India’s INR 20 Trillion Package: A Relief Or Bare Shell Package For Startups And MSMEs?

We have all seen the memes and the headlines — INR 20 Lakh Cr. India, like every other major economy in the world, allocated a significant part of its GDP to fight the recession caused by the Covid-19 pandemic. Initially announced by Prime Minister Narendra Modi, and detailed by the finance minister Nirmala Sitharaman over the course of the next six days, much of this relief package is yet to be rolled out.

A large focus of this package has been to support the impacted micro, small and medium enterprises (MSMEs), which are often called the backbone of the Indian economy. The government is allocating over INR 3.7 Lakh Cr to bailout MSMEs. But in the days after Sitharaman’s announcements, there have been several questions raised about the effectiveness of the package. Speaking to Inc42, former SIDBI deputy general manager Bhawar Lal Chandak said that the announcements seem good on paper and can be considered to have generated some amount of goodwill, but it will only benefit around 10% of the MSME base.

Even on the implementation side, MSMEs that can qualify for the incentives do not have adequate clarity around schemes such as credit guarantee, collateral-free loans or a fund of funds. An MSME ministry official told Inc42 on the condition of anonymity that a notification is in the making and expected to be out within the next week, which would remove this hurdle for startups and MSMEs.

A former union finance ministry official told us, “It’s neither a relief package nor a long term roadmap which can help bring the Indian economy back to normalcy.”

The former official, who chose not to be named, counted out a litany of reasons which still remain unaddressed to a larger extent.

1. According to Census 2011, the total number of internal migrants in the country is around 139 Mn. Instead of making states fight out on the streets, and resolving their issues on an ad hoc basis, the central government should have come up with a proper plan. Caught in a life and death situation, they have been roaming around in groups which may have a ripple effect across the country and has already impacted livelihoods, revenue and labour availability.
2. The package does not address the demand-side economics. Infusing money to supply-side alone will never restart the cycle until demand rises and this is only possible through consumer-focussed incentives. There’s no attention paid to increase consumer spending, whereas businesses may only get temporary relief with some of the measures.

He is right on both counts, but as others have told us, over the course of the next week or so, there’s a lot more missing from the package, and much of it is bluster. On May 12, when PM Modi announced the historic package, he recounted India’s contribution to helping solve the ‘Y2K crisis’ and other achievements. It’s another matter that these things are not at all connected to the current economic crisis and Y2K feels like a pinch compared to the massive cut that Covid-19 has left. However, what can be noted is the pattern of the speech, similar to the speeches made in the past for demonetisation, when announcing the $5 Tn economy, Smart Cities projects and many other flagship projects where little groundwork was done to meet the key objectives before making the big announcement. The latest package is no different.

This could also be understood by the fact that while the government has claimed that the package constitutes 10% of India’s GDP, reputed financial institutions from across the world have said the additional spending is on average 1% of the gross domestic product.

Moreover, while other countries have released a major chunk of their relief package on an immediate basis, in India’s case, it’s the opposite. The RBI’s INR 8 Lakh Cr package seems to be ineffective so far with liquidity flow still in opposite direction and a major chunk of the other big allocations by the government of India such as INR 3 Lakh Cr loan and guarantee-free loans where the government may have to spend a few thousand crores, but only if MSMEs/NBFCs default on the loans taken, which is not a big percentage.  So, even if the allocation is INR 3 Lakh Cr, the government may not have to pay more than 30K Cr, given the rate of NPAs at 10%.

Experts also point out that many of the announcements are not new but were already a part of Union Budget 2020-21 announcements. As quoted by The Print, DK Srivastava, chief policy adviser at EY India, says, “Only about 10% of this stimulus can be traced as direct additional budgetary cost to the central exchequer. Nearly 5% of the stimulus relates to already budgeted expenditures.”

Exaggeration And Assumptions

While presenting the details of the INR 20 Lakh Cr package in the media, Sitharaman specified that INR 50K Cr would be allocated as fund of funds for MSMEs. However, in the same presentation, it was also made clear that the government will be spending only INR 10K Cr and the rest INR 40K Cr will be invested by AIFs.

The fund of funds will be operated through a mother fund and several daughter funds. The question here is how can the government claim private money from investors as part of the official public package? Speaking to Inc42, Siddarth Pai, managing partner 3One4 Capital commented,

“The government has also included 25% reduction in the TDS rate as part of the entire package. The reduction in the TDS rate is not a revenue forgone by the government, but a shift in the cash flow. In the case of the fund of funds, the government is assuming that the INR 10K Cr would galvanise INR 50K Cr of investment.”

Given the fact that SIDBI has committed only INR 3,798 Cr in the last five years as part of fund of funds for startups under Startup India, the questions about the announcement are thoroughly valid. According to SIDBI website, some of these funds have also been infused in MSMEs. Looking at the current numbers on fund infusion through fund of funds, it would take at least a decade to inject the INR 10K Cr fund of funds into MSMEs. No one can claim that this is then an immediate response to support MSMEs fighting for their survival.

Speaking to Inc42, Kunal Varma, cofounder of MoneyTap, further pointed out that unlike startups, MSMEs traditionally in our country have not gone ahead and taken equity funding because promoters retain ownership in their smaller business or family businesses. So this route is not the most attractive for this class of businesses.

Investors Unenthused By India’s Package

While startups and investors have welcomed the idea of promoting equity funding for MSMEs as it will position them better for stock market listings, MSMEs have so far primarily relied on loans as their source of funding.  And owing to the fact that many of them missed timely payments in the past two years, it has hugely impacted their credit score. Varma said, the government is now seeing that in these scenarios a lot of banks and NBFCs will not be willing to give fresh credit to MSMEs, so there will be a larger need for equity investment and not just debt funding and loans.

“And in the long-term the idea is to push MSME towards liquidation in the stock market and reduce the dependence on debt.” — MoneyTap’s Kunal Varma

However, before wholeheartedly welcoming the fund of funds for MSMEs, investors are awaiting further clarity from the Indian government. 3one4’s Pai explained, “There is a category of SEBI-registered AIFs called category I, subcategory SMEs. We are now looking for clarity from the government as to whether only funds in this category can actually qualify for the investments from INR 10,000 Cr fund of funds, the detailed operating guidelines in this regard.”

Will Startups See Any Benefits? 

Prima facie, yes the startups that meet the new MSME definition and have registered themselves as MSMEs as well can definitely be eligible for the benefits being passed on to MSMEs. But can a startup registered as MSME get the best of both the worlds i.e benefits as an MSME as well as the tax and other benefits that startups can avail if registered with Startup India and DPIIT?

Pai explained, “Yes, startups are recognised by the DPIIT, under the ministry of commerce and industry, however, MSMEs are registered under the separate MSME ministry.”

This means that in principle a startup can apply for collateral-free loans under the new provision and simultaneously could also avail tax benefits under Section 80(IAC) which is applicable only for startups and so on.

In the last few years while some SMEs have registered on Startup India portal to avail benefits, some of the startups have also gone on to register as MSMEs to avail MSME benefits. However, Pai argued that the number is still very small.

Even if they are registered as MSMEs, many of these benefits may not be directly applicable because of the conditions that are there, MoneyTap’s Varma said. For instance, in the case of collateral-free automatic loans, one needs to have a minimum turnover of about INR 100 Cr and up to INR 25 Cr of outstanding credit and a lot of startups won’t even fall in this category. As startups that have a turnover of INR 100 Cr may need not necessarily have minimum outstanding credit of INR 25 Cr. This is because startups are mostly equity funded rather than debt-funded.

The Catch In Collateral-Free Loans

In the INR 3 Lakh Cr collateral-free loans under 100% credit guarantee scheme, the guarantee is not directly being extended by the government or the public sector bank. There is a separate body called the Credit Guarantee Fund Trust For Micro and Small Enterprises (CGTMSE) which offers the guarantee.

However, this is not a fresh loan being given. “It’s an enhancement of the credit facility a startup or an MSME had from either a bank or an NBFC as of February 29, 2020. So, If I took a loan from a bank as of March 1, 2020, for example, I would not be eligible for this enhancement. Thus, the number of startups that will be benefited from this very few,” Pai added.

Explaining the applicability process, Pai stated that an eligible MSME/startup first needs to apply through its regular bank for the particular enhancement. After that, the applicant will have to separately apply for the guarantee on the CGTMSE website. The interest rate is capped as 1% above the MCLR (marginal cost of lending rate) for banks and is capped at 14% for NBFCs.

What’s In It For NBFCs

From the RBI to the Indian government, there has been a slew of announcements in an effort to increase the liquidity for NBFCs. A support package of INR 3.70 Lakh Cr for MSMEs as well as INR 75K Cr for NBFCs has been announced.

Under the partial credit guarantee scheme, non-banking financial companies (NBFCs), housing finance companies (HFCs) and microfinance institutions (MFIs) with low credit rating will be given to borrowings such as primary issuance of bonds or commercial papers to do fresh lending to MSMEs and individuals. Under the scheme, 20% of the loss will be borne by the Indian central government as the guarantor.

The Special Liquidity Scheme (SLS) paves way for investment in both primary and secondary market transactions in investment-grade debt papers of NBFCs/HFCs/MFIs.

While other startups would be struggling on the demand front, with MSME loan proposals, NBFCs are definitely on the other side and will not only witness a rise in demand but they would also have the liquidity to cater to the demand. To some extent, other startups for which MSMEs are the clientele would also benefit.

Besides the government announcements, Saurabh Jhalaria, head of SME lending at InCred said, in the TLTRO 2.0 (Targeted Long Term Repo Operations 2.0), the RBI has specifically introduced a window where banks can borrow at a lower rate only if they will lend to the midsize and small NBFCs and not to larger NBFCs, or deploy it back to the RBI.

“However, the TLTRO has also met with only limited success for NBFCs as the entire amount was not taken up but INR 25,000 Cr only and didn’t meet the full subscription. And, it’s been about a couple of weeks since the auction day, but we haven’t heard of any sanctions or any kind of confirmation in terms of which NBFCs have got liquidity from the bank that had applied for this,” said Jhalaria.

MSME Schemes: Why It Won’t Be Much Effective For Majority Of MSMEs  

According to the MSME ministry’s annual report for 2019, India has currently over 63 Mn MSMEs out of which 99.4% are micro-enterprises. An estimated 32.4 Mn lakh MSMEs (51.25%) are in rural areas and 31Mn lakh MSMEs (48.75%) are in urban areas. However, till the end of May 2019, only 68.25 lakh MSMEs had registered as MSMEs on the UAM (Udyog Aadhar Memorandum) self-declaring platform.

Besides registration, questioning the efficacy of most of the government initiatives for MSMEs, former SIDBI DGM Chandak stated that the initiatives remain ineffective as the majority of the MSMEs don’t even take loans from banks.

Also, the credit guarantee fund would be applicable only where MSMEs go bankrupt and won’t be able to pay their loans. The percentage estimates of MSMEs going bankrupt vary from 10% to 15%. Hence, in reality, the government would have to pay only a partial amount to the banks, much less than INR 3 lakh Cr.

Further, most of the MSMEs have been dealing with cash and many times, the payments or the receivables do not occur within the proposed timeline. Hence MSMEs at large have not been able to show the actual line of credit based on their transactions. This also prevents them from benefiting from many government’s lending initiatives, especially for MSMEs. As a result, the RBI launched TReDS, an electronic platform for facilitating the financing / discounting of trade receivables of MSMEs through multiple financiers.

Chandak, however, argued that TReDS does not record these automatically and the 45-day payment period for MSME dues is circumvented by non-acceptance of goods in time, asking suppliers for revising bill dates. Hence, the value of bills discounted was merely INR 5,500 crore in FY 2018-19 against the estimated MSME annual sales of about INR 14 Lakh Cr, a massive deficit.

As part of the recent announcement, the government has also decided to link TReDS with the government-run e-marketplace (GeM).

Startups, MSMEs Need More Than Atmanirbhar Bharat

India has been facing the worst economic crisis since 1991. With lowest ever consumer spending, demand and therefore the government’s revenue has drastically gone down. The demand factor has forced the supply side to go down. However, the government instead of working on to fix the demand side economics opted to follow the outdated economics using the supply-side. Besides, there has not been much attention paid towards a permanent resolution against Covid-19.

In its headline-grabbing package, the Modi government has also added around INR 8 lakh Cr liquidity based on the RBI initiatives taken in the last few months. However, the reality says otherwise as banks and NBFCs face twin issues of balance sheet and liquidity flow. Before RBI announcements, the banks used to deposit INR 2.86 Lakh Cr a day with the RBI which has now increased to an average of INR 7 Lakh Cr even after the RBI reduced the reverse repo rate to 3.75%.

Speaking for startups, clearly, the government hasn’t done enough, said InCred’s Jhalaria. The startups are suffering and struggling from the demand slowdown more than liquidity issues. Most of the measures will only help in the medium to long term.

Utkarsh Sinha of Bexley Advisors said that there was some expectation of direct sops for IT and IT services companies, which are a significant cylinder in the Indian economic engine. The absence of this means the burden on many of India’s startups hit by this crisis will not be eased by this package, as debt-based liquidity is not the primary source of funding for such companies.

Be it demonetisation, which sent investors scurrying to digital black markets such as cryptocurrency, or the rushed implementation of GST or even the current lockdown, one of the biggest criticisms of the Modi government is not accepting the harsh realities of economics and thereby planning accordingly. Playing with the economic numbers and data, as earlier indicated by Modi’s former economic advisor Arvind Subramanian in the case of GDP growth rate and later for consumer spending, is another example of running away from the ground reality and trying to build air castles. It’s no wonder then that most of these initiatives have shown such limited results despite grand ambitions. Will Covid-19’s relief package be a case of more of the same?