Why focus on MSMEs?
One of the key factors that can determine the progression of achieving higher goals pertaining to sustainability is the economic well-being of an individual and the family.
It is a conundrum that the poor hardly contribute to the carbon footprint while the rich account for the maximum.
This does not mean that the goal of achieving economic well-being of people can be sacrificed in the process of getting the rich to walk lightly. This will be tragic.
In order that large populations are lifted out of poverty it is critical that Agriculture & Small Scale Enterprise start thriving since these two sectors employ a humongous number of people.
It is only when all achieve minimum economic wellness will environmental sustainability make actual sense.
In this article, we shall focus on the Indian Small Scale Manufacturing Enterprises, popularly represented as MSMEs, and address a few pain points that can make a difference to them.
MSMEs have endured a legacy of suffering due to various reasons – bad infrastructure, poor governance, license & inspector raj, lack of support by financial institutions, lack of skilled human resource and so on.
The business environment is better now but not good enough. MSMEs are still in stress and this has left them extremely vulnerable to economic downturn.
It is extremely critical that the Indian Government (including State Governments) & the institutions such as Reserve Bank of India(RBI) address MSMEs’ pain points on a war footing.
Amongst the biggest problem that MSMEs face is the management of cash flow.
Why MSMEs face Cash Flow crisis?
1) Banks have either little understanding of the specific nature of the business or just do not care.
For instance, Manufacturing and Production need to be defined as different verticals. The former is project based and the latter is recurring or repetitive in nature.
For example,
A Tool Room is a manufacturing business. This is project based. Every order is a project and it may take anywhere between 3 months to 12 months to execute an order. Every tool has to go through several qualifications and approvals before it is approved for Billing. Banks need to classify these as manufacturing business. There is no mass production here. The nature of recurring revenue is different here & not easy to predict. Manufacturing business, presently for various reasons, cannot operate at more than 65% operational efficiency. Working capital and long term Capital expenditure would need to be customized to the nature of the Tool Room.
Injection Molding is a Production business. A Tool is loaded on to a machines and parts mass produced for periodic supply. The recurring revenue pattern is much more predictable here. The working capital and capital expenditure assessment would, again, need to be customized for the nature of the business here.
2) Banks follow a standard method for both working capital and capital expenditure assessments. As explained in the above point, elements of the nature of the business need to be considered in these assessments.
3) In most cases, Banks demand Land & Building as collateral and fund up to 80% of the collateral value. However, Promoters do not carry an inventory of Land & Building and enhancement of both Working Capital and long term finance needs of MSMEs get completely stifled. Finance under schemes such as CGTMSE are blatantly refused or severely restricted by Banks.
4) MSMEs have a receivable cycle that can vary from 60 days to 150 days. Every negative impact in the economy puts a stress on receivables.
5) Banks are never prompt in enhancing working capital needs of the MSME and do not respond with speed to capital expansion needs as well. So, there is always a big funding gap.
6) This funding gap is to a large extent covered by raising finance from non-banking sources at high interest costs. So, any MSME will have a portfolio which has the high cost private finance component progressively occupying a higher share.
7) Modern businesses have become extremely capital intensive. On every INR 100 invested on a machine, at least INR 50 needs to be invested in supporting infrastructure & resource (such as Quality Control equipment, Coolers, Driers, Exhaust, Warehouses, Inventory Rooms, Storage, Software etc.) which is not directly productive. Financial institutions do not take a holistic view of this at all.
8) The labour laws also impose severe restrictions on the bandwidth of MSMEs.
9) Industrial Land is also not available at reasonable cost and even if purchased, the infrastructure development by local development agencies takes years if not decades. Connectivity is a big problem always. The rental values in cities are extremely high.
10) Shockingly, the Power tariff & deposits are very high for industries. This has a big impact on competitiveness. At least 25% of power is generated through Gensets and this aggravates the problem.
11) Skill gap is extreme.
One can add many more points but the above is quite indicative of why MSMEs are under so much stress.
Possible solutions:
A few simple policy measures that can mitigate many the causes of stress indicated above, are stated as under:
1) Revised Loan Tenures:
Make fresh & existing Term Loan tenures as 15 years. Production & Manufacturing needs patient capital. Banks must be asked to convert current term loan residual Principal amounts to 15 year term with revised EMIs. This will give a big cash flow relief to MSMEs without compromising the Bank’s financials. This is an easy decision since there is no financial subsidy or dole suggested but only spreading the loan over 15 years. Policy may need RBI approval.
2) Resetting Collateral Limit:
Land and Building as collateral can be set at 50% of limit and should be applicable only for Working Capital. Further, CGTMSE is made available by Government up to INR 2 crores. Only after exhausting this should the Land/Building collateral be used up for coverage.
Example: Let us assume that a Land and Building collateral of INR 3 crores is available. Such an entity should be eligible for a total working capital coverage of upto INR 8 crores of working capital (i.e. INR 2 crores CGTMSE + Twice of INR 3 crores land/building).
The Government can increase CGTMSE limit by INR 25% every year for units with good credit track record.
3) Proofing against NPAs:
Since, the loan portfolios of MSMEs now have a large component of very high cost and lower tenure Business Loans, Banks must take over these Business Loans under norms suggested in (1) and (2) above. Else, the cash flow load imposed by these loans on MSMEs will cripple them to either shut down or become a NPA. This is already happening.
4) Sectorwise collaterals:
For machinery, the collateral should only be the equipment itself. This should not be underwritten by Land & Building again.
5) Introducing a new Index:
Make half yearly automatic enhancement of working capital norm based on an index. The index can comprise of the following factors:
a) Top Line growth
b) Capital Expenditure
c) Increase in manpower.
d) Increase in floor space of factory
e) Quality Certification
f) Credit Rating
h) Environmental Management such as ISO 14000 standards.
This needs an algorithm and an expert group can be drawn from Banks and Industry to arrive at a suitable algorithm.
6) Introducing Patient capital Fund:
Create an exclusive fund that can invest patient equity capital in Tier 2 and Tier 3 manufacturing firms. Between INR 1 Crore to INR 10 Crores. This will enhance empowerment of Promoters to focus on opportunities without being bogged down on worries of being constrained by capital & ability to raise
7) Skilling Program:
Create a skilling program directly in collaboration with selected high precision Tool Rooms all over India.
These simple 7 steps can be a game changer for MSMEs in India.
A robust MSME sector is essential for a developing country like India which has youth as the majority of the population. It is critical that the energy of the youth is channeled purposefully so as to build equity in society. MSMEs also constitute the most dominant portion of supply chains.
Hence, it is a clear case that MSMEs can help achieve the potential of demographic dividend that the young people offer, while continually adopting sustainable practices that can impact environment in a big way!