Small can be beautiful: MSME sector gears up for transformational changes

The MSME sector may be on the cusp of a big change if it seizes on the opportunities in financing and protection in getting dues

The Small Industries Development Bank of India’s ‘MSME Outlook Survey Round One October-December 2024’ shows the sector is bullish. The MSME Business Expectations Index – it ranges between 0 and 100 – is consistently above 60 for the next four quarters: From January-March 2025 to October-December 2025. The index reading is above 65, reflecting greater optimism. For January-March it is at 66.35; April-June at 68.83, July-September at 68.93 and October-December at 69.94.

 

And measures in the Union Budget for Financial Year 2025-26 (FY26) may give a fillip to this upbeat mood. “The increase in the credit guarantee cover for MSMEs to ₹10 crore from ₹5 crore is something we have been asking for a long time,” says State Bank of India chairman C S Setty. This is critical, as Setty explains: “Since we are moving from collateral-based lending to cash-flow based lending. There is a need for a backstop facility when we move completely to cash-flow based lending.” Also, for exporters “if they want to put money for capital expenditure, there would be a credit guarantee. They have also reduced the fee of this guarantee to one per cent.” 

 

Enabling business

 

A big leg up, according to Ritesh Jain, co-founder of Flexiloans, is the rollout of an updated Central KYC Registry with AI-based algorithms. As he sees, “the new system will simplify customer onboarding, provide an extra layer of data protection and minimise fraud in digital lending. This will enable lenders to significantly lower acquisition costs.”

 

These measures build on the steps taken in Union Budget FY25 for MSMEs: The move to lower the turnover threshold for buyers to ₹250 crore from ₹500 crore on the Trade Receivables Discounting System (TReDS), an invoice discounting platform. It brought in an additional 22 central public sector enterprises and 7,000 companies into play. On the credit side, banks were asked to accommodate MSMEs even if some of them were in the special mention account category for reasons beyond their control (this was to be supported through a guarantee from a government-promoted fund). Off-record, bankers were of the view that they would not like to run afoul of the supervisory staff of the Reserve Bank of India (RBI). What if such loans were to turn into non-performing assets? And given the forbearance nature of these decisions, they would wait for RBI’s guidance.

 

But that said, according to the ‘Report on Trend and Progress of Banking in India (FY24)’, the revisions in TReDS guidelines (June 7, 2023) enabled insurance for financiers to hedge against default risk, expanded the pool of financiers, and enabled secondary market for factoring units. This led to the number of invoices uploaded and amounts financed moving up; the strike rate in the number of invoices financed improved to 94.4 per cent from 93.9 per cent in FY23.

 

Can more be done for MSMEs? Shachindra Nath, executive chairman and managing director (MD) of U GRO Capital, points to a technical aspect. While the definitional changes will bring in a lot of new firms into the MSME fold “you must remember that within banks’ priority sector lending (PSL) for MSMEs, you now have retail trade also. So, while the footprint of those eligible has gone up, and banks are meeting priority targets, it could be that the money is moving from one bucket to another.” His point: There is a need to incentivise and motivate non-banking financial companies (NBFCs) engaged in MSME financing. This could be done by creating a new category called NBFC-PSL. That would bring both liquidity, lower cost of capital and expansion of credit.

 

At a December meeting at the RBI, the issue of onboarding a million MSMEs onto TReDS was discussed. “We have streamlined digital onboarding through e-KYC and e-signing, reducing delays and helping MSME getting onboarded in minutes,” says Ketan Gaikwad, MD and chief executive officer, Receivables Exchange of India. The integration with GeM (government e-marketplace) and GSTN (under discussion for implementation) will help in the procurement through these channels. “Large buyers, including state-run entities, must ensure MSME participation, with marks for compliance.” 

 

Challenges ahead

 

Yet, what you can’t get away from are the issues highlighted in the 'Report of the Expert Committee on MSMEs' (Chairman: U K Sinha, 2019). It held that most large firms deal with MSMEs on a credit basis; and buyers do not honour invoices on time. MSMEs hesitate to file complaints against large buyers. What you have in effect is buyers using MSMEs as a funding avenue: An alternative to banks. What few say on record is that while discounting systems such as TReDS are changing the game, more needs to be done.

 

The Sinha committee, even as it made a passing reference to the “naming and shaming” being used in the United Kingdom and other European nations, made a case for an Information Utility (IU) to help resolve this problem. IUs set up under the Insolvency and Bankruptcy Code (IBC) and regulated by the Insolvency and Bankruptcy Board of India are a repository of electronic legal evidence pertaining to any debt/claim submitted by a financial or operational creditor that is verified and authenticated by parties thereby making the information non-refutable evidence. For a small user charge, creditors (MSMEs in this case) can electronically file their outstanding or default amounts on the IU and invoke IBC provisions. If a creditor does not settle with an MSME within 45 days, the amount cannot be deducted from taxable income.

 

As on date there is only one IU: National E-governance Services (NeSL) registered with the Insolvency and Bankruptcy Board of India (IBBI). A research paper by Ankeeta Gupta called attention to the fact that only banks are shareholders of NeSl. She believes that “it is possible that companies are likely to feel intimidated by the controlling ownership of the banks over NeSL.”

 

Clearly, much more needs to be done, but the MSME world is in for big changes.