Micro, small and medium enterprises staring at enduring financial distress

Last week, the Parliamentary Standing Committee on Industry made a case for extending the repayment period under the Emergency Credit Line Guarantee Scheme (ECLGS) up to seven to eight years, from the current three to four years. The scheme was rolled out in May 2020 as part of a relief package for micro, small, medium and small enterprises (MSMEs) at a time when they were reeling from stress caused by the pandemic.

The committee’s announcement was not unexpected, for Finance Minister Nirmala Sitharaman had said so in her Budget speech — but this lifeline was to be alive only for another year, until March 2023. So, how bad is the situation that MSMEs find themselves in, now that a longer time-frame for squaring off the support availed under ECLGS is almost on the table? Well, it’s a sensitive issue.

Says Rajkiran Rai G, managing director (MD) and chief executive officer (CEO) of Union Bank of India: “MSMEs may not have to go through another spell of pain. They will be able to pass on the increase in raw material costs to a great extent, and bring down operating costs as well.”

Rai explains that the ECLGS was mainly meant to supplement the promoter’s equity: “During the pandemic, they incurred losses, reducing many firms’ equity capital. Bank borrowings have also to be repaid as per schedule. So, for the first few years, they can repay bank loans and then settle the support they took under ECLGS.”

Others are not so optimistic, however. While the moratoriums on servicing loans extended by banks are for varying tenures, Karan Gupta, director, financial institutions, at India Ratings and Research, believes that “beginning Q3FY22, a portion of advances under ECLGS and restructuring schemes will start exiting moratoriums, a part of which could prove difficult to service, and hence, will reflect in slippages.”

How deep is the cut?

The union minister of state for finance, Bhagwat Kisanrao, in a written reply to a question in the Rajya Sabha last Tuesday, said that the National Credit Guarantee Trustee Company — the agency which operates the ECLGS — had supported 17.87 lakh businesses which had utilised the fully-guaranteed collateral-free loans; and, of these, 95.21 per cent were MSMEs.

It also needs to be mentioned here that the Parliamentary Committee also wanted the moratorium period under the ECLGS to be extended by at least two years. Another fact: Sitharaman, while extending the ECLGS up to March 2023 in the Budget, had upped the guarantee cover by Rs 50,000 crore to Rs 5 trillion. Put all these points together, and the picture that emerges is not rosy by any standard.

“The entire manufacturing food chain is under stress. You should also remember that many small businesses supply to other such entities too. So, it’s not that one part of the chain is insulated from the stress,” points out Y S Chakravarti, MD and CEO of Shriram City Union Finance. “Working capital cycles have gotten longer, as it takes anywhere between 90 days and 300 days to get paid for your job order — be it by private firms or state-run entities. It’s tough.”

This puts a massive amount of pressure on working capital cycles, and is an issue that had been flagged by the Report of the Expert Committee on MSMEs, submitted in June 2019 (the committee was headed by the former chairman of the Securities and Exchange Board of India, U K Sinha).

This report had observed that MSMEs faced delays in payments from private companies as well as state-run entities and government agencies — at both the Centre and the states — because of their low bargaining power. It worked out the average debtor days over the two-decadal period 1997-98 to 2017-18, based on the Center for Monitoring Indian Economy’s data in the absence of other credible sources.

 

It considered 15,000-20,000 companies each year, of which the smallest size-class (10th decile) was used to get close parity with the definition of MSMEs. Some 1,500-2,000 companies were in the smallest size-class (10th decile) across the years. Size-classes were defined using net-fixed asset value as a proxy for investment in plant and machinery.

MSMEs are being played

The data showed that the average number of debtor days for MSMEs had been consistently in excess of 90 days, and that the gross working-capital cycle (days) for these firms was always 300 days (“very high”, according to the report). “This led to a high inventory-turnover ratio; and the very small bandwidth available from the creditor made things worse,” the report observed.

In effect, buyers “tend to use MSMEs as an alternative to banks”, have an incentive to raise objections, and point out errors in bills that had been submitted, in order to avoid payment. Also, strict legislative measures mandating payment within a specified number of days (and penalty in the form of interest) hardly had an effect, as MSMEs feared loss of business, if they were to complain.

What was most unusual was the severity of the cure suggested: “Naming and shaming are being used quite effectively in countries like in the UK and other European nations.”

What’s adding to MSMEs’ woes is that the Trade Receivables Discounting System (TReDS) platform — an electronic platform for facilitating the financing and discounting of trade receivables of MSMEs through multiple financiers — has also not delivered in the way it was meant to.

“It’s been observed that MSMEs don’t publish their invoices on TReDS platforms despite having the registration, due to unsaid pressure from corporate buyers,” says Ketan Gaikwad, MD and CEO of the Receivables Exchange of India Ltd (RXIL). He’s brutally frank: “Buyers don’t approve the published invoices, which defeats the entire purpose of these platforms, as banks can’t fund such invoices.”

The RBI’s guidelines on TReDS categorically state that an invoice has to be accepted by buyers before they can be financed by banks. And not many are aware that RXIL is a joint venture between the Small Industries Development Bank of India — the apex financial institution for promoting and financing MSMEs — and the National Stock Exchange of India.

All this was well before the impact of the Ukraine conflict, followed by the huge disruption in global supply chains, the search for alternate shipping routes and the clogging of ports in China. Add to that higher fuel prices, and the attendant pass-through effect on inflation, leading to a firming up of interest rates, and you have a perfect storm in the making.