MSME sector: Eight ways India can back its small enterprises

MSMEs face Covid-19 crisis
The six crore enterprises that employ at least 12 crore people are now in a difficult situation where mortality rate has increased manifold.

This article is the second of a four-part series on a viable strategy for India against the economic impact of the new coronavirus outbreak. Follow Policy Circle for the the rest of the series.

READ PART I: Govt should extend the lockdown for another five weeks

Micro, small and medium enterprises are the lifeline of the economy. They account for more than a third of the manufacturing output of the country. The six crore enterprises that employ at least 12 crore people are now in a difficult situation where mortality rate has increased manifold. MSMEs will are badly hit by the nationwide lockdown announced by the Narendra Modi government to tackle the new coronavirus outbreak. The government will have to encourage the small and medium industry and ensure adequate finances to ensure that the employment situation in the country remains robust.

1. Working capital loans

The Reserve Bank of India has already addressed the problem of working capital shortages by instructing commercial banks to provide a three-month moratorium on payments. However, this may be applicable to only those MSMEs which have a bank account and avail loans from commercial banks, which are generally large and medium industries.

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2. Loans to micro and small units

It is noticed that micro and small businesses generally do not avail loans from banks as they prefer to operate with their own savings and resources. In these difficult times, these small units could close down due to a lack of working capital. The RBI’s monetary policy would only be helpful to them if bank loans are available. Banks are also not keen to lend to these micro and small businesses due to their inability to offer collaterals or lack of appropriate ratings. Therefore, these industries should be incentivised to avail loans from banks by extending some benefits such as loans equivalent to three months salary, rent and electricity bill at nominal rates of interest, or even preferably without charging any interest. The government can direct the units to pay salary for next three months to all their staff from the newly opened bank account which will help generate and sustain demand in the economy.

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3. Setting up escrow accounts

Lending to micro and small businesses and MSMEs should happen through an escrow account with the condition that when the unit is productive and starts to earn revenue, the loan should be repaid over monthly instalments over the remaining nine months of the current financial year.

4. Cut delays in payment

The payment of MSMEs, especially micro and small units, is generally delayed by more than 45 days. While the government extend the payments in 45 days, private firms and even some public enterprises delay payments. The government can help by opening an escrow account of the supplier firm and the customer/client, and if payment is not received in 45 days, the unpaid bill of the supplier can be discounted in the escrow account to the extent of 80-90% so that credit flow for MSMEs is not affected. When the payment is finally received from the customer, the supplier gets the complete payment and escrow account will be settled. The escrow account can operate through the bank, and the bank can charge a commission on the service provided.

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5. Subsidising MSMEs

MSMEs will play an important role in reviving the economy. To encourage MSMEs, land, basic infrastructure/amenities and interest-free seed money would have to be offered at nominal rates, considering that China provides free land and highly subsidised electricity to MSMEs. The government could consider export processing zones, creating clusters and even small townships for MSMEs to reap the benefits of forward/backward linkages. The newly set up MSMEs not only will help to absorb labour, but also will help in producing output and boosting local economy. These activities yield tax revenues through sales, and income, and therefore should be visualised as investment rather than expenditure.

6. Firewalling domestic units

In India, MSMEs, if properly positioned, can serve to create maximum employment, if Start-up India can be combined with it. The competition that China provides is unethical whereby the government subsidises output substantially, especially if it is exported. To firewall the MSMEs, the government could highlight the malpractices of the Chinese and ban import of those items which are being produced in India. This will provide a level playing field to budding entrepreneurs in India who are setting up plants and machinery in the MSME sector.

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7. Flexible MGNREGA wages

The government has enhanced daily payment under MGNREGA to pump in purchasing power in the hands of the labour. However, most of the migrant labour that works in MSMEs on low wages has gone back to their homes and will reap the benefits of working under MGNREGA. To incentivise the labour to come back to their places of work when the lockdown is over, the government may consider lowering the daily compensation rate under MGNREGA.

8. Fresh funds for the scheme

The Escrow account could be set up with government grants/loans to banks. The central and state governments could borrow from the RBI (monetised deficit) or avail facility under COVID Fund from multilateral institutions.

(Dr Charan Sigh is a Delhi-based economist. He is the chief executive of EGROW Foundation, a Noida-based think tank.)

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