Mitigating MSME Distress

Posted by harikrishnanvenkat98 on August 28th, 2019

wrote substantial part of this blog a couple of days back. I would have completed it before noon on 23/08/2019. I held back and waited for Finance Minister Ms.Nirmala Sitharaman’s announcement. My original couple of paragraphs read thus. “One does not know the impact of abolition of Article 370 and Article 35.  It may be good or bad, time will tell.  However, something else has happened, which is really good for the country.  The Government of India has come out of its denial mode and has indeed acknowledged that the economy is in serious trouble.  In Article 370 deliberations, one did not see Ms. Nirmala Sitharaman.  This is because she was having a series of meetings with various groups of people on the problems of Indian economy and the measures to be taken for reversal and speedy growth.  This is quite heartening.” Well, FinMin has created all the sound bytes the Industry wanted to hear. She has fully taken care of the grievances of Dalal Street Gamblers. She has taken care of problems of Venture Capital and Private Equity Investors. Large cap companies also will be happy. But there is nothing much for key employment generators except the optics. Directionally speaking, Government is still barking the wrong tree. Well, the first tranche of ‘Industrial distress alleviation programme’ has been delivered and Dalal Street is bound to be happy. We can expect to save a few thousand jobs. But who are the real job providers? Agriculture, Real Estate, Infrastructure and MSME. If North East monsoon is good and the Industrial package announced by Finance Minister takes off, there would be GDP growth. The same jobless growth of UPA II. Still worse, really. Gap will widen, some formal high paying employment will be added and informal employment will be the biggest casualty. Granted, compliance, tax payment and being on the right side of the law are not long suits of God fearing Indian psyche. Waging a war on it can hardly be a bad idea but successive actions ended up isolating MSME, Infra and Real Estate, the real employment providers. By late 2015 Real Estate showed signs of slipping and the inventory started piling up, just like cars today. Government wanted to cleanse the system. Introduced Voluntary Disclosure Scheme and then followed it with Demonetisation in November 2016. The Industry is limping, to be benevolent. Lot of MSME players closed shop and with that went scores of unorganised jobs. Infra companies also tanked. Next is GST. Even today, after two years, MSME is running from pillar to post to comply. Flavour of the season now is annual return. Lot of MSMEs are fighting to comply. MSME is slowly but surely getting finished. Soon only organised players will operate. GDP Growth will happen but there will be shrinkage in unorganised labour. I am skipping Real Estate and Infra in this post and concentrating on MSME. Finance Minister made a passing reference to this report. MSME in India is categorized by out moded and dilapidated definition based on investment in plant and machinery.  More successful world has classifieds its MSME based on turnover or number of employees or both.  We hope to move in this direction and keep turnover as the basis.  Expert committee report has sought to correct this and we should classify our MSME based on turnover.  I think we can call less than Rs.10 crores is micro, Rs.10 crores to Rs.75 crores is small, Rs.75 crores to Rs.500 crores is medium. This would pretty much cover 90% of non agricultural financial activity. But what has it got to do with trying to discipline the sector to comply? Noncompliance, black money, gaming banking sector, non payment of taxes… Wealth creators operate in an ecosystem. When they are continuously penalised when rest of the ecosystem goes scot-free, it is an unfair situation. I am passing tax terrorism up in this blog since the FM acknowledged it in no uncertain terms. But she confined herself to Income Tax. With the advent of GST, erstwhile Excise Duty officers and state VAT officers are available to hound the wealth creators. It is a open secret that the wealth creators were distributing wealth at every step of the way during compliance – at the time of return filing, assessment, audit and dispute resolution. They are now faced with faceless assessments. (Pun intended). What if the assessing officers want to be personal wealth creators? Diluting the statutes will result in business going to the old ways. Making tax administrators to exercise restraint may or may not yield results. FM has a daunting task ahead. I can only wish the Government good luck. For the record, generally, they are never brought to books. It is only the wealth creator who takes all the fury. They also know how they managed to not treat an account as NPA largely out of corporate compulsions of the banks.  Bigger loans got the blessings of Chairmen of banks and political bosses.  Sanctioning of smaller loans kept the bankers happy. Managing the loans from being classified as NPA was the name of the game.  Additional loans were given to slipping advances, i.e., they used to give more loans and use the proceeds to re-pay loans.  They used to re-schedule it.  They used to take it to corporate debt re-structuring mechanism and classify all these loans as performing assets. They simply want to get away from accountability.  None of the past deeds of the bankers have any bearing on them and they have gone scot-free too.  End of the day, only MSME suffers. Does this mean, entrepreneurs are angels? No. They have their share of the sin. This is a systemic failure. Targeting only MSME for cash cleansing and compliance will only bringing down the economy. DeMo, GST and strict compliance drive have achieved just that. That’s why I believe a one time amnesty scheme to clean up Balance Sheets is in order. MSME entrepreneurs generally don’t have clear understanding of long-term funds and short-term funds.  If a machinery is broken down, it is replaced from the Cash Credit Account right on the same day. And then there were planned diversion of funds in the form of purchase of non-core assets – expensive cars, land and building with an eye for appreciation… One has to understand the effect of all these. A few case studies will prove the point. This required more loans. Increase in loan requires over statement of stock and book debts and showing more profits. After all, cash credit loan is a function of Inventory, Debtors and Profits. The actual stocks were much less than what is shown in the books, actual receivables were much less than what is given in the books. The real business, however, was growing and was quite profitable.  So, the time came for expansion and every year loan component was more. Banks wanted more and more securities.  Initially personal properties were given. Subsequently.  The property that was brought with cash credit was given. A new project report was prepared for doubling the plant capacity and to utilize the steam for production of electricity.  As always time and cost over run ate the project viability and pushed the estimated cost.  So, the revised plan had to be drawn on and validated for techno-economic feasibility.  The margin of the promoter was obviously met by working capital.  The net result of all these is the company is now in NCLT, despite the fact the company is capable of selling newsprint worth Rs.100 crores with the gross margin of about Rs.10 crores. Receivables and book debts total about Rs.100 crores in the books, the actual amount is anybody’s guess.  It may not be more than Rs.25 crores. Indian SME and they constitute 90% of the companies.Now it is quite easy to provide sermons to the entrepreneurs, point finger at them and crucify them.  This is considered cleansing, and this is what is going on.  Net result is hundreds of employees lose their jobs with each company going down. It’s lot easy to take moral high ground, but the ground realities were very different.  Corruption was considered a norm.  The banker-enterprise relationship was like that of a marriage under Hindu Marriage Act before thirty years.  No matter what banker or entrepreneur did, they were destined to live together.  There was all round corruption.   No one had any qualms about generating ill-earned wealth.  While rest of the eco-system is going scot-free, the SME entrepreneurship has become a casualty.  Tightening of NPA norms, Companies Act 2013 and the bankruptcy legislation have affected only SMEs while rest of the eco-system has gone scott-free. Think about it.  Starting with License Raj, we were having an immoral eco-system.  Trying to clean this has resulted only in endangering SMEs.  The question here is not morality.  The question is survival of a sector, which was contributing 40 to 50% of the exports of the country, producing 25% of the GDP and employing 40% of labor. We have introduced de-monetization, breaking the cash economy the SMEs were thriving in and providing employment.  We have introduced GST to bring about transparency and collection.  Compliance takes enormous effort for the SME’s.  Prior of demonetization, we have been introduced voluntary disclosure scheme.  We need to have a separate scheme for cleaning the Balance Sheet.  One simple method will go a long way in rejuvenating the economy. Roughly 90% of the Balance Sheet have camouflaged and incorrect numbers.  This has to be cleaned once for all.  All enterprises should be allowed to clean up their books once.  This may result in reduction in drawing power in bank loans.  All the excess borrowings should be converted to a ten-year loan with concessional interest.  Differential fresh funding should be provided for, wherever required.  This does not require money, just postponement of NPA declaration. Money has already been given based on wrong Balance Sheet. This is the single most important economical reform needed at the moment. Hope Government thinks about it.