Nursing SME

Small and Micro Enterprises (SME) top the public dialogue today on surviving the Covid19 pandemic in India. And why not - SMEs as a sector is the highest employment generator with more potential, the largest source of exports and a relatively lower contributor of non-performing loans (NPL) to the financial sector. In the immediate post-pandemic situation when employment and re-employment should demand the big attention of the government, SMEs naturally claim the top priority. While it is true that the space for free suggestions is already crowded, most such suggestions fall into three categories - industry lobbies that mostly seek freebies, waivers and reliefs, lenders' appeals that seek regulatory reliefs to help them postpone or avoid making provisions for the expected loan losses and government's own internal (selectively leaked) plans to dole out subsidies while increasing bureaucratic control over the sector through more controls, approvals, releases, etc.. There isn't much time for the government to study through committees and review their reports through more committees.  There is a economic and social disaster just about to unveil without big, laid out action plans.

Here are a few thoughts from an end, that isn't part of the SME sector, lender or from within government, on strategy for nursing the SME sector to back on to its legs from its current state of Shavasana. Two caveats are in order - 

1. It is assumed that the country and the government are ready for a bout of fiscal deficit putting the FRBM in a short nap of a few years,

2. No numbers are used here as the numbers are all with the support system of the decision makers..

Immediate challenges of an SME are   

1. Immediate financial obligation servicing - RBI has given a 3 month holiday which, in all likelihood will get extended. But that only postpones the inevitable and makes it worse as SMEs can, in no way, be expected caugh up interest for past 6 months in one go.  The payment after 3 months or later will have had compounding  effect as no Bank will forego interest on amounts due. Hence, that's a postponement of a problem, not a solution. It is just the oxygen while ventilator. to be weaned ASAP.

2. Activity is closed with zero cash flows, but fixed overheads, including salaries, are piling up, putting the post-pandemic future  with a big handicap. Effectively, 2-3 months' fixed overheads is an additional liability that future earnings (whenever operations recommence) have to bear. An SME will continue to be strained for liquidity over the next 2 - 3 months after the restart till they reach normal levels of activity.  SME will need funding support that does to put its recovery phase in a serious handicap of having to immediately absorb this absorbing these funds in their cash fows. 

3. Getting back contract labour - given that anything from 20% to 50% of the workforce is on contract basis in a SME and these temporary workers would have moved away and may not return in full strength, at least for some time, quality manpower in the short term is a challenge. A reduction in the wages and salaries to manage thruough the difficult period of recuperation may be acceptable in the market. But some of the savings from that may also be consumed by the higher wages that firms may have to shell out to get back dispersed essential labour. In sum, it will be a premise for increased working capital funding in short term. No better time than now for government to push through long pending labour reforms to provide flexibility to the promoter and freedom to the worker and universalise social security cover to unorganised labour.

4. Supply side - the lock down having made everyone sit on unsold stocks for 2 months or more, the average purchase cost would be lower initially at re-start and even over the short term. This helps the SME reduce the costs and some of the reduction may persist and be sustained over longer time based on the demand supply situation.

5. Demand side - customers off take would be lower and given that some kind of social distancing norms will persist in the near future, demand may not reach attractive levels or even break even levels for sometime, even up to 2 years. Challenge will be to sustain the business with cash support that may be required for longish times, even  up to 2 years.

6. Given the overall cash flow crunch across the system, an obvious problem to be expected in delayed payments by customers who are typically medium or large corporates.

7. Unlike previous instances of difficulties, this pandemic has most of European American markets which are the major export markets for SMEs are affected to an extent unseen by many of the current generation. This also opens a window of opportunity for Indian SMEs to gain back their market share. The erosion of trust in the China and its super - efficient suppliers also provides a never - before opportunity to Indian SMEs expand their market share.

8. Given this, it is two needs that are obvious - immediate liquidity support, help in gaining financial strength to to quickly get back to normal working and strategic support to join the global supply chains that have been dominated by China for sometime now. The immediate action points:

(i) firms need long term funds to the extent of anything from three to 5 months' sales, an amount that can be expected to be nearly twice their existing working capital loans and far more than an amount that they can take on as a regular loan to be serviced, even in a short term of 1 -2 years. But that means forcing the already reluctant banks to to do unattractive loans. But these loans should be made attractive to the Banks on one hand and affordable to the SMEs. This can be through a combination of the following two ways.

(a) Medium term loan to fund 66.67% of this requirement with 5 years' repayment period with a six months' holiday, that shall be backed up by first loss deficiency Guarantee (FLDG), to the extent of 25%  by  Credit Guarantee Fund Trust for Micro and Small  Enterprises (CGTMSE). The SME shall pay a commission in the normal course for this guarantee to CGTMSE. Given this mitigant the loan becomes attractive to the Banks and sustainable to the SMEs whose payout, including the guarantee commission, in the first half year will be at little above RBI's Repo Rate, say around 6-% in the near future, The FLDG from CGTSME should be restricted two years from disbursement subject to half - yearly review.. 

(b)  Provide a subvention of 2% of the discount rate for bills of SMEs that are put out through Trade Receivables & Credit Exchange (TCE) of RBI for trading. With an initial nudge guidance from RBI, banks will move to TCE to finance the receivables and book debts of their SME clients, also followed by corporates once the volumes pick up. This will  also gradually help in price discovery for SME funding.

(c) The remaining 33.33% of the funding requirement should be provided as equity by the central government through a trust set up for this purpose. The trust should have government representation but no control. While it shall be funded by the government, it should have a specific timeline to dissolve itself. The dissolution can be through liquidating its holdings first by the respective SME promoter and to any other bodies like industry associations or investment funds pension funds, etc.. A suitable exchange that makes it easier for SMEs to be listed with on the lines of NASDAQ is a natural development that SEBI can help incubate. This would also provide an opportunity and incentive to SMEs to go public to grow.  

(ii) Not all SMEs would be able to sustain operations and continued support to those that are unable get out of their difficulties within a period of one year may end up being good cash down the drain. The CGTSME cover should be subject to review on a quarterly basis subject to lending bank's review. Either at the entrepreneur's initiative or as a result of bank's review, a quick liquidation process may be initiated under IBC. It requires a tweaking of the IBC to make it an exclusive process for SMEs by permitting the process to go under retail liquidation process that has much shorter timelines than than the normal corporate insolvency process.

(iii) the costs involved in these steps to the exchequer are - the losses that CGTSME may suffer on the FLDG net of the commission it collects from SMEs and the 2% cost of subvention on bill finance through TCE. Both of these should be provided by the central government through budgetary allocation. 

(iv) One the second need, the brilliant minds at Niti Ayog and the central ministries and industry bodies are, for sure, already at work and it would be  a fallacy to attempt adding anything what they already know and will articulate.

All of these require quick government action, both legislative and administrative and regulatory action.The most important point is immediate, comprehensive and effective implementation, JanDhan accounts and Ujwala cooking gas connection would be good benchmarks to follow.