The vulnerability of MSMEs to policy shocks needs urgent attention

Policy shocks like Demonetisation and GST bring to the fore a need for a mechanism to assist distressed MSMEs to secure a new lease of life.

On November 8, 2016 Mr Naredra Modi, Hon’ble Prime Minster announced a policy measure of demonetisation.

The entrepreneur was not prepared for the kind of action undertook by the Govt. The industry (real estate) had a huge shock. There was utter chaos in the market. The planned business did not accrue. However, the loans raised to set up the new unit started coming up for servicing. As there is no liquidity to service the loans due to lower sales, he started feeling the heat of distress.

He was in dilemma with regard to keeping the full labour force. If he asks them to leave, his fear was that he might not get skilled labour once the industry revives. This adds to more operating cost without much business leading to operating loss.

Left with no choice and unable to bear with pressure for servicing EMIs, he started borrowing from money lenders at an exorbitantly high cost, hoping that business sentiment would revive in the immediate future and he would be able to come out of distress.

Waiting became longer, reached a stage of inability to service the debt. The bank loan becomes NPA and they served the notice under SARFAESI Act.

As he was struggling under the impact of demonetisation, there was another back to back policy decision that also hit him hard like many other entrepreneurs. That is the introduction of GST that came just after eight months of demonetisation.  This further complicated the financial situation and recovery became a far cry.

Credit Score(CIBIL score) deteriorated. Despite having good collateral security, he could not raise a new loan because his accounts are NPAs.

Though market picked up later, the accumulated debt and lack of liquidity deprived him of capitalising the opportunity. Still, the struggle is on as he is always under constant pressure from lenders and whatever the little earning comes from the operations has been going to service the interest alone without seeing the reduction of principal.

RBI findings echoed the same across the MSME sector:

Recently RBI published its assessment on the recent credit dynamics and export performance of Micro, Small and Medium Enterprises (MSMEs). It concluded that demonetisation led to a further decline in the already decelerating credit growth of the MSME sector, while GST implementation does not seem to have had a significant impact on overall credit to MSMEs. It also mentioned that  MSME exports appear to be affected more by GST implementation vis-à-vis demonetisation.

MSMEs are extremely vulnerable to policy shocks

The vulnerability, also known as the sensitivity/weakness of the entity, represents its negative feature, may lead to distress and destruction of the value of an enterprise. The impact may be the loss of market position, cash flow, image, credibility, the health of entrepreneur etc

In crisis condition, smaller enterprises, in particular, are most vulnerable to financial difficulties, as they often lack the resources to adapt to rapid changes in the economic environment.

It is a fact that a business is able to continue to operate as a going concern following an incident increases with the size of the organisation. There are several potential explanations for this finding. The first lies in management deficiencies that are more frequent in small businesses. The second lies in the strong commitment of the owner to their business and a failure to separate personal and professional affairs. This can lead, in an already critical situation, to a refusal to give up and resorting to funding the business from personal or high-cost informal borrowing. These two points underline that the late detection of the problem or a particularly delicate situation inevitably leads the organisation to liquidation and the family will have to suffer at financial and social fronts.

How policy framework operates for assisting MSMEs segment?

An important aspect which needs to be debated over the crisis like situation in MSME community in India is – how present policy frameworks, aimed to assist proliferation of small businesses, are working.

We have many schemes from central & state Govts like subsidies, investment incentives, allotment of industrial units, promoting ease of doing business, tax breaks for startups etc. Also, there are regulatory supports to extend credit support to MSMEs, collateral-free loans, start-up funds, etc.

All these policies and support schemes are meant to promote entrepreneurship otherwise incentivize people to become an entrepreneur.

Policy support to rescue the MSMEs in distress-unsatisfactory:

Many entities suffer the distress at some point in time in their life cycle. The distress may be due to internal and external factors. Though we have many schemes to encourage new MSMEs, there is no systemic support mechanism to rescue those are in distress and need a new lease of life.

Many of the stressed MSMEs can be turned around with a little bit of handholding and non-ambivalent policy support for revival.

Govt may support MSMEs in the following measures:

a)Expand and simplify the Framework for Revival and Rehabilitation of Micro, Small and Medium Enterprises: This framework from MSME ministry and RBI looks very robust however its application is cumbersome and also its applicability for NPA accounts still unclear. Govt to come out with concrete measures to make it easy to implement and take away the uncertainty associated with the access to it.

Please read Framework for Revival and Rehabilitation of MSMEs- An early stage support for SMEs showing signs of distress.

b)Enlarge the scope of Insolvency and Bankruptcy code(IBC): IBC is also an effective instrument to deal with distress. However, its reach requires to be expanded to make it more accessible. Govt may set up Bankruptcy courts all across the country to expedite the process.

Please read: Insolvency and Bankruptcy code (IBC 2016)- Morale booster for SMEs in India

c)Extend support to distressed entities under CGTMSE: Many units which are having the potential to turnaround require helping hand. In order to encourage banks to support them, the new exposure may be brought within the credit guarantee scheme. This will help MSMEs to overcome transitional challenges especially case like one discussed above.

Please read: Universalising Credit Guarantee Scheme- A need of the hour for MSMEs

It is easy to turnaround small firms:

Small firms by nature are very agile and may prove that they can successfully pass over distress period having certain advantages compared to the large ones:

  • Flexibility – it is often easier for small firms to change the business strategy and even a change of direction depending on the market conditions (exploring new sales channels or new markets).
  • Financial control – is easier to reduce costs in a smaller organization, including moving the manufacturing place or temporary employment.
  • Fast response (rapid reaction) – the entrepreneur/owner is closer to customers than the head of a large corporation; it can infer the spirited mood, try to anticipate what will be required and therefore to act rapidly to keep the customer base of the company.


The economic results of businesses are significantly influenced by the policy changes. Smaller organizations are more likely to be affected by sudden policy changes. However, it is easy to turn around quickly if there a mechanism to handhold them.

There is no comprehensive policy to take care of those who are struggling to cope with the policy changes brought too rapidly without public consultation and sufficient time for transition preparedness.

If we show an inclination to assist those in distress as much as policymakers show for new MSMEs, it will boost the morale of people and will be a propellant for the proliferation of MSMEs in India.