Impact of Covid -19; Review of Measures taken

RBI in its Monetary Policy statement on the 27^th March 2020 front-ended the effort of banks through pumping liquidity, 3-month moratorium on term loan instalments, working capital while interest will continue to accrue during the moratorium period with a further clarification that instalments will include the payments falling due from March 1, 2020 to May 31, 2020: (i) principal and/or interest components; (ii) bullet repayments; (iii) Equated Monthly instalments; (iv) credit card dues; review of working capital limits of all enterprises. 3% CRR recommended by Narasimhan Committee, Tarapore and Ashok Lahri at different points of time has been announced.

Interest will continue to be charged on the EMIs and they would to that extent enlarge the instalments that follow the moratorium. To expect the industry to recover immediately after the lockdown period is over will be an overestimation. McKinsey says:” Restarting production facilities can be more challenging than shutting them down. It requires a thoughtful approach to revive the supply chain, match volume to actual demand, and, most importantly, protect the workforce.” They require minimum six months to get back into the full supply chain. Banks’ sagacity to reassess working capital lies here. Banks should not cut down the limits because the size of the Balance sheets of all firms will be downside of the previous years including their own.

Future lending shall be cash flow based and not Balance sheet ratio based or even just turnover based (Banks are asked to extend minimum of 20% of projected turnover while most have adopted this as the maximum and this includes SIDBI).

RBI February data indicates that as of January 2020 credit growth to agriculture and allied activities decelerated to 6.5% from 7.6% in January 2019; to industry more than halved during the same period; to services sector decelerated to 8.9% from 23.9% whereas for personal loans it grew by 16.9%. This position prevails despite liquidity infusion measures during the last two monetary policy initiatives. Therefore, risk aversion and not liquidity is the problem with banks.

The already risk-averse banks can hardly lend during this period of lockdown seeing temporary shutdown of 90% enterprises. They can only provide online comfort following the policy announcement, al bait for three months! For a running industry to increase capacity is easier than a re-opened industry after lockdown. Further, investment required after re-starting is also going to be much more than now. Therefore, banks must prepare to lend more aggressively immediately after the current period. But can they move away from aversion to appetite in taking legitimate credit risk, without improving their lending infrastructure?

A few special efforts that still beg attention are:

·       Banks to stop all SARFAESI proceedings and developing forbearance for the manufacturing MSEs.

·       Extension of NPA threshold to 180 days, effective January 2020 quickly that will keep accounts standard for any further booster doses to flow to the industry.        

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Special Mention Accounts 1 & 2 categories will also need uniform forbearance.

·       Unfunded limits – LCs, Guarantees, ECGs falling due between January and May 2020 should not be revoked for non-compliance but their periods extended by another six months. RBI directive is imperative.

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A       All viability tests shall be done by State Government accredited agencies

·       GST should be reduced to 5% till the end of December 2020 for all the enterprises that would submit their quarterly returns as required under law, even if at exempted thresholds. Review of impact should be based on an evaluation study by all the Industry Chambers.

·       All MSMEs that maintain record of manpower employed verifiable with EPF and ESI registrations.

·       All MSMEs may be permitted to engage contract labour with the social security burden absorbed by the State Government on reduced commitments annually by 20% provided they all are digitized for all transactions.

·       Power Tariff should be cut by 50% for all the manufacturing enterprises provided they are all digitized and registered under Udyog Aadhar or TSiPASS.

·       All MSME Funds should be maintained and monitored by the DC-MSME through NSIC instead of SIDBI.

GoI may focus more on cleaning up the financial sector with a sense of urgency to render its services effectively in tackling this uncertainty effectively. At one end, cash relief from the exchequer should flow to all digitized Jan Dhan and Mudra loan accounts and at the other end, credit shall pump prime the economy with responsible and timely deployment post lockdown.

More digitized developed economies are redirecting their efforts to containing the spread and holding people in discipline using WhatsApp, digital alarms at the Carona Control Rooms etc.

South Korea has transferred cash to all the SMEs to pay for their labour for one month. US has announced a $2 trillion package to combat the new war. Several nations across the world – with 196 affected by this monster Carona - are seriously contemplating the relief packages. G-20 announced $5trn relief package. For once everyone stopped thinking of fiscal deficit. Extraordinary problems require extraordinary solutions.

No time for Hobson’s choice. Saving lives is more important than saving the economy, no doubt. But preparing the economy to respond to the post COVID-19 very effectively also brooks no let-up in efforts.

*This is part of the article published on the 30^th March in Telangana Today with some additions.  A Response write up to the CII.

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