MSME Funding Package of Govt of India – A Critical Analysis
MSMEs are offered a financing package to overcome pains from COVID19 lockdown. The package is not universal and likely to have limited impact on the segment.
Govt of India recently announced a scheme for supporting MSMEs who are affected due to sudden lockdown and resultant total disruption of their money flow on account of COVID 19 pandemic.
The package comprises the following:
- ECLGS Scheme -Three lakh crores collateral-free automatic Loans, with a tenure of 4 years, which will have a one-year moratorium on repayment.
- Rs 20,000 crore subordinated debt will be provided for stressed MSMEs under the ambit of CGTMSE.
- To set up a Fund of Fund with an outlay of Rs 10000 that will create a total of Rs 50000 crores of equity for MSMEs
The package apparently sounds very good. It is felt that these measures require critical analysis.
ECLGS Scheme- Three lakh crore loan scheme:
The highlights of the scheme: It is available for those who have SMA 0/1 gradation and obviously SMA2 is not eligible. It is guaranteed by NCGTC, a central govt entity meant to undertake credit insurance activities. The term of the loan is 4 years with one year repayment holiday. It is a cash loan without any requirement of drawing power. The package restricts its relevance for those who are already having a loan as a top-up.
It does not cover those who do not have a loan but require some support to transition through the painful situation and the next two quarters are crucial for them.
It is not a collateral-free loan. Rather it is said that fresh collateral will not be asked. It implies that the collateral security already given will be extended to a new loan and added to that there will be an additional cover of guarantee.
The product is extremely risk-averse: In the event of default, the guarantee cover will be relevant only after executing the recovery action against the securities extended. Against this backdrop, one can easily assume that the relevance of guarantee cover is very minimal. It may be useful to those who already availed under CGTMSE scheme (Maximum of Rs 2 crores).
To set up a Fund of Fund(FoF) with an outlay of Rs 10000 crores that will create a total of Rs 50000 crores of equity for MSMEs
Along with the above, Govt. made an ambitious announcement of setting up funds to provide equity investment to MSMEs. It has proposed to set up an FoF of Rs 10000 crores.
There are two issues here- Mechanism of FoF and past performance of Govt’s FoF
Mechanism of FoF: Whenever I interact with MSMEs they have an impression that Govt will be providing equity capital support of Rs 50,000 crores. Hence I found it is better to clarify the exact position in the matter.
In this scheme, Govt will provide 10000 crores to a notified organisation most likely SIDBI. In turn, SIDBI will invest this money in daughter funds. Here the daughter funds are private equity/venture capital funds set up by private entities. These entities will have to secure 80% of the fund on their own and then only they will be eligible to secure balance 20% from this fund.
In the ideal situation, this should lead to the creation of an equity fund base of Rs 50000 crores.
To check the reality, it is better to review the similar scheme of the Govt in the recent past.
Recent History of Fund of Funds Set up by the Govt of India:
Upon assuming power NDA Govt announced an FoF of Rs 10,000 crores to support startups. Even after six years of existence, the performance of this fund is abysmal.
Under that fund as on 18th February 2020, SIDBI has committed Rs 3,123.20 crore to 47 SEBI registered alternative investment funds (AIFs). These funds have raised a corpus fund of Rs 25,728 crore. This information is shared by none other than Mr Piyush Goyal Miniter of Industry & Commerce.
The Minister’s statement is the pointer to what will be the fate of new FoF that they are proposing.
It is unlikely to garner the interest of PE/VC funds to participate in the FoF because they may not be comfortable with the conditions which are normally associated with Govt money and it is just 20%. Secondly, the impact will be felt in the very long run and not in the immediate future to help MSMEs to beat the challenges from COVID 19.
Rs 20,000 crore subordinated debt will be provided for stressed MSMEs under the ambit of CGTMSE.
Govt proposed a new fund to help MSMEs in distress to revive their business. As per the press statement, each entity will get 15% of their equity capital as subordinated debt to the maximum of Rs 75 lakhs.
It implies that an entity having a capital of Rs 5 crores will be eligible for Rs 75 lakhs. Secondly, it will be restricted to limited companies or may require conversion of the firm into a limited company to become eligible to issue subordinated debt papers to investors (In this case banks).
It is a welcome step for one reason. For the first time, the Govt made an attempt to identify potentially viable firms through policy and fiscal support. Instead of whitewashing the stressed businesses as bad people and emphasising to recover through various means leading to the destruction of the economic value of the enterprises.
However, given the magnitude of the stressed assets in India and the size of the scheme (Rs 20000 crores) is disproportionately low. The govt’s commitment (not necessarily an investment) will be Rs 4000 crores in this scheme.
Govt should lead by committing more own resources:
One thing that is apparent in these measures is that Govt is not providing leadership in the crisis time. Govt has turned risk-averse. Instead, Govt is satisfying itself by creating a scheme that is aiming to transfer the risk on one hand and deflate the interest rate to public depositors whose money banks are supposed to protect. If Govt can’t, the banks which are already having strained balance sheet may not be able to serve with full vigour and assist MSMEs to overcome the challenge from lockdown.
Another point is Govt is abundantly cautious and maybe fearing that the facility may be misused. Against the backdrop of their own fierce campaign against misuse of banking facility during the previous regime, they are treading cautiously, it appears. Secondly, Govt is not parting with money in any of these measures and sounds extremely vary of rating downgrade by the international rating agencies. Hence they are trying to do without expressly committing any monetary support.
The measures announced so far not enough to support the MSMEs segment. It is not universal and not reflective to address the needs in sufficient quantity. If Govt chooses tread carefully, who else will bear with the risk that too when the COVID spread is getting severe.
COVID 19: The key risk for MSMEs- Liquidity or Solvency?
Post lockdown there is confusion about MSMEs’ real challenge- Is it temporary liquidity mismatch or long term sustainability.
Recently RBI announced a relief of moratorium (to pay EMIs) to businesses for three months. There was indeed a sigh of relief for many MSMEs as the cash flow is completely dried up and the obligations are firmly staring due to sudden disruption under COVID 19 lockdown. In addition, RBI also extended the relief from NPA classification for three months for the accounts in arrears.
They are welcome steps but will they suffice? Whether MSMEs will revert to normalcy even if the lockdown is removed now and economy return to normalcy immediately.
Because each industrial segment has its own timeline to return to normalcy assuming every other factor is constant, and COVID19 will be at a manageable level.
Recently, Mr Deepak Parekh, an outstanding public personality and thinker said that the recovery may not happen at least for the next nine months. He also urged RBI to extend debt recast to enable the businesses to cope with the challenge.
I believe that it may take three quarters or more before we can see the normalcy returning to pre-March 24 level(the date of announcing the lockdown) in view of the steep demand destruction and uncertainties in the general economy that may lead to restricted consumption and investment.
If the general the situation should persist for such a long time, then obviously the question is whether the challenge for MSMEs is of Liquidity(cash crunch) or its solvency (survival).
It is indeed solvency. The measures announced by RBI will not be sufficient to save the MSMEs from distress.
The present measures ( Moratorium and Suspending NPA classification) will last till May 2020. It requires one to think of the possible solutions in a longer-term horizon. We are of the view that the policymakers need to extend more measures and options to deal with the crisis and to take away the pressure points in the relationship between creditors and borrowers.
What are the other options?
a) Debt Restructuring
b) Resolution support
Debt Restructuring: Debt restructuring is beneficial in the long-run to save from the distress and create breathing space to mitigate the impact of sudden disruption. MSMEs must look at this option without any hesitation. However, they have to have a properly drafted debt recast plan to realise its value.
Present debt restructuring scheme is available to those whose accounts are classified as standard and not availed the scheme earlier. This will last up to December 2020. Govt may prevail upon RBI to allow those who had already taken before this CoVID-19 event to help them as well.
In any case, it is desirable to wait (to apply) until the clarity in the situation emerges, maybe till June /July or before the account turns NPA.
Resolution Support: There are many firms which have been sustaining their business on informal sources and even the suppliers also extend credit to them. Some of the MSMEs are used to funding the business through multiple business loans from different banks and NBFCs. In the present circumstances, people with diverse borrowing practice will suffer the most. Their numbers are not few. Bank loan restructuring scheme won’t solve their problem.
Supporting these organisations is important because they are huge in number and secondly they play an important role to facilitate return to normalcy in the economy.
The revival of these debt-laden yet potential firms require a different approach. The normal debt restructuring is not effective to help them sail through. There is a need to create a new roadmap within the existing institutional and policy measures.
Govt may help them by leveraging two instruments: Reactivating MSME revival framework and using the service of Insolvency Professionals to create a resolution framework.
Govt of India in the year 2015 came out with a framework to assist stressed MSMEs to undertake a Corrective Action Plan(CAP) to give the second lease of life. It is titled as “Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises (MSMEs)” In consonance with this framework, RBI came out with new regulatory guidelines in 2016 ( ref: RBI/2015-16/338 FIDD.MSME & NFS.BC.No.21/06.02.31/2015-16 dated March 17, 2016 )
This framework is quite comprehensive. A little bit of clarity and more inclusivity of interested persons /stakeholder will definitely help to find a viable solution to through resolution.
Some of the rules can be simplified For example it asks for forming a committee at the bank level to consider the cases and classification of the loan restructured as NPA. We suggest that in place of the committee, Certified Insolvency Professionals who are specially trained and certified to handle the cases of distress may be roped in. Insolvency and Bankruptcy Board of India (IBBI) has empanelled a large number of professionals countrywide.
This special pool of competent people may independently assess the viability and bring on board all the interested persons to create a solution that will work at the grass-root level.
Another point is keeping the asset classification standard will obviously incentivize Banks and NBFCs to opt for this route.
Lastly, any resolution requires all the stakeholders to accept the longer timeline to recover their dues. Also, this mechanism may require that Banks and others commit to a lower rate of interest for the past as well as future. Still, it is a better option than One-time settlement that calls for a deeper haircut and causes permanent damage to the credit history of the borrowers. Whereas reviving potential business asset leads to the huge economic multiplier effect.
The situation is alarmingly different. Explicit policy support is the need of the hour. Without active policy support, many of the MSMEs may not sustain in the long run. Govt needs to bring a comprehensive broad range of options to support the distressed entities to overcome the challenge posed by COVID 19 crisis without any element of uncertainty. It is because what MSMEs are facing is not just immediate liquidity risk alone but also long term solvency.
Covid 19- Banks need to be more flexible to support the businesses
Evolving scenario due to Covid-19 endemic is creating a huge liquidity crunch for many businesses especially MSMEs. Banks should support by extending loan with very flexible terms.
Post lockdown announced by the Hon’ble Prime Minister, the economy suddenly came to grinding halt. There are hue and cry in the business community for a rescue package to help them to overcome the challenge they face in managing the cash flow. In response, RBI Governor on March 27, 2020, announced to extend the moratorium on loans.
Alongside few Banks have announced schemes to support the business to tide over the acute cash crunch.
Against this backdrop, we reviewed the CoVid-19 loan of few banks on how they support the struggling businesses.
COVID-19- is an uncertainty based risk:
The present global crisis triggered by the Coronavirus outbreak is one of its kind never seen since the organized lending (under the regulatory oversight of central banks) is started in the global economy. The pandemic is not a routine risk confronting the businesses. No positive probability can be assigned to estimate the likelihood of recurrence. It is an uncertain risk and can be classified as an act of god. In other words, it can be described as a force majeure event.
Since it is a special event and an extraordinary situation is developed and still evolving. Its longevity, spread and impact are still unclear. The world economy is entering into uncharted water and does not have the capability to estimate the impact.
Hence the situation demands special attention to those who need help to stabilise the economy by supporting the economic enterprises to prevent their collapse and or value destruction due to their inability to adjust to the new challenge. It is more pertinent to the MSME segment who are shouldering the social burden of engaging unorganized & semi-skilled labours and largely financially weak to navigate the challenge from Covid 19.
Banks have an important role to bail out the business in the scenario
The circumstances we are discussing is extraordinary and the global community never experienced this in the past. It needs special attention. The consequences on the business as well as finance providers are needed to be handled with the utmost sensitivity to the people who are affected.
RBI and Banks are responding well. Many banks have shown an inclination to assist the businesses in many ways. We have been seeing the press publications of special loan products launched by the banks in India to help businesses to tide over the cash crunch. Their enthusiasm is amazing.
I had a chance to review the special COVID 19 loan products launched by three banks recently. Though the narrative signifies the commitment and concern for the businesses affected, the finer reading of the products is highly disappointing.
Out of three banks, two are major nationally important banks and. The glaring aspect is- products seeks to limit the eligibility to those customers whose account/s is graded SMA0 only. (SMA0 grade indicates the account which is a standard asset in the books of the bank and not having any adverse features in the operation. Other two categories are SMA1 and SMA2. These two categories are also standard assets but suffer from some deficiency in meeting their commitment on a timely basis).
There are two important points which negate the relevance of the Covid-19 loan products of these banks:
a) Narrow scope: Limiting the eligibility to SMA0 means exclusion of a very large section of the borrowers to get accommodation, especially MSMEs. They lack the financial flexibility to remain SMA0. It is quite likely that banks mightn’t have made an assessment of what proportion of their customers will be eligible. As a result, this product is just a narrative than a source of comfort in the trying circumstances for many.
b) The product does not recognize the evolving scenario: In the global crisis like the one we are witnessing, the risk across the asset class converge as we had seen in the Global Financial Crisis in 2008. In other words, the riskiness of SMA0 and SMA2 will be the same in this scenario. The distance between these two asset classes is not significant enough to predict the better default probability. Because they are going to confront the challenge in almost equal level. If the business scenario deteriorates and the default chances will be almost the same.
In the nutshell, the products of two banks have narrow relevance and have ignored an important aspect- how default probability will behave in the face of evolving uncertain scenario. Unless it is made more inclusive and having flexible terms, there are high chances that many of the standard loan accounts may not be able to navigate the challenges, especially in MSME space.
Businesses are confronting a very unique challenge and scenario is going affect them in almost equal measure for a large section of the business community. Banks need to structure the Covid-19 loan products to make it relevant to bail themselves out.
SMEs in Distress- Beware of ‘Soldiers of Fortune’
When in distress, many SMEs chase new money and normally end in traps of mischievous elements who make tall promises and swindle money.
I recently met one entrepreneur after a gap of two years. Once he had a flourishing business in excess of Rs 50 crores. He had built the business by himself brick by brick. Having come from a middle-class family, despite the success, he stuck himself to the higher values-Extremely affable, god-fearing, and committed to meet promises.
The back to back the introduction of policy measures – Demonetisation and GST-pushed him to the slippery position. Before he could make the required changes in the business process and financial management, the situation went out of control. The liquidity stress started appearing and he started defaulting on the payments resulting in personal insinuations from the providers of loan and suppliers which he never experienced in his life. On the other hand, the trade cycle got disrupted and order flow dried up as his principals started realigning their business to adjust to the new reality.
While he was battling in multiple fronts he started getting offers for a comprehensive bailout. Obviously these offers attract him as he was already exhausted to deal with demand from various people.
They offered to arrange a very large sum and consolidate the borrowings into a single source along with a very attractive rate of interest much below the RoI applicable to well-rated borrowers despite being highly stressed.
The waiting is still on…
Unfortunately, he is still hoping for the new money ever after two years. In the meantime bank and NBFCs have initiated recovery action against his properties and have been establishing their rights. The business is closed and the family is living with agonising pain and praying for better days.
It is commonly observed among the entrepreneurs in distress:
Most of the entrepreneurs in financial difficulty look for quick solution fearing that continued distress may affect the business and their reputation. Having pledged every asset to lenders they fear the impact of distress much more than what it really is. That in turn, prompts them to seek an instant solution. They tend to react to any proposal with much more intensity and avoid confronting those mercenaries to understand their credentials.
Fortune soldiers- Mercenaries who boast about exclusive access to money:
These agents claim that they have an exclusive arrangement to secure money at very soft terms. They show a lot of empathy and promise to work for clients with all the sincerity. If we analyse the experience of interaction with these fortune soldiers there are commonalities in their approach. Some of them are :
- They present as if they enjoy a high degree of confidence of the financiers.
- They seek very small fraction as advisory fee and a still smaller fraction as advance
- Terms are so compelling to justify taking risk of giving advance
- The advance will be packaged as a commitment fee or insurance premium to bring the money from abroad etc
- They do not reveal much about the financier.
- They prop up the names of people in higher offices
- They set the meeting in very premium places
Eventually, their target is to extract advance as much as possible, keep giving excuses to frustrate and eventually make one go away.
Entrepreneurs are more vulnerable in India for financial distress than in any other country:
The options for turnaround are limited in India. The general perception of the stressed enterprise is highly prejudiced. Many see them with suspicion of laundering money from the firm. Being in stressed and struggling lonely, entrepreneurs are obviously vulnerable.
Many take risk of giving the advance in the hope of getting a large sum. Unfortunately, many entrepreneurs have lost a huge sum of money in their hunt for fortune.
The greater damage will be when an entrepreneur diverts his attention to chase this route and keep away from immediate tasks. Lack of credible proposal may prompt recovery action leading to the collapse of the business and destruction of enterprise value.
How to deal with this situation?
If anyone offers a deal which is cheaper than a bank loan, it is to be examined thoroughly before committing. We have not still come across a charity extending helping hand to distressed businesses.
Entrepreneurs should desist from the temptation to seek quick money and allow them to be drifted away from reality. It is nothing but a distraction to find a viable solution within their reach and exacerbating the distress.
Keep your attention to immediate tasks such as talking to creditors and suppliers.
Many a time we falsely blame the absence of money for our distress. However, the fact is that most of the reasons for distress lie elsewhere and pumping more money won’t solve the problem.
Review the business strategy with the support of professional advisors. With professional assistance, you can build a new roadmap and lower the risk to sustainability. When an outsider is roped in, fresh scrutiny will open the mind to explore alternatives.
Distressed entities require better policy support:
MSMEs need better implementation of the law to assist entrepreneurs to undertake course correction. Unfortunately, half-hearted implementation of regulations to support distressed entities in India is preventing entrepreneurs from taking an orderly path to turnaround. This will naturally make them fall prey to unscrupulous elements.
The Insolvency and Bankruptcy code needs to be made universal. The option of restructuring of loans should be enforced upon all the banks(public/private) and NBFCs.
In the present era of globalization, the vulnerability for risks is unlikely to recede rather likely to go up. Thus a stable policy environment is needed to support the turnaround of distressed entities. Also tagging prejudice of criminality with distress situation must end.
Entrepreneurs in distress should appreciate that there are no short cuts to come out of it. Recovery from distress is an orderly process and time consuming requiring one to review in entirety and draw a new strategy.
Anil Kumar Shetty, Founder, SME Advisors