Industrial Sector Updates – Industrial Policy, Ease of Doing Business, etc.

Credit guarantees to MSMEs: What are they and how will they help?


From UPSC perspective, the following things are important :

Prelims level: Credit Guarantee Scheme

Mains level: Reviving MSME Sector of India

Finance Minister has announced some details of the Atmanirbhar Bharat Abhiyan economic package. The main thrust of the announcements was a relief to Medium, Small and Micro Enterprises (MSMEs) in the form of a massive increase in credit guarantees to them.

Practice questions:

Q. Discuss the efficacy of various tranches of credit facilities to MSMSEs provided under Atmanirbhar Bharat Abhiyan.

Q. Discuss how the nationwide lockdown to control the coronavirus outbreak has led to the resurfacing of inherent bottlenecks in India’s MSME Sector.

What is the package about?

  • Instead of directly infusing money into the economy or giving it directly to MSMEs in terms of a bailout package, the government has resorted to taking over the credit risk of MSMEs.
  • These credit guarantees should help the formal banking system meet the credit demand of the MSME sector (see Chart 2).

What is the credit guarantee scheme for MSMEs?

  • Loans to MSMEs are mostly given against property (as collateral) because often there isn’t a robust cash flow analysis available.
  • But in times of crisis, like the one currently playing out, property prices fall and this inhibits the ability of MSMEs to seek loans. It also means that banks are less willing to extend loans.
  • A credit guarantee by the government helps as it assures the bank that its loan will be repaid by the government in case the MSME falters.

How does it work?

  • For instance, if the government provides say a 100% credit guarantee up to an amount of Rs 1 crore to a firm, it means that a bank can lend Rs 1 crore to that firm; in case the firm fails to pay back, the government will make good all of Rs 1 crore.
  • If this guarantee was for the first 20% of the loan, then the government would guarantee to pay back only Rs 20 lakh.

Why need credit guarantees?

  • Even before the Covid-19 crisis, Indian government finances were in poor health. This pandemic has meant that government revenues will come under further pressure.
  • For instance, experts are already talking about a GDP contraction of 5% to 10% in the current financial year. It will result in a revenue loss of anywhere between Rs 5 to 7 lakh crore.
  • And yet, this is also the year when employees and firms want the government to help them out financially.
  • Banks, quite justifiably, suspect that any new loans will only add to their growing mountain of non-performing assets (NPAs).
  • So the government was facing an odd problem: Banks had the money but were not willing to lend to the credit-starved sections of the economy, while the government itself did not have enough money to directly help the economy.

  • The solution — credit guarantees — finally chosen by the government is not a new one, because this fiscal conundrum is not a new one either (Chart 3).

Quantum of credit guarantee facilitated by FM

  • There are three proposals but the main one is for standard MSMEs — that is, those MSMEs which were running fine until the COVID-19-induced lockdown disrupted their work.
  • For these, the government has provided a credit guarantee of Rs 3 lakh crore.
  • This is like an emergency credit line, said the Finance Minister, and it is for MSMEs that have an already outstanding loan of Rs 25 crore or those with a turnover less than Rs 100 crore.
  • The loans will have a tenure of 4 years and they will have a moratorium of 12 months (that is, the payback starts only after 12 months).

Why Rs 3 lakh crore?

  • The total outstanding loan to MSMEs by the banking and NBFC sector is around Rs 16 to 18 lakh crore.
  • Assuming that 80% of these loans are working capital loans where there would be a 20% incremental funding needs, that gives an amount of approximately Rs 3 lakh crore.
  • So the government is hoping that this credit guarantee will help those MSMEs take out another loan and recover.
  • The hope is that since these MSMEs were able to pay back before the crisis, there is no reason why they cannot after the crisis, provided they are given some extra money to survive this period.

What were the other measures?

  • There is a subordinate debt scheme, worth Rs 20,000 crore, which will allow loans to MSMEs that were already categorised as “stressed”, or struggling to pay back.
  • In this case, the government’s guarantee is not full, but partial.
  • The third measure is the creation of a fund with a corpus of Rs 50,000 crore to infuse equity into “viable” MSMEs, thus helping them to expand and grow.
  • The government intends to put in Rs 10,000 crore and get others, possibly institutions like LIC and SBI, to fund the remaining amount.
  • Then there is a change in the definition of an MSME that was pending for long. Now MSMEs are judged on turnover and there will be no difference between a manufacturing MSME and services MSME.

How far will these measures help?

  • The Rs 3 lakh crore credit guarantees are the most substantive announcement as it will most likely have a significant impact.
  • It will help MSMEs pay salaries and keep their heads above the water even as the economy slows down.
  • This measure is expected to help as many as 45 lakh MSMEs.

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