- Alok Mittal
CEO & Co-founder, Indifi Technologies Private Limited
The roll-out of the Goods and Services Tax, a new taxation regime that replaced 15-odd indirect taxes in India, was marked with unmatched fanfare across the country. The reason behind this was simple: the tax had perceptible benefits for every stakeholder within the value chain, from raw material suppliers down to the end-consumers of the finished goods. But good things often come at a price, and as far as one can see, Indian MSMEs have been paying a high price for enjoying these benefits.
Let’s first understand the country’s MSME sector, and why it is deemed so important. Micro, small, and medium-sized enterprises contribute about 45% to our nation’s GDP. This figure is three times the contribution made by corporate India towards the same. Moreover, India is estimated to have 42.50 million registered and unregistered SME units — a number which essentially amounts to around 95% of the total industrial units operating within the country. The MSME segment also generates more jobs when compared to other sectors, including the public sector.
And yet, it is by far most disadvantaged.
One of the prime challenges that the MSME sector in India faces is in terms of credit penetration. MSMEs are often outmuscled by larger enterprises, which have broader business networks and are benefited by the economies of scale. In order to compete against these players, small businesses often have to extend credit to their customers through debt on invoices. The settlement of this debt might take 90 days or even more. This creates a significant shortage of working capital that MSME businesses require to procure raw materials and to pay their suppliers. This increases the capital — and credit — requirement for MSMEs, which is denied to them by traditional financial institutions more often than not. A report reveals that the prevailing credit gap within the MSME sector stands at a whopping 56%, or about INR 1,765 lakh crore.
It is not that nothing has been done to counter this challenge. Several institutions such as SIDBI, NABARD, and NSIC, along with MSME-centric government schemes such as MUDRA, have been established to address this disparity. However, since many of these initiatives have not altered their strategic approach to reflect the dynamically-changing business landscape, they are still far from eliminating the MSME credit deficit and generating the desired results in the bigger macroeconomic picture. Adding to this prevalent challenge, the GST rollout in 2017 — which is a promising development expected to deliver significant benefits in the long-term — has further crippled the sector.
Also Read: A Quick Guide To SUDBI For MSMEs
Good, Bad, Better, And Best Of GST For MSMEs
The MSME sector in India has borne the maximum brunt of the country’s transition to the new tax regime. With the GST rollout, the sector is now subject to a revenue threshold limit of INR 10 lakhs for North-eastern states and INR 20 lakhs for the rest of the country. The new limits are substantially lower in comparison to the INR 1.5 crore threshold defined under the excise duty, thus considerably increasing the tax burden on MSMEs.
However, this isn’t the only tax burden that they’re experiencing. Earlier, stock transfers were subject only to excise duty on the removal of goods. Under GST, ‘supply’ includes all transactions between a principal and an agent. Therefore, supply of goods from a taxable entity to a non-taxable entity also comes under the ambit of supply. The quantum of impact varies depending on multiple factors such as stock turnaround time (at warehouse), credit cycle, and magnitude of stock transfer. These higher working capital requirements impact MSMEs negatively by directly increasing the operational costs, which in turn leads to an increase in the price of finished goods. Services have also been placed in the higher tax slab under the new tax regime, subjecting service-based MSMEs to higher tax rates.
Centralised registrations have also been scrapped. This implies that if services of a state unit of a company supplies services to another unit in a different state, then such transactions are also liable for taxes. Under GST, input tax credit is not available to a compliant company if its vendors do not apply for the same in their returns. As a result, supply chains have been affected and disrupted by the variance in GST compliance across the board.
Working On Capital Availability: The Challenges Encountered In Financing MSMEs
GST has also benefited MSMEs in many ways, with the biggest and most obvious being the consolidation of various regions across India into a unified market. Earlier, Indian businesses had to pay interstate taxes for supplying their goods to regions beyond their home states. While larger businesses tackled this problem by establishing regional warehouses, such an approach was not a feasible option for MSMEs given their limited corpus. This ended up restricting them largely to their chief arena of operations. But even as GST has provided a fillip to MSME growth by offering smaller businesses a national market to cater to, capital availability continues to limit any attempts towards the same.
If capital is adequately available, MSMEs have the potential to push India towards its aimed double-digit economic growth. The advent of online lending marketplaces been extremely beneficial for MSMEs in tackling the prevailing financial challenges. Using various cutting-edge technologies, new-age platforms are actively filling in the credit gap and providing some much-needed relief to smaller businesses. Some leading platforms are even extending innovation-driven products, such as invoice-based credit, enabling MSMEs to improve their efficiency by utilizing their unproductive assets.
Though credit penetration has significantly increased with the rise of such tech-driven platforms, there are certain challenges that are preventing the credit advancement. MSMEs largely need loans that are oriented towards short-term needs, such as ensuring enough working capital. With the digital enablers in place, lenders are now in a position to service such shorter tenure requirements that have a loan period of less than one year. However, as per the current RBI guidelines, term loans up to 2 years need to be held on the originators’ balance sheet for a minimum of 3 months before they are eligible for securitization. This effectively makes such loans ineligible for securitisation.
The intention behind establishing the Minimum Holding Period (MHP) and Minimum Retention Requirement (MRR) is understandable, i.e. to minimize the credit risk, but changing the MHP requirement for MSME loans below INR 25 lakhs will help lenders broaden MSMEs’ access to credit. In order to ensure more ‘skin in the game’ for lenders, a lower MHP may be allowed with a higher MRR.
With substantial GSTIN data also available now, opening API access to the GSTIN database will allow lenders to verify the authenticity of invoices, purchase orders, and cross-verify business incomes from the MSME financials. This data will, moreover, pave the way for a faster and more efficient underwriting of the borrower. Similarly, the ability of lenders to directly retrieve transaction data from the borrowers’ bank account will go a long way in eliminating fraud and improving access to credit. With most of this data already available, it would be easier and more time-efficient for prospective lenders to receive this directly from banks through APIs rather than through intermediaries.
One thing that often goes unnoticed in India is that we do not utilize alternative data repositories that provide critical insights into a borrower’s financial health, such as utility bills and postpaid telecom payment cycles. Utility companies and telecom operators must be mandated to report payments of dues to the credit bureaus. This will essentially serve to facilitate better access to credit for MSMEs that do not have a prior credit record.
MUDRA is refinancing MFIs, NBFCs, and banks who lend under the scheme. This, however, comes with a cap on the final rate that can be charged: 3% above the refinance rate for banks, 6% for NBFCs, and 10–12% for MFIs, depending on their portfolio size. The small-ticket and shorter tenure of loans on digital platforms entail higher operating costs than typical NBFCs and become unviable with 6% cap. Since most of the new lenders incur high operational expenditures, it is recommend that this cap should be increased to 10–12% for lenders in line with MFIs (for loans up to INR 5 lakh) and 8–10% (for loans in the range of INR 5–25 lakh). This will help in expanding the reach of financing to MSMEs through digital lenders. MUDRA should also extend its credit enhancement to digital lenders, both platforms and NBFCs, as this will go a long way in increasing the MSME access to capital.
As India gears up to re-emerge as the fastest growing large economy this year, it will be interesting to see when the country will finally achieve the much-anticipated double-digit growth rate. But while there’s uncertainty about the timing of the same, one thing is absolutely certain: the instrumental role that Indian MSMEs will play in realising this vision.