By Shachindra Nath
MSME loans and economic revival: The world is going through the most severe health emergency in more than 100 years. So, there are few parallels in recent years from which we can draw from as the last pandemic of this scale was the Spanish flu of 1918. The only lesson the policy makers of the government and the top decision makers at the corporates have is that the crisis will end at some point of time.
When the pandemic broke out, the policy response was designed on the belief that there will be only one wave of Covid-19, it will end in four months, and everything would be fine after that. That was a mistake. But whether it is two waves or three, it is going to end, humanity would survive and would be back to normal. You have to make policies based on this assumption.
The first thing needed at the policy making level is optimism — you have to believe that something is going to work. Let me explain with an example. I focus on financing MSMEs. When I became an entrepreneur in July 2018, I raised roughly around Rs 1,000 crore and said wow. It was July and then the ILFS crisis happened. Everybody told me, you are lucky that you raised money, but what after this? As if the world would come to an end. And I said that’s fine and we will see how it unfolds.
Then the pandemic came and obviously after that everyone said this could be the worst time to start a lending business. I told them that at the end of the day if this country has to survive there is this sector of roughly 6.3 crore MSMEs that employs 11 crore people. If the governments have to survive, they have to address this issue to get votes. Eleven crore people means roughly around 25 crore direct and indirect voters. This is not a sector which is going to end completely.
Lenders do not understand MSMEs
Obviously, this is a volatile period and we have to do something about it. And there was obviously massive policy support which was coming. We may argue that something was sufficient or insufficient, but it was there. Among lending institutions, we were witnessing a complete aversion to offer MSME loans. There is roughly a $600 billion lending gap because lenders don’t understand MSMEs. If you don’t understand their revenue, their expenses, their non-homogeneous nature, geography or everything, then how do you lend to them?
Fortunately, we now have a tripod of data in India from GST, banking, and bureau. Using historical data and the current data, we created a program in June 2020 called Sanjeevani. It was named Sanjeevani because we took inspiration from the Ramayana story of herbs that revived Lakshman. Obviously, our size is relatively small. In spite of our capital size, the method helped us extend a supporting hand to MSMEs by providing credit.
As a lending institution we lend to receive back our money along with the interest. We did two things. One, we started taking from every prospective customer GST and banking data pre-pandemic and post-pandemic. We created an algorithm that analyses the turnover on GST and cash flow on the banking to see the MSME is reviving or not. We are a sector-focused lending institution — we focus only on 8 sectors or 100 plus subsectors.
Use technology, data for MSME loan approval
We created a mortality rate. Within hospitality sector, for example, we calculated that a banquet hall has a mortality rate of 10, which means it won’t survive. Fast food chain has 1 which means it would grow back and we applied mortality rates to the trend of cash flow. And basing that we created eligibility and started giving credit. In July, we disbursed around Rs 260 crore, and in August, the amount went up.
It’s all about having faith and being able to support. So, in a stress scenario, both the government and corporate sector, especially lending institutions, have to be innovative to provide support. I continue to believe that India will not achieve its aspiration to become a $5 trillion economy unless the contribution of MSMEs rise from the current 30% of the GDP to more than 40% and employment from MSMEs from 11 crore to 20 crore plus.
Large corporates continue to concentrate on big clusters. Small businesses are mostly in tier 2, tier 3 towns. The recent change in policy that classified retail trade and wholesale trade would change the trajectory of MSMEs and the support that can go to them. It is a massive change and people are not realising. I wrote an article on Policy Circle that contained the concept of CDGS — credit through digitally enhanced guarantee structure. Small businesses have been hesitant to invest. If you go asking small business for GST data, will it be helpful? They will say no. If you incentivise them, you can do a virtual profiling of customers.
Today, the government has a scheme wherein up to 75% of the loan is guaranteed. You change that scheme like every small business that has an increasing trend on its GST, increasing trend on cash flow and an increasing trend on employability will get 100% loan guarantee. Digitisation will allow doing that, and even if the government takes a total loss of say 5-6%, the increase in the revenue just from GST would compensate for it.
100% guarantee a win-win for govt
So, if you have a 100% guarantee scheme for small businesses, the amount of liquidity which is there in the market would start going into MSMEs. With capital support, they would start recovering. Even if the 100% guarantee scheme for MSMEs fail, it won’t make the government insolvent. But it could unleash animal spirit of the economy. So that’s what I would say is broadly what is required. We are too small to make a real big impact, but we are doing as much as we can.
In India, companies with a turnover up to 200 crore are also considered small businesses. But the universe which we look at are companies that have turnover below Rs 5 crore. Our view is actually facilitation, because these small businesses are led by an entrepreneur whose livelihood is dependent on it.
What we have seen in the two waves of the pandemic is that while every time the pandemic hits and there is a lockdown, their ability to pay back drops dramatically. But in same way, their recovery is V-shaped and extremely fast. This is because the small businesses are made to survive. That’s the core difference between them and a mid-size or large corporate. Mid-size corporates and large corporates, by intent, want to do restructuring, want more moratorium, want more money.
Small businesses want to survive because they have a livelihood attached to them. It’s about an entrepreneur’s personal reputation and good will. Think of a tier-3 town where in a small business, a merchant running a shop. He just cannot afford to go out of business. Because of the social stigma attached to that forces them to survive. So, if you have the ability to support you should, even though government is unable to provide direct balance sheet support.
The liquidity is available in the market and what you provide is off-balance sheet support. That’s why I said it is in the government’s benefit to make sure that this segment recovers fast. I define policy makers as not just politicians, but also the people who actually guide politicians write the policy. In my hometown, we used to call them babus. The problem at that level is that they start getting worried. When the emergency credit line was coming up, somehow, I was consulted. They wanted to come up with emergency credit line with a 75-85% guarantee.
I said it won’t work because you are expecting a bank to lend in the middle of a pandemic with 15-20% risk associated with them. They have no reason to do it. Because if it’s a public sector bank, somebody will penalise them two years down the line. Private sector banks are responsible for their shareholders and won’t do it. That’s why the emergency credit line has up to 100% – and see its impact. For a period of time if government shows the courage, it won’t damage the government’s balance sheet. And it has the potential to help the economy revive at a fast clip.
(Shachindra Nath is Chairman and Managing Director of U GRO Capital, a technology-focused small business lending platform based in Mumbai. This article is the reproduction of Mr Nath’s speech at a conference conducted by Policy Circle.)