SMERA Analysis: The evolution of Indian MSMEs: 2006-2017

The evolution of MSME sector has been very much in line with the development of the Indian economy. Such has been sector’s importance that India established the Small Industries Development Organization in the year 1954, during the first five year plan. Year 2000 onwards, the focus on the MSME sector became even more pronounced with the Government bringing about several packages and initiatives to solve the persistent problems relating to credit availability, technology upgradation, enabling infrastructure and other subsidies. The biggest change was however brought about by the passage of the Micro, Small, and Medium Enterprise Development Act (MSMEDA) in the year 2006. The Act seeks to “facilitate the development and enhancing the competiveness of such enterprises.” With this Act, the Government of India envisions the integration of the Micro, Small and Medium enterprises in order to effectively promote the sector at large. The very definition of an enterprise, incorporating both service and manufacturing units has also been put forward.

Role of MSMEs in Indian economy:

• As of 2017, the country records nearly 40-50 million enterprises operating in the sector; creating employment opportunity for nearly 130 million people
• Since 94% of the sector is unorganized, until recently, no clear estimate was available regarding the sector’s GDP contribution
• However, the Economic Survey 2015-16 has changed all that and has pegged the size of the MSME sector equivalent to 37.5% of the GDP
• The sector records a normalized growth of 4% over the last ten years and will likely remain the growth engine of the Indian economy’s next growth phase

Source: Planning Commission; Ministry of MSME; SMERA Research

Credit Offtake:

Planning Commission of India Estimate for demand of credit by MSME

**All figures in Billion Rupee; Source: Planning Commission of India

• The Prime Minister Task Force Report on MSME has pointed out the criticality of credit to the sector’s future growth and sustainability. There exists a credit gap of over 60% for small and medium enterprises and over 70% for unorganized micro enterprises. As per Government of India estimates, average per unit credit offtake for the sector is nearly Rs. 7.2 lakh and this number is expected to rise drastically in the coming years
• Since the year 2006, with the passage of the MSMDEA, Indian micro, small and medium enterprises have witnessed significant increases in their access to capital. Credit offtake has been expanding at 12.5% on average since 2007 and currently stands at around Rs. 9 lakh crore. While comparing these figures with those of 2006, MSME credit outstanding has expanded by over 200% and the sector maintains its weight of over 12% in total credit outstanding
• India’s erstwhile Planning Commission had estimated that Indian MSME’s current demand for credit is Rs. 37.5 lakh crore; pegging the working capital requirement at Rs. 26.3 lakh crore. Considering the credit gap of over 60%, there is an incremental credit demand for Rs. 28.5 lakh crore (working capital + term loans) in India. The overwhelming dependence of Indian MSMEs on commercial banks and promoter financing has now given way to other innovative funding avenues that are emerging at this time. NBFCs as well as private equity are such alternatives currently very popular among MSMEs. The gap however remains given entry barriers to the Bond market and the nascent equity markets for SMEs

Asset Quality and Accounts:

MSME Accounts with Commercial Banks

Note: Accounts in Lakhs; Amount in Billion
Source: Planning Commission; SMERA Research

Sector Key Takeaways

• The number MSME accounts more than doubled between 2008 and 2011 when credit offtake to the sector averaged 20%. Even though credit offtake has since then slowed down, MSME accounts can safely be assumed to be over 20 million in the year 2016. As compared to that of the year 2008, growth in MSME accounts is recorded at over 300%. This is commensurate with the growth in credit offtake as well as the incremental MSME units coming online. The largest contributor in this growth have been the public-sector banks which are also responsible for over 95% of the entire credit outstanding to the sector
• The Prime Minister’s Task Force Report on MSME envisages a 20% YoY growth in credit offtake for the sector. If this growth is achieved, the supply of credit to the sector might go up to over Rs. 20 lakh crore, almost double of current levels
• However with the current slowdown playing havoc with industry, not only has demand for credit fallen but also supply side constraints have restricted offtake. As of now, public sector GNPA levels are hovering at over 9%, with overall PSB stressed advances crossing the 16% mark. Under pressure from the Finance Ministry and the RBI, banking sector in India might strengthen their due diligence mandates (lending operations) and make it more difficult for the already vulnerable MSME sector to access much needed finances. Expansion and R&D goals will be incidentally held for ransom with stricter credit policies

While considering the results of RBI’s Sustainability Report, credit to MSME sector is however safest and presents a contrarian view to the prevailing situation. As on December 2015, percent slippages of overall loans to NPA category was recorded at 3.2%. Loans less than Rs. 5 crore were the least vulnerable with a slippage percentage maintained at just 2.3%. Modern Indian MSMEs that access such small denomination loans are therefore less susceptible to defaults on loans despite being under severe negative pressures. According to SMERA’s understanding, the following remain the most challenging factors, which inhibit MSME growth in the next phase;

• Non-availability of information, which in turn leads to an information gap does not allow a conducive environment for MSMEs to prosper. Banks, policy makers and other financial institutions must strive to mend this shortfall to unlock unprecedented value in the sector
• Due to their smaller size, MSMEs are rated lower and generally carry a higher risk weight. Smaller entities are perceived to have a lower resilience as compared to their larger counterparts; the belief is more pronounced in the current volatile scenario. Therefore, lending rate is higher for this category by at least 200-300 bps as compared to larger entities
• Compliance and other tax obligations arising due to the implementation of the GST
• Forging alliances and fueling R&D to enter global supply chains

Ultimately, bankers must evolve a new methodology to identify the right MSMEs to lend to. The high potential MSMEs must be segregated and incubated. SMERA Ratings Limited can play a critical role in creation of this methodology. The evolution of the sector is important at this time, given the fact that it is the very backbone of our economy. It is also the Government and RBI’s role to make the MSME sector an attractive segment for disbursement since there is a lot riding on its performance, from both the employment as well as economic growth’s perspective.

Polling Results (compiled from the responses of delegates of SME Activator, 2017)

Percentage distribution of sample size in various category:

Which services are required to scale up your business?

Surprisingly, over 35% of the participants currently cannot assess the scalability of their business. In line with the current slowdown, it is clear from the responses that capex cycle is subdued along with low capacity utilization levels. In light of these circumstances, businesses have not assessed their expansion plans in the near term. Financing however was seen equally important for scaling of operations but the emphasis will be lower borrowing cost. R&D and Skill remains a low focus area for the respondents.

Other source of investments to foray in public markets?

Again, majority of the respondents are not looking for any finances and the demand for other sources of financing remains low. Nearly 20% of the respondents indicated some interest in Private Equity while less than 10% showed some interest in Debt and Equity. A higher preference for PE is probably because of the perceived higher entry barriers in the Debt/ Equity markets.

What are the hurdles in listing in BSE?

Most respondent believe that they currently have no experience in raising money through the equity markets. Also, a significant 15% believe that they do not have the requisite knowledge to list themselves on the exchange as they are not sure about the repercussions. Availability of data was cited as the least important concern for considering a listing.

Whether listing on BSE will help to grow

Despite citing lack of knowledge and experience, a majority of the respondents believe that a listing will help their cause. Even among the naysayers, the majority was limited by knowledge rather than actually negating a future listing completely.

Regarding GST, what is the support expected by SMEs?

As much as 43% respondents believe that training will help them deal with the new tax regime effectively. Further, 20% wanted more clarity on the guidelines and compliance costs involved. Less than 5% wanted a deadline extension while 18% sought no help in this regard.

Specific concerns pertaining to GST/Level of preparedness

Less than 5% respondents indicated that they are fully prepared to meet the GST obligations while nearly 13% out rightly suggested that they are not prepared at all. 35% and 25% of the respondents believe that Clarity on the processes and Compliance respectively are their chief concerns. Infrastructure issues were surprisingly the least concern for the respondents, when it comes to GST and its implementation.