Coronavirus – Economic Issues

How the economic package will play out for MSMEs?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Measures announced for MSMEs

Mains level : Paper 3- Significance of MSMEs and measures for supporting the MSME during corona crisis.

Recently, a stimulus package worth 20 lakh crore was announced by the government. How effective will these measures prove for the MSMEs? How the liquidity issue plaguing the NBFCs is sought to be solved? Finally, what are the issues with the package? All such question are dwelled upon here!

Why ensuring flow of credit is important?

  • While assessing policy measures during the lockdown there are two over-arching principles one must keep in mind
  • One, the flow of funds will slow down with economic activity.
  • Two, firms do not go bankrupt because of insolvency, but because of lack of access to funds also called liquidity.
  • World over policymakers are pulling out all stops to make sure that the flow of credit continues.
  • Of the Rs 20-lakh-crore economic support announced by the Prime Minister on May 12, we have details for about Rs 16 lakh crore.
  • Monetary and financial interventions taken by the government and the RBI to provide credit to those who need it make up more than 90 per cent of it.

Limited impact of RBI’s measures

  • Most of the measures announced by the RBI earlier have not had the desired effect.
  • The quantum of cheap funds being made available being more or less the same as the increase in the amount being deposited in the RBI every night by banks.
  •  Just reducing the cost of funds (i.e. lower Repo rate and LTRO) had no impact on the volume and cost of the credit they provided.
  • This happened due to the heightened risk aversion in banks.

So, how government sought to address this problem?

  • The series of measures announced to provide credit support to the micro, small and medium enterprises (MSMEs) attempts to address this gap.
  • For MSMEs that have been servicing their loans so far new loans up to 20 per cent of the current outstanding credit will be fully backstopped by the government.
  • That is, if there is a default, the government will pay the bank.(i.e. act as a backstop).
  • So, how backstop by the government could help?
  • The move could lead to immediate credit creation, as guarantees are available only for loans extended in the next six months.
  • Also, the lenders have zero risk, and the borrowers are most likely stressed and would want these funds.
  • It is possible if not likely that firms will use these loans to just pay interest and cover losses.
  • But if so, that in a way is the purpose of this scheme — the government absorbing losses upfront rather than the likely larger lost taxes and potential bank bailouts if there is a bankruptcy.
  • For the government, the costs of this guarantee would be spread over several years, with at most 10 per cent incurred in this fiscal year.

Move to provide liquidity to NBFCs

  • The two schemes together, targeting to provide Rs 75,000 crore of liquidity to non-banking finance companies (NBFCs), may be a bit less successful.
  • The special purpose vehicle that is to provide liquidity to NBFCs provides funds for three months at a time, may succeed in addressing problems like an NBFC defaulting due to lack of liquidity.
  • But it may not suffice to get them to grow.
  • The partial credit guarantee given to banks’ loans to NBFCs may be more effective for a subset of NBFCs.
  • But as it is only available to public sector banks, it would depend on their willingness and ability to extend new loans.

Fund to provide equity for MSMEs

  • The Rs 50,000 crore fund to provide equity for MSMEs, with a corpus of Rs 10,000 crore being provided by the government, which would then be leveraged, is an interesting initiative.
  • Losses incurred in the current lockdown are depleting risk capital.
  • Replenishing if not growing that is paramount to restoring India’s growth potential.
  • While global as well as local private equity and venture capital funds would continue to explore and invest in smaller firms, such a fund can scale up the funds availability significantly.

Issues with the package

  • The natural limitation of the policy interventions thus far is that they only affect enterprises in the formal sector and in agriculture.
  • The problems in informal non-agricultural enterprises may stay unaddressed, and remain an impediment on growth.
  • While less than 10 per cent of the announcements thus far has been the fiscal cost.
  • One senses a fiscal caution in government measures that is overdone, and could hurt more than it helps. (avoiding direct expenditure)

Stability: of bond market and value of rupee

  • Two things minimised the volatility in the bond market: 1) pre-announcing the additional bond issuance for the year 2) giving an implicit assurance that additional deficits would be financed separately.
  • Even though that potentially means the RBI purchasing government bonds, the rupee has been remarkably stable.
  • There was fear that fiscal spending financed by the central bank would be frowned upon and drive currency weakness.

Consider the question-“MSME sector forms the backbone of Indian economy. List challenges it faces in present times. Critically analyse whether the current stimulus package is suitable to boost growth in this sector.”

Conclusion

The road ahead remains unclear, but it is likely that the economic damage is already much larger than the measures undertaken so far. A continued focus on reforms and on sustaining India’s growth potential will be critical in preventing macroeconomic instability.


Back2Basics: The two schemes announced for NBFCs

  • The FM announced a Rs 30,000-crore liquidity scheme for NBFCs.
  • The government will buy debt papers by NBCs, MFIs and HFCs.
  • The buying of papers will be fully guaranteed by the government of India.
  • Under this scheme investment will be made in both primary and secondary market transactions in investment-grade debt paper ofNBFCs/HFCs/MFIs.
  • The move is seen providing liquidity support for NBFCs and mutual funds and create confidence in the market.
  • The FM also announced Rs 45,000 crore partial credit guarantee scheme (PCGS) 2.0 for NBFCs.
  • Existing PCGS scheme will be extended to cover borrowings such as primary issuance of bonds/ CPs of such entities.
  • The first 20 per cent of loss will be borne by the government of India.

50000 Crore fund for MSMEs

  • Finance Minister Nirmala Sitharaman announced Rs 50,000-crore equity infusion through Fund of Funds for MSMEs.
  •  The Fund of Funds will be set up with a corpus of Rs 10,000 crore.
  • The Fund of Funds will be operated through a mother fund and a few daughter funds.
  • The fund structure will help leverage Rs 50,000 crore at daughter-fund levels.
  • This will help MSMEs expand size as well as capacity.
  • It will encourage MSMEs to get listed on the main board of stock exchanges, the government said.
  • Based on the recommendations of UK Sinha Committee, the Fund of Funds was first announced in the Union Budget on February 1, 2020.
  • An investment of Rs. 10,000 crore was proposed in the Budget for the scheme.

 

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