The Sweet and Sour Package for MSMEs

Following the PM’s thunderous announcement of Rs.20trn constituting 10% of GDP, the highest by any government post-pandemic, the Finance Minister came up with a six-point package sounding big relief for the MSMEs. When the final figures came for counting the five-day pack whittled down to bare 2% of GDP. Will the relief be long lasting or comfort, lasting for short time?

MSME sector is soar over the package as it did not provide virtually any relief for either payment of wages or immediate payment of bills pending with the government itself ( approximately Rs.5trillion – both the GoI, PSUs and State Governments) and even forbearance of the loans for at least 180 days.

The initial moratorium on the term loan instalments and working capital and the deferment of working capital were just a breather in pandemic. Since the units were under lockdown, most of those availed, have no output to support the additional working capital. They are now offered relief in the margin. This would mean that the Banks would give more working capital loan against deficient stocks, wages to the labour for the lockdown period etc.,- knowing it as an unsustainable debt because there is a National Credit Guarantee Trust and there is pressure to deliver by September 2020. Against this, Cabinet provided Rs.41,600cr over a three year period. Banks are not happy with this type of guarantee dispensation since they still have to provide for likely capital erosion.

MSMEs that received the incremental credit during the quarter Mar-June 2020 post-Covid at 7.4% p.a., are now told that they have to pay 9.25% for Emergency Credit Relief Package extending over four years with a moratorium of one year!

The other measure is a follow-up of Budget 2020-21. The FM announced sub-ordinated debt  (SOD) at the hands of the same banks that have all along been winking at the revival of micro and small enterprises and on easy and timely credit access as part of Covid relief package.  

Banks that do not have a subordinated debt in their balance sheets thus far, should now look for providing it under investment category and that too upfront labeling it as NPA!! They should develop standard operating procedures and help the clientele know of the nuances of availing it. To embrace innovation for a sector that is always viewed with suspicion, will they fall in line with the thinking of the FM?

Subordinated debt in simple terms is defined as a debt subject to subordination when there is creditor’s default. If ‘A’ Bank has offered a subordinated debt to a micro, small or medium enterprise, and this enterprise goes bankrupt after a certain period, and therefore becomes a defaulter. Bank cannot claim the money it has given as a loan from the enterprise’s earnings or assets.

After the senior debts are paid off in full, the left over will accrue to the clearance of the subordinated debt. Singular advantage however is that in case of Companies (this category is just 2 to 2.5% of the total MSME borrowers) bank will receive its SOD claim ahead of preferred and equity shareholders. Banks will be able to recover their usual unsubordinated debt in the shape of term loans and working capital ahead of sub-ordinated debt.

This simply means that SOD is riskier than the normal term loan and working capital loan offered either as cash credit or overdraft. Banks that have been lurking to grant loans against CGTMSE guarantee to the extent of Rs.2 crores cannot be expected to grant SOD again at the same guarantee window!

Sub-ordinate debt, by definition, stands higher in risk and lower than the principal loan in terms of claims by the Bank. For Rs.20000cr infusion, CGTMSE is being given Rs.4000cr. It would have been a fairer had she extended the Rs.3lakh sovereign guarantee cover to these set of borrowers too. Offering this high-risk product to already declared NPAs could trigger lot of problems in operationalising this product.

It will be now for the Banks to roll out the product. Standard operating procedures for releasing this SOD will be very tough if not tricky for the Banks. On top, the CGTMSE guarantee with which the banks are already unhappy is supposed to provide guarantee. Quite likely, several of the 2lakh MSMEs pitted out this benefit may have already been covered by the CGTMSE and the claims must be hanging at one end or the other for consideration in order that the banks concerned will close the NPA accounts!!

It is advisable instead to offer equity to micro and small manufacturing firms – proprietary or partnerships, most of them – up to 50% of their total financial requirements and the balance as debt. This equity should be left untouched by the Banks for a period of five years. The purpose for which such equity is rolled out shall be for buying a leasehold right/outright sale in the site where the manufacturing unit is set up and or purchase of machinery/technology or acquiring of intellectual property rights. Once it is given as equity, Banks will be forced to become the development partners that may provide route for scaling up the enterprises from the micro to small and small to medium.

Assessment of revenue stream and monitoring it continuously is extremely important to culture the enterprise in apportioning some percentage towards the equity contributed by the Bank. There are two ways of ensuring this: 1. Banks physically monitor the functioning of the enterprise as its partners to its committed capacity; 2. Set up a consent-based ERP architecture to monitor their debtors, creditors, sales and cash flows on the system. The purpose is to ensure that any aberrations are remedied timely.

Such equity can flow across the enterprises but shall be on sound credit risk assessment and effective follow up and supervision.

Banks with their limited manpower can hardly be expected to do the former. Handholding, mentoring and counseling continuously and ensuring that the enterprise makes seamless transition from unorganized to organized, Banks may have to outsource these services to competent and State Government accredited professional institutions. Even regarding the second step, Banks should be able to re-engineer their work- spaces and train their executives to catch up with the task.

Relief package is at best a pack of intentions. The relief is additional loan burden. MSMEs’ cost of production will go up at a time when they are totally uncertain about the demand. They also become uncompetitive compared to any other SME across the globe that has received cash relief and interest-free loan to rebuild their manufacturing business.

Neither RBI nor GoI has issued operational guidelines for the treatment of existing NPAs. Without revival of the viable micro and small manufacturing enterprise and carving out a definitive future, Banks taking part in equity of such firms through sub-ordinated debt route will be a wild goose chase.

But for the risky NPAs, sub-ordinate debt to roll out is a future, worthy to watch. Banks may innovate, who knows? In essence, the package is sweet in words and soar in delivery.

https://telanganatoday.com/sweet-on-words-sour-in-delivery

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

The Probability of Gains and Risk Aversion

The Probability of Gains and Risk Aversion:

The frontiers of failed negotiation of Jet Airways

Toss a coin to help a friend taking decisions with 80 percent success unlike in Sholay picture where Amitabh Bachan showed 100 percent success with a coin of both sides’ heads only and no tails to lose. In the case where the coin has both head and tail, the risk of loss looked far lower than the prospect of gain.

I had a friend who bargained the landed properties stuck in litigation knowing well that the disputes take at least 20-25 years to settle in court. In the interregnum he used to invest on land – for a dug-well or borewell, commercial farming, horticulture and food crops in an admirable mix. In 80 percent cases his gamble paid. In the 20 percent cases where he lost also, he recovered the entire investment. He left a huge property for the progeny to gain. His estimation of risking the loss proved negative and probability of gains proved positive.

A colleague of mine, since the days of joining the bank, used to buy just Rs.100 worth gold and at the end of 30 years when he reached the position of Deputy Managing Director, he was rich with gold and cash. On a fateful day for him, after attending a marriage function noticed huge burglary and his life’s gold fortune is lost excepting those worn by his wife. The Risk of loss was least expected by him so much as the probability of gain.

In all these cases, to quote ‘Thinking Fast and slow’ by Economics Nobel Lauriat (2002) Daniel Kahneman, both probability of gain and risk of loss are a combination of skill and luck. Indian banks’ ability to measure the probability of gains versus the risk of losses missed out both on ‘skills and luck’!!

Take the latest case of Jet Airways that involved Rs.8500cr of assets in banks’ books and Rs.25000cr of non-banking assets for recovery. Banks involved that included the lead lender SBI taking the pilot seat must have spent Rs.100-150cr in terms of time spent, travel and negotiation costs and yet failed and now it is taken to the NCLT. 50% of debt is already provided for losses.

In this case like in all corporate bad debts, the borrower-firm is provided ample opportunity to put forward its point of view. Naresh Goyal placed his cards dexterously and the final jolt came when Etihad wanted 85 percent haircut. And there is no case in Middle East where Banks ever conceded 85 percent haircut!! Indian banks proved that they lacked both skill and luck to ensure a probability of gain even amidst huge loss staring at them.

Theoretical underpinnings in behavioural economics suggest that the tendency to overcome the desire to achieve gains is blurred by the desire to avoid losses. Foreseeing gains with a historical hindsight of losses require certainly either a broad vision or fresh thinking. For the involved parties it is difficult to have either. RBI seemed convinced of the need for an independent evaluator in their June 7 instructions relating to the Resolution Plans of corporate and mid-corporate enterprises.

Take the case of around one lakh estimated sick MSMEs involving about Rs.102000cr of which at least 50 percent could easily revive if  (1) such independent evaluation for revival package is done; (2) the package is discussed with the beleaguered enterprise;  (3) the cost of evaluation is borne by the Bank and (4) revival package is delivered within specific timelines. The probability of gain against the provided loss of 50 percent is around Rs.51000cr with employment gains to the extent of 4-5lakhs and tax gains to the exchequer to an extent of at least Rs.15000-20000cr.

T

he cost of revival even if third party assessor is engaged for both the revival package and follow up would be far less than that for corporates of the likes of jet airways and Kingfisher. Since the regulator has already announced a policy for resolution and if the regulator is non-discriminatory similar guidelines should be announced for the MSME sector.

The problem, however, is in the identification of assessors/evaluators since the presence of MSMEs on the brink of failure is spread throughout the country, al bait, in a few states like Andhra Pradesh, Gujarat, Haryana, Karnataka, Maharashtra, Punjab, Telangana and West Bengal.

It is only Telangana that thought of Industrial Health Clinic to tackle sickness on a firm footing. During the last one year, this state promoted fintech firm has revived 41 enterprises, stabilizing employment of around 500 persons and protected investment of around Rs.10.62cr.

Right diagnostics, timely release of resources and continuous handholding and monitoring supported this process of revival. Had the Banks shown initiative, the effort would have reached at least 200 enterprises.

MSME Committee that presented its report to the RBI suggested Diagnostic Clinics as part of the Entrepreneur Development Centres little realising that the persons and skills required for diagnostics and resolution are far different from those for enterprise development  Even the fund suggested for distress resolution, viz., Rs.5000cr has not been structured properly, particularly when the stress of MSEs is prevalent in 10-12 States. Hope the RBI would draw lessons from the failure in revival efforts thus far from the Banks and review its directives. If the Banks can contribute to the Fund to the extent of 1% of NPAs in such portfolio and help the States setting up Industrial Health Clinics like Telangana Government, results can flow and investments can revive speedily.

Daniel Kahneman says: “Overweighing the small chance of a large loss favours risk aversion and settling for a modest amount is equivalent to purchasing insurance against unlikely event of a bad verdict.”

https://knnindia.co.in/news/newsdetails/features/the-probability-of-gains-and-risk-aversion-the-frontiers-of-failed-negotiation-of-jet-airways

MSMEs on the Roller Coaster

Unhelpful Banks and Less Understood Regulations

B. Yerram Raju and K. Manicka Raj*

In a recent address RBI Governor Raghuram Rajan said: “A Banker who lends with the intent of never experiencing a default is probably over-conservative and will lend to too few projects, thus hurting the growth.” In the same vein he added: “Indeed, sometimes banks signed up to lend based on project reports by the promoters’ investment bank (in the case of MSMEs chartered accountants), without doing their due diligence.”

There is a total mismatch between the banks understanding and RBI's intentions on the guidelines issued in respect of MSME financing , follow up and useful implementation of the various schemes. Because of accumulation of NPAs banks seem to have lost their sense of judgement and MSMES are the victims and the SARFAESI ACT 2002 has become very handy. Even in the best of times banks did not revive or restructure small scale industries more than 1.5 percent of their own assessed potentially viable enterprises as revealed by the RBI Annual Reports.

MSME Amendment Bill Destroys the Sector

MSMEs in India have great significance as they will be the drivers of ‘Make in India’, Start Up India, and Digital India strategies unfolded by the Union Government. They are governed by the provisions of MSME Development Act 2006, with the principal objective of promoting, developing and enhancing the competitiveness of the MSMEs.

Two years since the NDA government came to power MSME sector seems to be in a confused state with unresponding credit markets, slow moving equity, and adverse global positioning in spite of large potential for job growth.

MSMEs are redefined in September 2015 by way of amendment to rules to the 2006 MSMSE Act providing for vertical growth. Earlier definitions of SSI and MSMEs post 2006 accommodated horizontal growth and perverse incentives. But all the states have not fallen into grove.

New regulations and rules seem to be compounding the problems for the sector when it comes to revival and rehabilitation even as the Bankruptcy Law provides the long awaited relief for the large industry.