Give market to MSMEs, not loans

Bharat Jhunjhunwala

The Micro, Small and Medium Enterprises (MSMEs) were in trouble even before the Corona Pandemic. The share of MSMEs in the non-farm credit extended by the banks declined from 5.58 percent in March 2019 to 5.37 percent in February 2020. This means that MSMEs are not able to hold their fort against the big businesses in the present economic milieu. The MSMEs are not in a position to take loans; and banks are not in a position to give loans to MSMEs because they are losing their competitiveness against large businesses. The lockdown has further increased their woes.  

A loan is beneficial when there is demand in the market and the businesses are able to sell the goods at remunerative prices and make profit. Businesses use this profit to pay the interest on the loans as well as repay the principal amount. This same cycle of borrowing and repaying does not work when there is no demand in the market. The loan then becomes a burden. The income remains stagnant because there is no demand in the market and the prices are flat; while the outgo increases due to the interest burden. On the other hand, MSMEs will somehow manage to raise the money for working capital or investment and survive through the lockdown if their goods are selling briskly at good prices. They may take advance from their customers, borrow from relatives or persuade the banks to give additional loans. The point is that the main driver of MSMEs is market demand; not loans.

I had the occasion to study a Self-Help Group (SHG) in a village many years ago. The NGO that had promoted the SHG informed me that the village people had bought buffaloes from the loans given by the SHG and their incomes had increased. The villagers also confirmed this. However, when I asked the same villagers whether the total number of buffaloes in the village had increased—the answer was a clear “no.” This meant that the loans were not actually used for buying new buffaloes. They were being used for making a house or meeting expenditures of a wedding. In the result, the lending by the SHG actually led to deterioration in the incomes of the people. Previously the income from the sale of milk remained in the hands of the villagers. Now, courtesy SHG, a share of the income was going as payment of interest to the bank. The income remained the same since the number of buffaloes remained the same. The interest payment became an additional burden. Similarly, increased borrowing by MSMEs in absence of true additional income will only lead to deterioration in their incomes—though this will happen after a while when the interest payments become due.

We have already seen how demonetization led to results that were entirely opposite to the objectives of the Government. Instead of black money being unearthed and the Government collecting income tax on the same; the black money was routed into the banks. Only chartered accountants and corrupt bank officials made money. I apprehend a similar fate may be awaiting the present package announced by the Government for MSMEs. One bank official told me that the Government is already guaranteeing part of the loans being given to MSMEs under a host of schemes. The package could yet be helpful. The bank officials would be encouraged to lend, say, Rs 60 lakhs due to the guarantee extended by the Government; instead of the Rs 40 lakhs they would have lent in absence of such a guarantee. Such may indeed be the case in certain situations and this is welcome. However, the bigger danger is that this package could be used by the bank officials and the borrowers joining hands to fleece the Government. Consider this hypothetical example. Let us say a borrower has mortgaged his property worth Rs 1 crore to the bank and taken a loan of Rs 80 lakhs. The value of property has now declined to Rs 60 lakhs. His MSME is also making loss. He wants to exit. Now, the borrower and bank manager join hands and the MSME is given an additional loan of Rs 2 crores. The chartered accountant and the bank manager grab, say, Rs 50 lakhs; and the businessperson grabs Rs 150 lakhs. The factory goes under, the bank auctions the mortgaged property and recovers Rs 60 lakhs. But the Government pays Rs 2 crores to the bank under the guarantee. In the end, the package may only become an incentive to close businesses or fleece the Government in some other way. Let us not forget that India’s ranking in “Ease of Doing Business” made by the World Bank improved because it has become easier to close businesses due to the Bankruptcy Act. The present package could be used more in this manner because there is little chance of MSMEs borrowing for legitimate purposes in a situation of falling demand. One has to offer a carrot and also wield a stick to make the donkey walk. The donkey simply sits down if only the stick is wielded. Similarly, the MSMEs will “walk” only if they are presented with the pull of both market demand and push of easier access to bank credit. The present policy of giving additional loans without creating demand for their produce will only make them sink deeper into the red as has happened during demonetization.

The difficulty in increasing demand for goods produced by MSMEs arises from our commitments to the World Trade Organization and our penchant for promoting big “modern” automatic and robotic factories like has been done in the industrial countries. These big companies—both foreign and domestic—produce goods at a cheaper price which the MSMEs are not able to face. Therefore, the Government must immediately increase the import duties on all goods to the maximum level bound by us in the WTO. We may also consider quitting the WTO if we are not able to protect our MSMEs from cheap imports. President Trump has already ensured that WTO has become toothless in absence of a working appellate authority. India also has the honour of checkmating industrial countries on the question of food subsidies. We must show similar courage and kill the WTO. We must raise import duties to promote domestic production. At the same time the Government must provide lower rates of GST for MSMEs or ensure that MSMEs gain from the increase in import duties and notlarge domestic businesses. The MSMEs will raise working capital if they are able to sell their produce from savings, families or banks. The present policy of giving loan guarantees will not lead to the revival of MSMEs in absence of demand. It is like asking the patient suffering from cancer to take a loan for buying a luxury car so that he can enjoy a ride before he dies.

Formerly Professor of Economics at IIM Bengaluru

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May 17, 2020

Bharat Jhunjhunwala

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