“The slowdown in MSME credit points to a larger drop in production than India can hardly afford”
Credit and financing for MSMEs: India has an MSME problem: our economy is greedy for credit but our banks are reluctant to credit. We have historically been a nation built on bank loans. With the exception of a few prominent examples, when a small business needed capital to grow: whether it was investments to acquire new machinery, business financing to fulfill an order, or discounting invoices. for paying providers, the preferred route had been the bank loan. The credit slowdown points to a larger drop in output than a competitive economy can hardly afford. Cleaning up the banking sector under the leadership of Dr Rajan RBI has been a critical course correction so that banks’ balance sheets reflect an actual position in their credit books, and will undoubtedly prove beneficial in the long run. This has had an unexpected side effect, however: Public sector banks, which constitute 65% of business lending in India and have traditionally been risk-averse to begin with, have become increasingly so.
Slowdown in loans
There is an old adage whispered through the halls of bureaucracy: you are in no trouble for not taking action. This pithy truism has started to hold true in public sector banks as well. Managers who were previously willing and able to sanction legitimate loans now fear impending investigation if a creditworthy business they lend to eventually fails, for good or bad reasons. It is easy to slander PSU employees, but the simple fact is bank employees in India are a real success story. Some of the sharpest and most crafty minds sit behind these desks, and for decades they have played their silent role in ensuring a flow of credit to fuel growth in India. But a spurious investigation – which they often have to defend out of pocket – into a legitimate loan decision gone awry serves as a death sentence. This has led to a significant slowdown in lending that even precedes banking sector reforms. A similar risk aversion is also causing delays in accepting offers under IBC, where bankers are left to wonder how they would justify a big haircut that makes commercial sense during a vigilance investigation.
In an economy where the effects of fiscal and monetary policy are noticeably slow to spill over into the real economy, agile credit markets are needed. India has one of the slowest transmission rates of reserve rate changes to the main street among developing economies. Additionally, banks’ reluctance to lend has resulted in a plethora of NBFCs, which borrow from the same banks and lend to Main Street after applying an additional commission, making real interest rates more expensive. for the average borrower. This NBFC layer also slows down central bank transmission rates further.
Combine this with the fact that the commercial paper market in India is extremely thin (despite some enabling measures taken by SEBI and RBI), we could potentially face a significant growth capital gap in the country. The advent of Covid-19 will serve to make these effects more serious. This month alone, Indian sovereign bonds fell to their lowest level in three months, as the yield on 10-year debt rose 14bp, spooking the markets and further eroding the commercial paper market.
The path to equity
The way forward is through equity. The MSME stock market in India – both private and public – is anemic compared to the size of our GDP. While we have a relative overrepresentation in the tech sector (which mostly belongs to the MSME category), there is little private growth capital for non-tech firms. Likewise, very few companies make it public before reaching scale; and when they do, they receive little coverage from analysts and, therefore, are little traded.
There are no shortcuts to this, but three prescriptions will serve us well in the long run. The first would be the creation of a growth equity fund of funds (FoF) under SIDBI, focusing on non-technology sectors. The FoF model offers tremendous leverage by multiplying the amount of capital available to entrepreneurs. It fuels an engine that creates scale, jobs and exports. No developing economy has become a world-class economy without adequate access to growth capital, and India needs a long and solid bridge to the other side.
In addition, we must allow policies – particularly with regard to capital gains and the repatriation of capital – that encourage the flight of capital to India. We are fortunate to be one of the few economies to emerge from the crisis with significant room for growth, and therefore an inherent attractiveness for foreign capital. We need to marry this with enabling policy measures to ensure that this flow of capital occurs.
Finally, we need to create market mechanisms that allow transactions. Investment banks in India are (understandably) reluctant to deal with low value. It takes the same effort whether you’re working on a $ 2 billion or $ 20 million deal; and when your fees are commensurate with the size of the transaction, a business has a natural incentive to hunt whales. But there are enough small transactions that collectively can generate a lot of fees. A political incentive would be a big boost. Transactions, unlike weddings, do not take place in heaven. They are cooked by seasoned professionals who circle the ideas, often for long periods of time, before they finally bear fruit. And almost always, the deals lead to the creation of wealth, jobs and growth on a large scale. It is well noted that the richest fishing waters are located off the shallow seas adjoining deserts. You won’t catch a whale there, but you will leave with a rich catch. We need to create a new class of investment banks that make hunting small fish their daily bread.
Utkarsh Sinha is the Managing Director of boutique investment bank Bexley Advisors. The opinions expressed are those of the author.