MSME recovery status check: Micro segment trails small, medium peers

While overall asset quality across sectors has improved since pre-pandemic levels, bad-loan ratios for micro enterprises have stagnated

MSMEs are central to India’s growth story. Spanning artisans, rural entrepreneurs, and manufacturers, they account for one-third of the country’s economy and nearly half of its exports, making them the second-largest employer after agriculture.

 

Credit to micro, small and medium enterprises has grown in recent years, but bad loans remain a concern. Bad loans have eased since the pre-pandemic years, but the ratio now exceeds that of industry. The micro segment, which accounts for 84.4 per cent of active MSME credit accounts, deserves closer attention. It trails both small and medium enterprises in asset quality.

 

V Anantha Nageswaran, chief economic advisor to the Indian government, has stressed the need to revise non-performing asset classification norms for MSMEs. Existing norms ignore diverse cashflow cycles and working capital needs, he said, noting that a uniform global framework does not suit Indian business.

 

The numbers bear out his concern. Bad loans across banks have fallen sharply since the pre-pandemic years, but not at the same pace in every sector. Between FY19 and FY25, the gross non-performing asset ratio for the wider industry dropped by 17.13 percentage points. For MSMEs, it fell by 8.11 percentage points. Both improved, but the industry started from a far higher base, moved below MSMEs in FY24 and stayed lower in FY25. 

 

Within MSMEs, micro enterprises have gained the least. Their bad loans declined by just 0.6 percentage point from Q2 FY21 to Q3 FY26, the period for which detailed data is available. Small and medium enterprises did considerably better; thus, the gap with micro enterprises has widened.

 

In Q2 FY21, the bad loan ratio of micro enterprises was only 0.1 percentage point higher than that of small enterprises. By Q3 FY26, the gap had widened to 1.1 percentage points. Compared to medium enterprises, the position has reversed. Micro enterprises had a ratio 0.8 percentage point lower than medium enterprises in Q2 FY21, but it rose to 1.5 percentage points higher in Q3 FY26. 

 

The picture also differs by lender. Non-banking financial companies (NBFCs) had the weakest record among lenders serving MSMEs for much of the period. Their bad loans to the sector stayed below those of public-sector banks (PSBs) for six straight quarters, from Q1 FY24 to Q2 FY25. But the gains did not last.

 

In the very next quarter, the two ratios were equal. Since Q4 FY25, NBFCs’ bad loans have edged up, peaking at 2.7 per cent in Q2 FY26. That makes them the riskiest lender. By contrast, PSBs have improved further, to 2 per cent, while private banks remain the safest at 1.1 per cent. 

 

A recent SIDBI report on MSMEs helps explain part of the problem. It found that one in eight micro enterprises depends on informal credit, while small and medium enterprises largely use formal sources. Only 68 per cent of micro enterprises had access to formal credit, against 85 per cent of small and medium ones. One in four entrepreneurs also reported difficulty in obtaining credit.

 

MSMEs have great potential, particularly in employment and entrepreneurship. Targeted policy intervention in this sector therefore matters most.