is disappointing to see the absence of reforms in this sector. It would have been most appropriate to reduce the Government equity in these banks and usher in better governance than now. Bad banking and good economy are not good companions.

Banks irrespective of their size, in the current status will pull down the growth of the economy. The only solace is to the depositor whose Rs.5lacs is insured instead of just a lakh of rupees thus far. NBFCs are empowered to recover their bad debts through the SARFAESI Act provisions on par with Banks.

Extraordinary push to the digital economy with District Cyber Parks, AI, MML and ITES in addition to Travel and Tourism is likely to enhance the contribution of the Services sector. Start up, Stand Up India and Make in India have not thus far led to increase in the contribution of manufacturing sector and this budget also did not make significant strides to reverse the negative growth. Telangana State seemed to have provided inspiration on this count.

Agriculture sector alone may not reverse the slow growth of the economy. Employment intensity has little scope to increase. Unless 20% credit -GDP ratio is attained with better risk appetite among banks, recovery from slow growth is doubtful.

If both the government and private entities depend on market for raising the resources as indicated in the Budget, revised estimates of the budgeted revenues and expenditure fall short of growth expectations. The Budget failed to institute a monitoring mechanism for implementation of the ambitious projects. States should be taken into confidence while formulating the Budget as it is the States that should catch up and cooperate for the aspirational goals and ambitious announcements to turn into actions.

Intention of the FM to keep more money in the hands of the people did not result in compatible actions. Overall on a ten-point scale the Budget scores a liberal six, more due to comprehensive treatment to the farm sector than other sectors.

Published in Telangana Today 5^th February 2020.

Uion Budget 2020 worrisome

Hardly the time for a tight fisted Budget 2020-21

FM in her second year of budget presentation has very unenviable task in performing a balancing act. GST revenues are looking southwards and the input tax credit, the key for success of GST is mired in data upload controversy and hostile inverted duty structure. Markets do not seem to worry about this going by the forward movement of indices, blowing against the wind.

PSBs absorbed all the capital that the government buffeted and yet did not perform. On top, some banks have acquired the notoriety in manipulating balance sheets. Frauds have surfaced like never before to Rs.71,543cr – a rise of 74% over the previous year in the financial sector. NBFCs too joined the cry for capital or regulatory relaxations.

Through legal process – IBC, SARFAESI Act, DRT and Lok Adalats, 14.9% in 2017-18 and 15.5% in 2018-19 is the amount recovered out of the claims lodged. Recovery through IBC at 42.5% is the highest, while it is 3.5% through DRTs, the lowest, according to RBI -M&M Economic Research.

No economic recovery will be possible with a crippling banking sector like the one we have today. Some Banks having Insurance and Mutual Funds are still entrusting targets under these subsidiaries to the regular banking staff taking away their productive time for selling banking products like deposits, credit and digital services.

Creating demand in rural, semi-urban, and urban areas would occur when the people have enough money in their hands. Credit has not moved in tandem with the demand from farmers and MSMEs in manufacturing. RBI doing its job by reduction of 135 basis points in the base rate has no spread effect in retail lending market as there is no risk appetite among banks.

Knowledge in banking products and services has come down significantly among line staff and this is the reason for credit origination risk escalating to failure in repayments. Capital infusion without rectification of the basic malaise and governance, will not address the problems.

Why worry about fiscal deficit when the denominator GDP has many undisclosed data escaping entries? Several economists make mountain of mole hill while speaking about fiscal deficit. Right from the Union Finance Ministry to the regulators, all converge on the fact that the slowdown of the economy is real and need demand boosters. There were occasions when we reached around 6-6.5 percent (2008-11) of GDP and the economy registered growth thereafter.

The worry on employment growth is real. Unemployed youth hitting the streets would exacerbate the security risks. Industry, despite the skill development initiatives, bemoans that they do not find the right persons for the right job.

Sector-wise, agriculture grew 2 percent while manufacture showed less than 1%. Make in India, the flagship manufacturing initiative has not shown uptick during the last four years in continuum. Services sector too is showing decline.

Priced education and health have made increasing demands on the government. Several States and Union Government have schemes like Arogya Sri, Kutumba Sri, Ayushman Bharati etc., and yet their reach to the intended is still facing issues in payment for the services to the hospitals. Affordability is still an issue.

What should be the measures in the budget to boost employment? Which sectors need focused attention from such perspective by way of fiscal incentives? How can the States be brought on the same page as the Union Government?

The slowdown is both cyclical and structural. There should be consensus between the States and Union Government on the way forward. Union Government should release post-haste all the payments for the pending works under MNREGS.

Several States and Union Government have huge arrears to suppliers, contractors and sub-contractors for several project works that has choked the bank working capital releases and all these payments should be released to the last pie.

The paltry pension to farmers at Rs.6000 per annum should be altered to Rs.12000 per cultivator whereby even the tenant farmers would be eligible for pension payment after 60 years. Since the scheme envisages payment by the farmer between 40 and 60 years of age his/her contribution, several farmers who are of 60 and above right now, would not be benefitting from the scheme. The scheme should benefit those who are above 60 now. Adequate budgetary provision is necessary.

Budget allocation for health sector should significantly go up to a minimum of 6% of the total outlay from both the States and Union. Health infrastructure is pretty poor and needs improvement.

Education budget should target universal education up to Class 12 and this happens when teacher pupil ratio significantly improves, and school infrastructure also improves. National Education Policy shall indicate the prospect of resource allocation as well.

Ensuing Budget should convert intent into actionable allocations in the critical sectors and lay a path firmly for cleaning up the banking sector. Frustration should not be at the breaking point.

Published in the Hindu Business Line, 3.1.2020

www.thehindubusinessline.com

Enhancing Competitiveness of MSMEs in Slowdown

Strategies for enhancing Competitiveness of Manufacturing MSMEs:

Muted manufacturing with PMI just around 51, a fall from about 54 almost couple of years back, increasing protectionism of the US, UK with the BREXIT winning a thumping majority for Boric Johnson and global trade winds heading to recession have taken the toll of India’s growth story. Industry would face more challenging times than before due not merely to adverse headwinds on external trade but the turbulence in the domestic economy. Enhancing competitiveness for manufacturing firms in the small sector has several challenges and these can turn into opportunities for growth.

Inefficiency, increasing fraud rates and faulty Bank Balance sheets of almost all the major Banks in India compounded the woes of domestic debt markets. No surprise that the equity suppliers like the VCs and Angel Funds are distancing themselves. The impact is the most on the vulnerable – MSMEs, particularly in the manufacturing segment. The thriving or successful even in this current environment are those SMEs in the Defense, Aerospace, Gems & Jewelry, pharmaceuticals and a few agro-industries linked to market giants like the ITC.

Nobody can have a guess of how many MSMEs shut their shops due to the Banks’ unwillingness to revive despite the RBI and GoI instructions as no ‘exit’ statistics are captured. The corporate sector exits alone show up in the data because the Ministry of Corporate Sector statutorily demands it and IBC has become a barometer for industry and financial institutions’ health.

Banks never gave data on number of units financed or closed but only number of accounts. Each unit can have number of accounts: term loans for specified purposes; working capital – cash credit, overdraft, SME Plus, etc., and unfunded limits like LCs, Guarantees etc.

Since 98 percent of the MSMEs are either partnerships or proprietary and are linked to onetime registration on Udyog Aadhar, there is no way the closed shutters get into the data. Even the industry and trade associations do not get a wind of the closures as several so-called members are irregular in the payment of membership subscription annually.

This scenario leaves the policy maker to public noise and a wild hunch. Every State is concerned about improving the ecosystem for the MSME sector and more in conjunction with the Union Government. States do know that a robust MSME sector is a red carpet for the global investors. However, improving the MSME competitiveness remains the biggest challenge and it requires a more holistic approach than now.

Information asymmetry and adverse selection continue to be the biggest blocks for institutional interventions, both financial and non-financial. Several MSMEs complain of a serious setback due to demonetization and GST. The reasons for such a far cry should be seen in the advantages they got without them: cash sales not routed through the bank accounts and yet several MSEs thrived until their debtors ditched them; inventories over-invoiced could get into the recorded working capital cycle with banks as the banks have been going by what is shown to them instead of what they should see and count for want of field visits; there have been many qualified ‘account experts’ to show the convenient excel spread sheets for securing working capital limits from banks; the small volumes these enterprises produce and the small size of the firms have also distanced them from the reach to markets; and there have been very few mentors and counsellors to advise responsibly either from the financial institutions or others to advise the units right financial discipline would get them all the gains they are looking for as also their entry to new markets.

GoI on its part, unleashed MUDRA, SME99Minute Loans and whipped up the Shamiana Camps that could give the lever to the FM to announce that the Banks sanctioned 8lakh loans amounting to Rs.70000cr in just two months, which they could not do for years!! Future NPAs would show the unknowns and unseen among such crowd. Dy. Governor, RBI recently sounded the alarm on the growing MUDRA account NPAs.

MSMEs on their part should earn their right to grow by following best accounting practices. Working capital management basically rests on four important factors:

•       Predictability of Cycle

•       Material flows

•       Receivable – overdue

•       Independent Credit rating agencies’ assessments.

Some more essentials are set out below:

(i) Realistic Assessment of Morale Building Assurances: MSMEs would be well advised to cautiously assess morale building assurances during the current slowdown of the economy. MSMEs which accepted such assurances in the backdrop of global recession of 2008 and built up capacities and kept up production levels, resulting in very high inventories, were devastated. Furthermore, when demand for a product falls, there could be pressures on small enterprises not to cut output as this would eventually result in labour lay- offs. Units that accepted such suasion faced disastrous outcomes.

(ii) Capacity Expansion: Quite often, MSMEs come to the erroneous conclusion that their product would experience an unrealistically high increase in demand. Units which build up capacities on tenuous information invariably end up with serious problems. In a savagely competitive environment, it is these small units that end up in ‘fire sales’ which are available to buyers at attractive prices. There is merit in building up financial resources to avail of such opportunities rather than increasing the capacity of their existing units. It is time to realize that coopetition would bring better synergies among similar producers to meet up with temporary surge in demand.

(iii) Interest Rate Cycles and Excessive Dependence on Bank Credit: During the expansionary phase of the credit cycle, banks are only too willing to lend but during the downturn small borrowers are invariably the first casualties in being denied additional credit. As an abundantly prudent measure, MSMEs are well advised to seek bank credit essentially for inventory financing but be very cautious when using bank finance for capital expenditure. Excessive borrowing for capital expenditure generally puts MSMEs in to distress during cyclical movements in the economy. It is good to learn to build equity gradually from out of the revenues and avoid excess leverage. They should learn to conform to financial discipline when alone they will win the trust of investors. Strategic partnerships are best bet in times of stress and not overindulging in debt. It is good news for the MSMEs that Government of India has extended the Interest Subvention Scheme up to March 2021.

(iv) Importance of an Appropriate Exchange Rate: MSMEs account for about 40 per cent of exports. It is unfortunate that there is a widely held perception that a strong rupee exchange rate reflects good macroeconomic management. This is clearly erroneous. Large industry is generally import intensive while small industry is export intensive. Hence a strong exchange rate of the rupee (i.e. an overvalued rupee) helps large industry and hurts MSMEs. It is not as if the exchange rate should be excessively undervalued. As a rule of thumb, over the medium/long-term, the nominal exchange rate of the rupee vis-à-vis the major industrial country currencies, should be adjusted downward based on the inflation rate differentials between India and the major industrial countries. An overvalued exchange rate makes MSMEs uncompetitive in international markets. MSMEs should not attempt to be forex traders; they should concentrate on their own line of production.

As a staunch optimist and believer in the excellent capabilities of MSMEs in innovation, incubation and future growth, least expensive handholding, mentoring and counselling as process consulting tools have immense scope to become highly competitive both domestically and globally if certain synergies are built into the system. Telangana Industrial Health Clinic Ltd has adequate capabilities in this exclusive portfolio of handholding, mentoring and counseling as a preventive and stress relieving measure.

Supply Chain to Value Chain:

There is need for building ‘pools’ or aggregators to gain both cost advantage and brand image through co-branding of products.

India Mart are trying to do supply chain aggregation. MSME online Bangalore is also trying to evolve an ecosystem where a lot of questions of MSME are getting answered by about 50 consultants and they have started CEO Club for taking MSME entrepreneurs to next level by having a monthly meeting. Jeevan is trying to develop a 360' view for developing the ecosystem in Hyderabad on Hub and Scope model. These are welcome initiatives, no doubt. They need traction.

Many of the user population should not merely know such initiatives but should also know how best to access them. Second, by aggregators, I mean those that are fully capable of building a common brand for a set of products from the micro and small manufacturing enterprises through building also their capacities and capabilities to rise above their existing levels, introduce those practices and technologies that make them closer to the global standards even if sold in domestic markets and secure price at their doorstep within the promised wait-in period. These would mean investment on the part of aggregator and a price that the aggregator should legitimately get for such services without losing the competitiveness in the market. Ipso facto, it would mean that at the firm level, cost reduction should take place at each link in the value chain. There are different ways of doing it.

The Industry Associations can develop a Marketing Arm and establish net linkages with e-commerce players; 2. they can help the industry avail the host of incentives waiting to be used from the GoI-MSME schemes; 3. they can establish linkage with NSIC, MSME-DI and such other institutions. 

MSMEs should earn their right to grow. This happens only when they are quality conscious where precision, functionality and producing premium products will be their driving forces. Their passion and pride rest on satisfied customer. Intellectual property rights, improved technology processes and getting equity to fund such technologies are all their sustainable future. Employee retention strategies depend not just on higher remuneration but on building trust and social cohesion as also gender equity.

MSMEs should also realize that death is a process of development. They must know when to exit from the enterprise and how. Strategies to clear sovereign dues and realization of overdue creditors on a mission mode pre-exit have a clear role. Ignoring them will be suicidal.

*Author of ‘The Story of Indian MSMEs: Despair to Dawn of Hope’ (2019) is an economist and Adviser, Government of Telangana, Telangana Industrial Health Clinic Ltd., Hyderabad (www.yerramraju1.com)

https://www.moneylife.in/article/enhancing-competitiveness-of-manufacturing-msmes-i/58932.html 18.12.2019 and 19.12.2019

Rating the Ratings is imperative

CREDIT RATING – YET AGAIN ON THE BENDING MAT

It is three decades since CIBIL rating has commenced its operations and a decade since Brickworks has started. We also see the frequent sovereign ratings of Standard and Poor, Ind-Ra (Fisch) and Moody’s. Very recently, Nirmala Sitaraman, in the wake of serial failure of well rated corporates – eg., DHFL, IL&FS, and several other PSUs as well as Private Companies, mentioned her serious concern. Sovereign ratings are also not infallible. This article would like to see the present status and suggest the modifications.

Credit rating agencies (CRAs) are expected to play an important role in mapping the risks in the financial system. They facilitate investment decisions and can help investors in achieving a balance in the risk return profile. They assist firms in accessing capital at low cost. Allocative efficiency of capital across the sectors, and appropriate risk pricing would be the gain to the economy. Information asymmetry to an extent is resolved.

“A credit rating is technically an opinion on the relative degree of risk associated with timely payment of interest and principal on a debt instrument. It is an informed indication of the likelihood of default of an issuer on a debt instrument, relative to the respective likelihoods of default of other issuers in the market. It is therefore an independent, easy-to-use measure of relative credit risk.”[i]

If a bank chooses to keep some of its loans unrated, it may have to provide, as per extant RBI instructions, a risk weight of 100 per cent for credit risk on such loans. Basel regulations provide for supervisors increasing the standard risk weight for unrated claims where a higher risk weight is warranted by the overall default experience in their jurisdiction. Further, as part of the supervisory review process, the supervisor may also consider whether the credit quality of corporate claims held by individual banks should warrant a standard risk weight higher than 100%.

The working of the entire rating system was questioned after the sub-prime crisis resulted in collapse of not just Fennie May and Freddie Mac but even UBS Credit Suisse, Citi group, Deutsche Bank etc. This led the US Fed and the Wall Street to revamp the entire rating mechanism after a careful study of the processes they followed and the measurement they gave to different parameters. But such changes are not followed uniformly across nations.

Theoretically, internal credit scoring models are effective instruments for the banks in loan origination, loan pricing and loan monitoring.  But the banks’ rating architecture is different from the rating agencies and this is one of the reasons for the regulator to insist on a rating review mechanism to be part of the Banks’ Credit Risk Management Committee. 

The rating process involves assessment of Business Risk arising from interplay of five factors: industry risk; market position, operating efficiency, financial risk and management risk. While industry risk and market position can be assessed from the macro level data, operating efficiency and management risk can be captured by observation, frequent interaction and experience. Unless cross functional, sectoral, trade data from all sources is available on digital platform and that too verifiable easily, the rating agencies are bound to err.

As per Basel II (2000): “An Internal Rating refers to a summary indicator of risk inherent in an individual credit. Ratings typically embody an assessment of the risk of loss due to failure by given borrower to pay as promised, based on consideration of relevant counter party and facility characteristics.  A rating system includes the conceptual methodology, management processes and systems that play a role in the assignment of a rating.”  Understandably, there was a collapse of the rating instrumentality looking at the collapse of the corporate credit and investments almost without notice. 

One of the common failings noticed by informed circles, for example, has been, a firm that owes to MSMEs beyond Rs.2lakhs should have been rated lower than those that would have paid promptly. Most corporates both PSUs and Private Companies were chronic defaulters and this came to surface more prominently in all the NCLT-dealt with cases. Second, poor governance should have got bad rating. Including Banks, PSUs and Private Companies fare badly and yet got good ratings!!

Ever since the Rating is mandated by the RBI while extending credit, we have seen phenomenal failures in the well-rated corporates both in the private and public sectors, e.g., DHFL, IL&FS. SMEs have no option but to get the rating of one or the other agency and yet, the Bank concerned would have its own rating that would decide the quantum of credit.

Measuring policy risks, sovereign risks and governance risks is the major challenge and this challenge has become visible in the recent corporate rating failures. Banks severely compromised by pitching high on CIBIL ratings and particularly, the individuals and Directors of the Companies. The thirty-year old CIBIL needs to amend its ways if the ratings book should be cleaned.

Technology disruption, easy regulations governing payment platforms, data on merchant performance, changes in consumption patterns, differential product regulations across the nations for similarly placed products and increasing protectionism are all the new risk areas for capture by the CRAs.

In so far as Indian financial sector is concerned, consolidation following the merger of PSBs, failure of NBFCs, Urban Cooperative Banks, and the lackluster performance of the MFIs, metrocentric banking are all new challenges to the CRAs. Telecom regulations and their interface with the payment and settlement systems, Internet of Things, Blockchain technologies are the new disruptors and even moderate margin of error can impact heavily and the rating can collapse. Further, product regulations have also become dynamic. In a way, all these aspects seem to have their shadow cast on the rating instrumentality as a risk mitigant.

There is therefore an imminent need for a High Level Committee of the SEBI, RBI, PFRDA, IRDA, and Telecom Regulatory Authority to examine the methodologies of CRAs for a more reliable rating process and pricing of rating agencies.

*Dr. B. Yerram Raju is an economist and risk management specialist and can be reached at yerramr@gmail.com Also see my blog on the subject June 11, 2011

Published in the Money Life on 28.11.19

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[i] Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, Ministry of Finance, Corporate Affairs Division, December 2009

Negotiating a Loan during Slowdown

Ten-Point Recipe for Loan Negotiation with a Bank in Slowdown

Most first generation entrepreneurs, CFOs and CEOs of mid-corporates find it tough to negotiate a business deal with a bank. Banks usually are tight-fisted in times of recession to grant enhanced limits. They also claim full information of the enterprise, ecosystem in which it operates and the depth of the export markets. They also have a track record and credit record of the enterprise seeking to expand its operations. Economy in slowdown is tough time both for Banks and Enterprises. One has to run twice the speed in slowdown to remain where they are like Alice in the Wonderland.

Exacerbated NPAs despite the IBC have made Banks risk averse. Increase in frauds further accentuated risk aversion. The enterprises requiring higher working capital and those in export markets requiring packing credit facilities are facing formidable challenges. However, Banks may not like to lose good clients. Further, particularly those in PSBs, are also under pressure from the government to expand the portfolio in farm and MSME sectors.

Banks also actively work on the recoveries, write-offs of NPAs and topping up their Balance sheets. They are under pressure on the Asset side of the Balance sheet and therefore, look for clients who, despite slowdown, come up with a good proposal. And a good proposal in their parlance means that they would have little to exercise their thinking. Their time is under pressure most times in video conferences, meetings, Seminars, publicity and several internal committees.

Look at Mr. Raman who understands the predicament of the current banker and who is a CFO of a mid-sized corporate entrusted with the task of increasing domestic market by 100% and overseas market of the Company’s innovated tablets and injections duly approved by the US Food and Drug Administration. He is sure that the Banks would not like to lose a good client for another bank. Since his Company has proven track record, he was hopeful of the deal for higher limits on both working capital and export packing credit.

He took an appointment with the GM (mid-corporates) of the Bank one fine morning. He did his homework well. He gathered full data of the enterprise; environment in which the entire industry has been working; economics of his proposal; the area into which the Company would like to expand; the types of clients the company are targeting; the distribution system of the new markets; the incentives Company has on table; the drug controls of both India and the Asian economies in which the Company is going to operate; the disease patterns there; government health care and insurance mechanisms; the IPR and above all the financials. He also worked on the stress testing of his projections.

He presumed that in the first instance the Bank would know of the enterprise and ecosystem equally well. He started off with all humility. During the discussions, when he noticed that Bank officials do not have half the information, he had either on the product or competitiveness but are looking at only the financials and spreadsheets and not the rationale behind them, he pitched his fork high. He left some issues deliberately for the bank to come up with subsequently. He did not press for a solution instantaneously. He left a cooling time with the Bank.

After three days, when the call came, he went with his accounting team and with the required project proposal in the bank’s usual format. He took care to ensure that no additional collaterals would be offered. He kept under his armpit the directors’ individual guarantee to offer when necessary. Finally, when asked, he just mentioned that it was the company’s intention to go for public issue at a propitious moment and raise equity to meet future needs and therefore, it would be difficult to offer the same at the moment. The deal got through.

The recipe is simple:

1. Do your homework well: know your own enterprise, its SWOT.

a. Brainstorm possible implications of the proposal with the Board and internal management.

b. Cushion the proposal with adequate collaterals and guarantees but keep it undisclosed.

c. Go as a team for presentation with your confident technical and financial team for discussion.

2. Do not thrust yourself at inconvenient times for the banker.

3. Be transparent during negotiations.

4. Be humble; but do not compromise on limits sought as it might affect profitability.

5. ERP will help keeping the data required by the Bank and tax authorities transparent and timely.

6. Go with a vision, objectives and goals for the future.

7. Keep also the succession plan ready.

8. Give reasonable time to the Bank to think and come back with their offer,  but indicate your expectation for the result and also indicate that a Bank and a leading NBFC have also indicated their willingness to look at the proposal to attract competitive pricing of the loan.

9. Post sanction and post disbursal, keep compliance of terms and conditions tidy.

10. Make sure of half-yearly review of the limits by the Bank by feeding the required data online.

The above principles work equally well for the MSMEs. Since the MSMEs lack the attributes of a CFO and accounting team, they need to look for committed process consultancy firms like the Telangana Industrial Health Clinic Ltd (TIHCL) who handhold them and help scaling up with strategic interventions at the right time.

Published in Telangana Today 

Pre-Budget Blues for the Union Budget 20-21

Suggestions for the Union Budget 2020-21

Focus on Manufacturing MSMEs;

Industries should bloom like flowers 

We have the potential to overtake China if we trust our MSME sector more than now and provide long-lasting solutions.

Manufacturing Micro enterprises with specific focus on agro based industries and rural enterprises, which are unique and provide maximum employment need to be separated from Small and Medium enterprises and the existing MSME Act needs to be amended accordingly. All micro enterprises in future may be encouraged to be set up in clusters only with suitable infrastructure and marketing facilities. They should be enabled for scaling up and the required support system should come from the Entrepreneur Development Centres (EDCs), proposed to be co-located at the DICs. The DIC officials’ performance should be evaluated basing on the number of micro enterprises scaling up to small enterprises. Although this comes under the State domain, the Amended MSMED Act should provide for this appropriately.

The SMEs may be defined based on sales turnover and employment to incentivise them to join the formal sector and achieve GST compliance.

2. All the incentives from the government and other agencies to the MSMEs need to be linked to the employment they provide to people directly. 

3. All the subsidies and other payments by the governments and their bodies to MSMEs must be paid within 45 days from the due date. Any delay beyond this and up to 90 days should attract penal interest rate at twice the RBI repo rate. Delay beyond 90 days should be treated as criminal violation. Since the purchase and sale is a contract between the buyer and seller, Indian Contract Act should be amended appropriately, simultaneously.

4. An Independent Evaluation Office on the lines of IMF may  be set up as independent agency under Ministry of MSME/Finance/NITI Aayog to evaluate the policies, programmes, implementation and payments to MSMEs and submit a report to the Government for action and placing before the Parliament at the beginning of the Year.

5. SIDBI has had limited impact. The role and responsibilities of SIDBI may be re-examined by a High Level Committee.

Fiscal Incentives:

¡  2% to 5% of Income Tax / GST for up to every 10 in Micro & to every 25 persons employed in small evidenced by self-certified muster roll and corresponding increase in the expenditure on wages and salaries in the annual P&L statement.

¡  Micro: 1. No Cess on GST; 2. First 5 Years waive income tax for manufacturing enterprises

¡  Small: First 3 years for firms graduating from Micro exempt income tax; No corporate tax

¡  Small to Medium Enterprises: First 3 years 2% less than the usual Corporate tax for large enterprises;  

¡  Medium to Large Enterprises: First 2 years < 2% of the usual corporate tax applicable to the Corporates

¡  Technology: Micro to Small: transition with new or imported technologies – Duty to be exempted.

¡  Small to Medium: Duty to be 2% less than for large.

There should be no levy of Cess on export duties to enable the SMEs to be major contributors to export markets.

Banks and NBFCs helping revival of MSMEs:

Income Tax reduction of 1% if the institution revives 100 enterprises in a year – demonstrated by the increase in capacity utilization by 40% in six months from the date of revival for 80 percent of units revived.

Manufacturing Micro and Small Enterprises post revival earnings of up to Rs.5cr should be exempt from income tax.

With inputs from Dr. Subbaiah Singala, General Manager, CAB, Pune whose views are also personal.

Institutions loosing their relevance

Agri, MSME DFIs are failing to meet their objectives

The focus needs to shift from public sector banks to NABARD and SIDBI, whose functions greatly differ from their intended role

When one sees high inflation, the RBI comes to mind. When capital markets misbehave, SEBI is on the radar. When an insurance problem surfaces, the IRDA comes into the picture. These are institutions with proven credibility.

But when credit does not flow to agriculture or when farmers commit suicide, why does NABARD (National Bank for Agriculture and Rural Development) not come to mind? Why do farmers go to the government for a resolution? Similarly, when MSMEs do not get credit on time or do not get the services promised, why is SIDBI not under scanner? Why should the RBI still have a department to resolve issues relating to agriculture and MSMEs and prescribe priority sector boundaries, despite these other institutions?

Agricultural credit

NABARD, a statutory corporation, was set up in 1982, to take up the work of the Agricultural Refinance and Development Corporation (or, Agriculture Refinance Corporation, till 1970), as well as some functions of the Agriculture Credit Department.

The NABARD Act was passed in 1981. Its preamble states that it is: “An Act to establish a development bank...for providing and regulating credit and other facilities for the promotion and development of agriculture (micro-enterprises, small enterprises and medium enterprises, cottage and village industries, handlooms), handicrafts and other rural crafts and other allied economic activities in rural areas with a view to promoting integrated rural development and securing prosperity of rural areas, and for matters connected therewith or incidental thereto.”

NABARD is a development finance institution (DFI) established under the statute to serve the purpose of providing and regulating credit and other facilities for the promotion and development of agriculture. It started regulating cooperative credit, but that space was ceded to commercial banks. It also started with regulating RRBs, but most of them merged into larger entities and RRB branches are now mostly seen in urban and metro centres.

When the statute provided for regulation of credit to agriculture, why did the RBI continue to hold the reins? Is it because of lack of confidence in NABARD, or a reluctance to cede control?

The Rural Infrastructure Development Fund is administered by NABARD. Why should NABARD fund States for infrastructure projects, and in the bargain became a banker for the State — not for agriculture and allied activities, rural and cottage industries? It undertakes more treasury business (pure financial operations) than refinancing of cooperative banks and RRBs at very soft rates, and through them, lends to the farmers of all hues. There has been a compromise of objectives, with full concurrence of both the RBI and the government. NABARD’s income comes more from investments than refinancing or development projects.

Commercial lending

Let us see the other DFI — set up under a separate statute in 1989 — the Small Industries Development Bank of India, or SIDBI. There are several Centrally-supported ‘funds’ for the development of small enterprises. But there is no review in the public domain as to how these funds are performing.

The Centre established SIDBI Venture Capital and the ventures funded were of the real estate sector and MFIs. It has no credible record of financing and promoting micro and small manufacturing enterprises or clusters. SIDBI started direct lending sparsely, with a minimum of ₹50 lakh. It did not consider, during the first decade financing, SME marketing activity as a term lending portfolio. Manufacturing enterprises did not get venture capital at a lower cost than the normal venture capital funds.

Commercial objectives continue to govern its functioning. Its regional offices are so autonomous that they do not even consider responding to RBI guidelines. Most of SIDBI’s lending is through collateral securities. It basks under sovereign protection to diversified activities.

Schemes such as MUDRA, CGTMSE, 59Minute Loan are all under its umbrella, albeit indirectly. No one has questioned SIDBI’s way of functioning in relation to the objectives spelt out in the statute: “An Act to establish the Small Industries Development Bank of India as the principal financial institution for the promotion, financing and development of industry in the small-scale sector and to co-ordinate the functions of the institutions engaged in the promotion, financing or developing industry in the small-scale sector and for matters connected therewith or incidental thereto.”

Thus, both the DFIs targeting specific sectors are non-performers in their supposedly dedicated domains. At a time when the Finance Minister is keen on bringing about institutional reforms, she should shift her antenna from mergers to these two DFIs.

The writer is an economist and risk management specialist. Views are personal

https://www.thehindubusinessline.com/opinion/agri-msme-dfis-are-failing-to-meet-their-objectives/article29625262.ece

Equity route the best for scaling up in MSMEs

Trust equity to transform MSMEs

Along with its good oversight, equity brings greater financial discipline right from the start

By Author

TelanganaToday

B Yerram Raju  |   Published: 7th Oct 2019  12:05 am Updated: 6th Oct 2019  10:17 pm

It is well known that the micro, small and medium enterprises (MSMEs) live in debt markets in India unlike in many other parts of the world where they access equity and debt in reasonably good proportion. In India, 93% of MSME credit is flowing to just 13 States. This skewed distribution requires correction.

Of late, genuinely worried about the continual decline in credit to MSMEs, the government of India introduced MUDRA to comfort these enterprises with Shishu, Kishore and Tarun products. But not even 10% of the total 17 million estimated enterprises was in the manufacturing sector. Then the government introduced 59Minute loan window. Both these efforts have not improved grassroots lending to the sector.

Driven to the wall, the Finance Minister pushed the panic button asking banks to do aggressive canvassing of loans for MSMEs and retail in 400 district-level shamiana meetings. The FM must be aware of both adverse selection of beneficiaries and moral hazard consequences. She expects the banks to tackle them effectively.

Convenient Option

But are there no other means of meeting the financial requirements of MSMEs? Why is equity not being explored as a convenient option? Is it because of the unorganised nature of the sector or because of the undependable clients in the sector? Or both?

Debt has been the most convenient option driven by perverse incentives right from 1950 when the Industrial Policy was announced. Debt, apart from being less costly, takes less than 30 days to deliver while equity takes at least nine months, if not more, where the promoters are assessed through a rigid due diligence process and corporate governance and board rules are put in place before filing the IPO. This process can be shortened if the enterprise has credible historical data for the pre-launch and good governance structure.

Movement from micro to small and small to medium is more governed by greater stake of the promoters through equity infusion. Therefore, such a transition is also extremely slow.

Enabling Ecosystem

District Industrial Centres, introduced in 1980-81 when George Fernandes was the Union Minister for Industries, have been engaged by the State governments to dispense the incentives, raw material like coal, iron, and help in realisation of unrealised debtors through the MSE Facilitation Councils since 2006. The Facilitation Councils, however, did not succeed to resolve the problem of delayed payments to MSMEs.

Manufacturers are the worst hit. Hence, the FM came out with a strict mandate to the PSUs and Central government departments to pay up all their bills by October 15, 2019, and confirm. Hope this would provide a lot of liquidity to the beleaguered MSMEs.

For the transformation from debt to equity access, the ecosystem, capacities and capabilities of firms and the perceptions of entrepreneurs play an important role. Several entrepreneurs are knowledge-insulated and mostly unwilling to unlearn in their growth journey.

Successful Model

Equity firms can participate with the MSMEs over a seven-year period with a gestation period of 1-2 years. Revenue sharing is the model on which it operates and is assessed after sectoral analysis and exits at an appropriate time. The participating equity firm also keeps enhancing skills and scouts for market opportunities of the partner firm. The model is a success in the US.

This equity comes at a cost of 5% more than the market price of debt. But it brings along with it good oversight and greater financial discipline right from day one. Structuring finances and structuring enterprise during the growth is a seamless process.

Scaling them up requires a different level of investments to wean away the entrepreneurs from the protective environment to self-dependence. The biggest problem they invariably come across is the choice of directors for governance. While the Institute of Directors has got on its platform thousands of trained directors, accessing them at affordable levels and verification and validation of their credentials pose problems.

Incentivise Transition

With the economy targeted for $5 trillion by 2022, MSMEs as growth engines and seedbeds of innovation have a significant role to play. Such a role requires that they seamlessly migrate to a higher level of operations during the growth stage.

Fiscal incentives can help such a transition. Having eased the rules for FDI participation and amended the corporate tax structure, it is time to look at what best can be done to make MSMEs go for greater aggregation and contribute significantly to the growing economy.

We have the potential to overtake China if we trust our MSME sector more than now and provide more long-lasting solutions than kneejerk reactions.