BUDGET SERIES || CONSUMPTION

The solution to every problem can be found only if the problem is first decoded till the first principle. India’s economic slowdown should be treated and decoded the same way. The first thing that needs to be identified is whether the current slowdown in the economy is a cyclical slowdown or a structural slowdown. Cyclical slowdown is one that is characterized as a part of the business cycle, going through a trough which will eventually be followed by a recovery and peak. In gist, it is a short-term problem which can be solved through government’s fiscal and monetary policy. However, what the country is witnessing today is a structural slowdown and in order to garner a remedy for the situation, there needs to be a better understanding of the problem and there after damage control.

India’s growth story has always been driven by consumption. In terms of the components of GDP- government expenditure has been whooping for the economy, however government expenditure forms only around 10% of the GDP. Additionally, the fiscal deficit of the government raises concerns about what extent can the government afford to stretch the deficit to, especially with staggering tax collections. The current fiscal deficit stands at 7.5%, which is a notch higher than all the developing countries, barring Pakistan. Investments have been stalling, even after the corporate tax rate cuts. The reason is that if there is a weak consumption demand, why will the businesses invest even despite the incentives? The consumption demand, which is the most worrying concern, ironically forms around 60% or more of the GDP today. In such a situation, any policies, incentives or break throughs will not revive the economy until and unless there is a boost or rather revival of the consumption story of India. The current situation is worse than the 1991 fiasco, as during that time even though the government lacked the forex reserves, the consumption demand was strong. Today the government has ample forex reserves, but the main growth driver of the country has taken a backseat.

The demand can be broken down into urban demand and rural demand. FMCG sector of India, which is generally known for being the resilient and safe sector for the economy has been under trouble, which clearly highlights the gravity of the situation. There were times when the rural segment used to contribute 1.5times the urban segment for this sector. However, during the past few quarters the rural contribution has fallen to the level of urban contribution, and has dipped even more. Currently, the rural FMCG sales is growing by 5.2% and the urban sales is growing by 7.4%

One of the reasons for the above being, India is divided into an organized and unorganized sector. While the organized sector contributes two-third of the GDP, the unorganized sector contributes the rest, and certainly cannot be avoided. The informal sector is responsible for more than 80% of the job creation in the country, according to economists. The implementation of GST was done with the intent of formalizing the country. There has been interestingly a pattern observed, big firms in the industry that competed with a large portion of informal firms benefitted immediately after implementation of GST. The informal firms bore the compliance costs, many informal firms either shut down or witnessed a large drop in market share. The same firms which benefitted post GST, have now witnessed a decline in sales-reasons being slump in demand arising out of losses of job and high level of unemployment in the informal sector. For instance, biggies like Britannia, Marico first witnessed a plunge post demonetization. They again picked up post GST, due to the lessening of rivalry by their informal counterparts and now again a slowdown, due to their stressed counterparts.  

Additionally, there is an anomaly in the consumption behaviour of Indian consumers. According to the Consumption Expenditure Survey (CES), the expenditure compared between FY 12 and FY 19 indicates that the spending on durables, clothing, footwear, health, travel, entertainment and other miscellaneous good & services has actually increased. However, sectors like automobile and housing have witnessed a haunting slowdown. The anomaly is due to the lack of customer confidence. Customers do not want to spend on items requiring long term commitment in terms of maintenance and payments as they are not confident about their future income and revival of the economy. Hence, segments especially like travel and entertainment have seen robust growth figures as they are one-time expenditures for the customers. Additionally, events like big billion days witnessed e-tailors booking revenues worth $ 3 billion, plus 50% increase in terms of new customers for giants like Flipkart (mainly tier 2 and tier 3 cities). Major retail lending retail products, such as personal loans and credit cards continue to witness strong growth, though the pace may have decelerated. This brings us to the fact that slowdown does not necessarily showcase the lack of disposable income in the hands of urban middle class. These indicators highlight that there is sentiment issue, customers are still spending a robust amount of income in certain segments-segments which require one-time short-term low-ticket size expenditure, however not on those segments which are required to boost the economy.  RBI’s consumer confidence survey for November booked the lowest figure since its implementation back in 2010. The index stood at 85.7, which is even lower than the number observed in September 2013, where the country faced a BOP crisis. A reading below 100 denotes pessimism in the economy.

Budget 2020. The budget 2020 is imperative to bring the country out of a turmoil. There is a consensus view that the budget is likely to bring reforms which will stimulate demand and confidence of revival in the mind of Indian consumers:

With the corporate tax down to 25%, the next expected move of the government is a reduction in the income tax slab to leave more money in the hands of consumer. The current exemption of no tax for income up Rs. 2.5 lakh is expected to be increased to Rs. 5 lakhs. Slab of 5-10 lakh subject to a tax rate of 10% (20% currently), 10-20 lakh subject to a tax rate of 20% (30% currently) and above 20 lakhs subject to a tax rate of 30%. Next is increasing the deduction limit under section 80C from current Rs. 150000 to Rs. 250000. In order to revive investment and promote the housing sector, deduction for housing loan interest for self-occupied property is expected to increase from current Rs. 2,00,000 to Rs. 3,00,000. The rural economy needs to be given a priority; hence the budget should be focusing on bolstering the NREGA programme and funding rural road construction.

While all this may or may not work for the country, certain imperative deep-rooted measures need to be addressed to bring a long-term solution the country. One of the main forces believed to be positively linked to the consumption in an economy is the demographic dividend. India is believed to be the fastest growing country and unanimously agreed that it will reap the benefits of a “large working-class population” in the coming years. While there is no doubt of authenticity in the statement, what we fail to realize is that the above statement will materialize only when the current young population is provided with an environment of quality education and up scaling of skills. India is much behind this aim. Reforms in education and healthcare will pave the path for economic development in India. Successful Asian economies like China, Japan, South Korea, first focused on bringing reforms in the agriculture sector by promoting full-scale efficiency. Similarly, India should focus on reforms in agriculture in terms of access to seeds, technology, power and finance. They should look for ways to improve connectivity and facilitate easier leasing of land. Focus on such areas would not only solve the current problems but also cater to the problems the country has been facing for years but have been left unaddressed.

What a nationwide ban on Chinese products could mean for India

The border clash between Indian army and the Chinese PLA has sparked an anti-China sentiment in the country.  Calls to boycott Chinese goods and reduce import from China have been voiced out by political elites and nationalists in India.

A brief synopsis of India China trade

India, initially a non-aligned country to world trade during cold war era, enjoys the status of most favoured nation with most countries around the world. India presently trades with around 140 countries, with China being the biggest trading partner after US.

 (India- China trade volume)

The bilateral trade between India and China have grown fourfold in the past decade. The trade volume between the two nations stands at 730,550 Crore INR, more favourable for China than India as India has a trade deficit of 371,018 crores INR with China.

 Chinese products hold more than 60% market share in India’s smart phone, solar power and pharma market.

The following are the potential impacts of banning Chinese products or raising tariffs against Chinese imports

Solar Panels and Photovoltaic cells:

India imports solar panels and solar photovoltaic cells worth $1.5 billion from China. The prices of the equipment are believed to be much cheaper than those produced by domestic manufacturers.

 A ban on solar imports or increase in tariff duties shall negatively impact solar productions and subsequently affect India’s committed renewable energy targets under Paris climate accord and International solar alliance.

Pharmaceuticals:

India imports more than 60% of critical active pharmaceutical ingredients and key starting materials from China and 30% from countries like Germany, Sweden and Italy.

The prices offered by its Chinese counterpart are 25-30% cheaper than the prices offered by other countries. Moreover, the user companies of these APIs have invested deeply in building supply chains that traces back to China.

A ban on API and KCM imports impacts cost and competitiveness of user companies in the external markets especially Africa and South America i.e. the domestic API market is underdeveloped accounting for around 8-10% and API procurements from other countries are charged at cost plus premium which shall cost India with 0.89% of GDP annually.

Funding of Indian Start-ups:

(Chinese investments in Indian start-ups amounting to $4.6 Billion)

 Chinese investments in Indian start-ups have grown fourfold and presently stands at $4.6 Billion. Any adverse policy change by India like ban on products or increase in tariff shall affect India’s foreign policy credibility at a time when India has been trying to attract foreign investments. It shall also cause investors to liquidate their investments in India or realign their risk return perceptions and demand higher returns for the increased risk.

Consumers and Retailers:

A ban on Chinese products or increase in tariffs shall affect price sensitive consumers. The switching costs that a consumer shall incur in purchasing imported products of other countries are much higher. Moreover, since the Chinese products in India are already paid for, banning them shall affect the poorest retailers, because of their limited ability to absorb unexpected losses.

Approach to progressively reduce interdependence on Chinese products –

Government scheme’s and subsidies should be aligned towards creation of product alternatives which can compete both in terms of quality and cost against Chinese products. For example, Despite the existence of incentive schemes and subsidies to boost domestic production of solar panels and solar cells, the domestic products are not at par with Chinese products in terms of efficiency and durability

(India’s R&D expenditure as a % of GDP)

The Government should increase its resource allocation for R&D expenditure and encourage private investments in R&D via subsidies and concessions so as to revitalise the innovation ecosystem in India. Currently the government’s expenditure on R&D (as a % of GDP) is 0.86. An increase in R&D expenditure shall equip the industries with technology and skill to maintain their competitiveness in the market.

Liberalization of foreign direct investment norms are required to facilitate the domestic industries to move towards better productivity and efficiency as presently India receives only 25% of the FDI that China gets and 10% of what US receives.

The way forward

India adopting a protectionist policy at a time when it is facing a sharp GDP decline, could be more detrimental to India than China and turning a border dispute into a trade war is unlikely to solve the border dispute. The employment of traditional channels like dialogue and consultation are the need of hour to solve differences at the highest levels. Thus, a strong India-China relationship is important not only for the mutual benefit of its people, but also for the world.

Written By – R Mrithyunjay

SUPPORTING MSMEs SURVIVE THROUGH COVID-19 LOCKDOWN

SUPPORTING MSMEs SURVIVE THROUGH COVID-19 LOCKDOWN

Covid-19 has Created Existential Crisis for MSMEs

Small businesses- both industrial and services- play an extremely important role in meeting the consumption demands of final consumers and supplying intermediate goods to large businesses. These small producers are estimated to generate 30% of India’s GDP and 40% of India’s exports. The small businesses universe has about 7.5 crore micro, small and medium enterprises (MSMEs) and employ about 13 crore workers.

The economic lockdown imposed in the country on 23rd March, 2020 shuttered about 70% of the economy for more than five weeks. 50% of the economy is still shuttered after the lockdown was partially relaxed on 4th May. The MSMEs and the workers employed therein are the worst victim of the economic lockdown. Over 10 crore workers have lost their jobs.

How should India support small businesses, including their crores of workers, survive through this crisis and revive their businesses?

What should the MSME package be and how can it be delivered? I explore these issues in this blog.

MSMEs are Big in Number but Lack Identity

India identifies each of its over 130 crore individuals and assigns all the individuals a unique ID. But India does not uniquely identify and recognise each one of its micro, small and medium business enterprise. MSMEs are defined and classified in terms of investment in plant and machinery fixed in year 2006. These limits have remained unaltered for last 14 years.

We don’t know how many MSMEs are operational in the country. Firm wise data on their turn over, value added, number of people employed, location, wages paid, profits made, tax paid, credit availed etc. are simply non-existent.

About 7.5 lakh crore small businesses in India, in myriad forms, are almost totally unincorporated. These businesses have no unique business ID to be recognised as unique business entities. There is no single authority to recognise and maintain the register of unincorporated enterprises. There is no national business register of unincorporated MSMEs in India.

The MSME Ministry started assigning a unique ID number in 2015 to an MSME- called Udyog Aadhar Numbers or UAN. Total number of MSMEs assigned UAN by now is 92.63 lakhs. The UAN scheme is fundamentally flawed. It essentially assigns an enterprise number to an individual, not to a business. It also covers only about 12% of estimated MSMEs in the country. Finally, it does not have any details of business operations of MSMEs.

We should have a unique ‘business’ identity number, not an ‘industry or udyog’ enterprise number. It should better be called Business or Vyavsay Aadhaar Number or VAN. This number can then be universally used for transacting with small businesses by all- tax authorities, banks and other lenders, EPFO and all other entities.

We Have Only Broad Estimates of MSMEs

The last Economic Census, the Sixth, was conducted in 2013. It found 5.85 or about 6 crore business establishments in operation. The Economic Census 2013 also found that there were 13 crore workers employed in these businesses.

National Sample Survey 73rd Round (NSS 73rd Round) conducted in 2015-16 broadly substantiated the data and findings of the Economic Census 2013. It found 6.34 lakh unincorporated non-agriculture MSMEs in the country. It also estimated that more than 99% of these enterprises (6.30 crore out of 6.34 crore) were micro-enterprises.

During the intervening period of about 8 years between Fifth and Sixth Economic Census, the number of establishments in the country increased by a little over 40%. Even if we assume 1/3rd growth in last 7 years, the number of non-farm agricultural, industrial and services establishments in India should be around 7.5 to 8 crores presently.

Interestingly, more than 70% of establishments or about 5.5 crore establishment were estimated to be Own Account Establishments (i.e. establishments without any hired worker). About 90% establishments were proprietary establishments. A significant proportion of establishments were home based or without any fixed structure to work from.

Over 13 crore persons were found employed in the establishments in 2013.

This number could have grown over 15 crores by now.

The Economic Census did not classify the establishments in micro, small, medium and large enterprises. The 73rd NSS Round did. If we assume all the establishment employing 10 or more workers as large, 99% of the establishments are MSMEs. This corresponds with the finding of 73rd NSS Round.

Equity Finance for MSMEs

It is a stark fact that Indian governmental and financial ecosystem does not provide any equity support to MSMEs. It does not even talk about it. The Annual Report of the Ministry of MSMEs for the year 2018-19 does not use the word ‘equity’ even once in its entire 150 pages report.

International Finance Corporation (IFC), an affiliate of the World Bank, made an estimate of equity requirement of MSMEs in India. It found that the demand for equity finance by MSMEs was Rs. 18.4 lakh crore out of total finance requirement of Rs. 87.7 lakh crores. Unfortunately, after estimating the requirement of equity finance, the IFC forgot about it completely and the entire report concentrated only on credit finance.

The small and medium companies have an option to raise equity on the SME exchanges of BSE and NSE. This exchange allows companies with post issue face value capital up to Rs. 25 crores, which is far higher than the maximum Rs. 10 crores investment permissible for medium enterprises in plant and machinery. Still, only about 300 companies are, in all, listed on both the BSE and NSE SME exchanges. These companies raised a total of about Rs. 6000 crores in equity capital since the inception of these exchanges in 2012. Details of how many of these companies are MSMEs are not available.

MSMEs in India are completely starved of the equity capital.

Credit Support

There is a big gap between the credit required and credit being made available to MSMEs. The IFC report concluded that overall demand for debt for MSMEs was estimated to be Rs. 69.3 lakh crore.

The report further informed that a whopping 84% of the debt demand of Rs. 69.3 lakh crore i.e. Rs. 58.4 lakh crore was met by informal sources. Only about Rs. 11 lakh crore of debt demand was met by all the formal sources put together- the banks, regional rural banks, urban cooperative banks, non-banks, SIDBI and the government.

RBI data broadly confirms IFC findings. For the year ending March 2020, total credit outstanding against Micro and Small Enterprises (MSEs) from scheduled commercial banks was Rs. 11.63 lakh crore.

Grants by Government

By its very nature, grants can be provided only by the government and the charity. The MSME Ministry has an annual budget of about Rs. 7500 crores spread over 40 schemes.

The largest scheme is called Prime Minister Employment Generation Programme. Under the Programme, establishment of micro enterprises are encouraged by provision of a capital subsidy. There is an upper limit of support- Rs. 25 lakhs in manufacturing and Rs. 10 lakhs in service enterprises. Assuming an average capital subsidy of Rs. 5 lakhs, the scheme can provide capital subsidy support to 50000 enterprises a year, not even .1% of micro enterprises in the country.

There are two line-items in the MSME Ministry budget 2020-21 about Funds. One is MSME Fund and the other is Fund of Funds. The idea of a MSME Fund was conceived in 2017-18. For the past three years, a provision has been kept in the budget but not a single rupee has been used. This year, a Fund of Funds has been proposed and a provision of Rs. 200 crores have been kept. Considering that only Rs. 63 crores have been invested cumulatively by the SME Funds registered with SEBI, it will be interesting to see whether Fund of Funds idea takes off materially this year.

Fiscal Package for MSMEs

MSMEs need fiscal support for two main heads of expenditure/losses.

First, most MSMEs could not produce and sell goods and services during this 40-days lockdown period. At least 90% of MSMEs, numbering over 7 crores, simply shut shop. For a period of at least 40 days, these MSMEs received no income. These businesses could avoid the cost of inputs, but will have to bear several fixed costs- rents, interest payments (moratorium even when granted is only postponement of interest payment, not waiver), some wage payment, some maintenance expenditure and the like. Most MSMEs are not in a position to live with this liability. Unless supported, millions of MSMEs would simply close down and default on these obligations.

Second, the 8 crore MSMEs employ about 15 crore workers. Barring a few medium and small industries, most MSMEs, will not be able to pay wages to their workers. For the self-employed/ own account micro entrepreneur, their net income from the businesses is really the wages of the entrepreneur/labour. Over 10 crore MSME workers are estimated to have lost their jobs and wages. While a good part of these MSME workers may find their jobs again when the economy goes back in the normal production and distribution mode (this is likely to be a long drawn out process), the loss of wages suffered during 40 days of lockdown, at the minimum, requires government support.

MSMEs produce about 30% of gross value added. If we take 70% of GDP loss for the 40 days period of economic lockdown, India is likely to have lost about one month’s GDP or about 16 lakh crores of GDP. 30% of GDP contributed by MSMEs implies that MSMEs could have suffered losses of at least Rs. 5 lakh crores of gross value added.

MSMEs have larger share of wages in the gross value added. For micro enterprises, share of wages in value added might even be in the range of 75%-90%. On an average, let us take share of wages to be about 80% of MSME gross value added. This would mean that over 10 crores of MSME workers who lost jobs would have suffered wage loss of about Rs. 4 lakh crores of wages.

The government should offer to pay 50% of the normal wages for the period of shut down subject to a certain maximum, let us say Rs. 10,000 per worker. As an estimated 10 crore MSME workers are out of the jobs, this will not cost the government more than Rs. 1,00,000 crores. Lot of these workers will not go back to earn their normal wages/income for some more time and therefore it might be advisable to provide them additional transition support for some more time say until June end. This might cost another cost another 1 lakh crore. The wages package cost of Rs. 2,00,000 crores for 10 crore MSME workers can be juxtaposed against Rs. 75000 crores support package for 8 crore farmers. Farmers have lost their incomes marginally whereas the MSME workers have lost it majorly.

Second package of approximately Rs. 1 lakh crore can be extended to about 8 crore MSMEs to cover a part of their fixed cost (excluding wages) based on some self-certified details of fixed costs they have to bear for the period of shutdown.

The survival package for MSMEs should be made of two components- a part of the lost wages of 10 crore workers (Rs. 2 lakh crore) and a part of fixed cost which MSMEs have to bear for the period of lockdown (Rs. 1 lakh crore). In all, the MSME Survival Package should be of the order of about Rs. 3 lakh crores.

Will a Credit Financed Support Backed by Government Guarantee Work?

Two proposals are being speculated in the media. The first proposal envisages additional credit support of 20% by banks over and above the line of credit currently approved. Banks’ additional exposure is proposed to be secured by a government guarantee. The second proposal envisages creation of an SPV owned by the Government of India. This SPV will be provided equity by the Government of India. The SPV will leverage its equity to raise debt. The total funds so raised will be used for providing credit support to the MSMEs.

These proposals appear to be unsuitable for the needs of MSMEs and quite unworkable for several reasons.

The SPV proposal is a complete non-starter. Forming such an SPV, staffing and operationalising it, is impossible in the current circumstances. If the SPV were to only refinance the banks, existing vehicles like MUDRA Bank can do it.

A credit-based package does not address crores of MSMEs and their workers. 60% of MSMEs have no access to credit from Banks. A fraction of MSMEs get credit from NBFCs and Micro-finance Institutions (MFI) and not banks. Most MSMEs borrow from informal sources.

Even the MSMEs which have credit lines from banks may not be able to avail additional credit. A good proportion of MSMEs drawing credit from banks are not really creditworthy in the normal banking parlance. Several MSME loans have formally become non-performing loans. Many other MSME loans are structured accounts without formal classification as non-performing. A whole lot of MSME businesses have not made their due payments but these accounts continue as standard accounts. Moratorium granted for three months raises a lot of suspicions about the standard nature of such loans.

Banks will be extremely risk averse to lend to such businesses, even if supported by a government guarantee, especially when their credit standing would have further suffered on account of closure of business in the lockdown period. We have the experience of government backed financing facility created for addressing liquidity concerns of NBFCs.

Essentially, the affected MSMEs need grant support to survive through this crisis and not more loans. In their desperation, even if they accept credit, they may not actually repay. In such a case, the government, if it honours guarantee, will end up providing fiscal grant to cover the losses finally. Why go through the tortuous route?

How to deliver the Fiscal Package to MSMEs

Delivering fiscal package to unknown universe of MSMEs is a real challenge.

Yet, we have capability to deliver it.

The fiscal package for MSMEs can be delivered by taking two institutional action. First, we should leverage the strength of our Unique Identification Authority for quickly registering all MSMEs and assigning them as unique business identity. Second, the MSME Ministry can establish a digital system of Registrar of Unincorporated MSMEs for filing a two-pages return which provides key business operations details of MSME.

Using the opportunity of distress in the MSMEs caused by the Covid-19 crisis, the Central Government can announce survival package conditional upon MSMEs registering for a unique business ID with Unique Identification Authority and filing a return of business operations with the Registrar of Unincorporated MSMEs linked with unique ID.

Structural Reforms for Long-Term Growth of MSMEs

The crisis can be converted into an opportunity to place our MSMEs on a stronger formal pedestal. Fiscal package can also be delivered in a more organised manner.

Our policies and programmes for assisting small businesses in India are based on a fundamentally flawed view of small businesses being inherently unviable businesses and being poor cousins of large businesses. Small businesses are not weaker businesses; these are different businesses. The comparative advantage of large businesses is scale of business built on investment in machinery, automation and technology use. The comparative advantage of small businesses is customised, localised and personalised delivery of goods and services to consumers. Large businesses tend to employ large capital. Small businesses tend to employ larger proportion of workers.

The distinguishing criterion between large and small businesses should be the preponderance of the share of two principal factors of production- capital and labour- in the value added by the business. Businesses with more than 50% of value addition being used to pay wages should be classified as small and those which have more then 50% of value addition going to capital and taxes should be treated as large enterprises.

We should have a system of recognising and assigning a unique business ID to every small unincorporated business in the country. For this, the MSME Act, which should be renamed and reconceptualised as Small Businesses Act, should institutionalise a Registrar of Unincorporated Small Businesses to register and receive annual business performance reports.

A National Register of Unincorporated Small Businesses should be created on a decentralised-centralised mode. All the small businesses should be registered and assigned a unique small business identity (USBID). All the registered small business should be expected to file a short annual return digitally to provide key details of their businesses.

All interactions of government, banks and other institutional partners with the small businesses should be mapped to this unique ID- USBID. This would ensure that all relevant details of a business are mapped at one place. This would help enormously in delivering government benefits to such businesses, build creditworthiness record for better bank and non-bank financing and in conducting their businesses in general.

Government support for small businesses should be thoroughly reorganised. Plethora of schemes with small allocations and overlapping objectives are not delivering any results. Evan otherwise, a budget of Rs. 7500 crores for 7.5 crore small businesses is too small. It should be better targeted. It would be far more effective if the government budget is used for delivering two benefits to small businesses. One, an incentive linked to registration and filing of annual returns on digital small businesses platform. Second, to provide equity support for covering the rental expenditure of small businesses for initial period of 3-5 years.

CONCLUSION

Small businesses- both industrial and services- play an extremely important role in meeting the consumption demands of final consumers and supplying intermediate goods to large businesses. There are an estimated 8 crore small businesses in the country. The small businesses, or the MSMEs as we call these, employ about 15 crore workers.

The economic lockdown imposed in the country on 23rd March, 2020 shuttered about 70% of the economy for more than five weeks. 50% of the economy is still shuttered after the lockdown was partially relaxed on 4th May. The MSMEs and the workers employed therein are the worst victim of the economic lockdown. Over 10 crore workers have lost their jobs.

MSMEs produce about 30% of gross value added. If we take 70% of GDP loss for the 40 days period of economic lockdown, India is likely to have lost about one month’s GDP or about 16 lakh crores of GDP. 30% of GDP contributed by MSMEs implies that MSMEs could have suffered losses of at least Rs. 5 lakh crores of gross value added.

MSMEs have larger share of wages in the gross value added. On an average, share of wages form about 80% of MSME gross value added. This would mean that over 10 crores of MSME workers who lost jobs would have suffered wage loss of about Rs. 4 lakh crores of wages.

The government should offer to pay 50% of the normal wages for the period of shut down subject to a certain maximum, say Rs. 10,000 per worker. As an estimated 10 crore MSME workers are out of the jobs, this will not cost the government more than Rs. 1,00,000 crores. Lot of these workers will need additional transition support for some more time say until June end. This might cost another cost another 1 lakh crore.

Second package of approximately Rs. 1 lakh crore can be extended to about 8 crore MSMEs to cover a part of their fixed cost (excluding wages) based on some self-certified details of fixed costs they have to bear for the period of shutdown. In all, the MSME Survival Package should be of the order of about Rs. 3 lakh crores.

Two credit-based stimulus proposals are being speculated in the media. The first proposal envisages additional credit support of 20% by banks over and above the line of credit currently approved. Banks’ additional exposure is proposed to be secured by a government guarantee. The second proposal envisages creation of an SPV owned by the Government of India. The SPV will leverage GOI equity to raise debt. The total funds so raised will be used for providing credit support to the MSMEs. These proposals appear to be unsuitable for the needs of MSMEs and quite unworkable for several reasons.

The SPV proposal is a complete non-starter. Forming such an SPV, staffing and operationalising it, is impossible in the current circumstances. If the SPV were to only refinance the banks, existing vehicles like MUDRA Bank can do it.

60% of MSMEs have no access to credit from Banks. Any credit-based package will leave these out completely. Even the MSMEs which have credit lines from banks may not be able to avail additional credit. A good proportion of MSMEs drawing credit from banks are not really creditworthy in the normal banking parlance. Several MSME loans have formally become non-performing loans. Many other MSME loans are structured accounts without formal classification as non-performing. A whole lot of MSME businesses have not made their due payments but these accounts continue as standard accounts. Moratorium granted for three months raises a lot of suspicions about the standard nature of such loans.

Banks will be extremely risk averse to lend to such businesses, even if supported by a government guarantee, especially when their credit standing would have further suffered on account of closure of business in the lockdown period. We have the experience of government backed financing facility created for addressing liquidity concerns of NBFCs.

The fiscal package for MSMEs can be delivered by taking two institutional action. First, we should leverage the strength of our Unique Identification Authority for quickly registering all MSMEs and assigning them as unique business identity. Second, the MSME Ministry can establish a digital system of Registrar of Unincorporated MSMEs for filing a two-pages return which provides key business operations details of MSME.

Using the opportunity of distress in the MSMEs caused by the Covid-19 crisis, the Central Government can announce survival package conditional upon MSMEs registering for a unique business ID with Unique Identification Authority and filing a return of business operations with the Registrar of Unincorporated MSMEs linked with unique ID.

This system can be converted to serve long term goals of formalising small businesses in India as described in little more details in the last section of this blog.

SUBHASH CHANDRA GARG

NEW DELHI 05/05/2020

(Subhash Chandra Garg is an IAS officer of the Rajasthan cadre. He has served in various key positions for both the Union Government and the Government of Rajasthan. He served as Economic Affairs Secretary and Finance Secretary of India. He has also served as an Executive Director in the World Bank. To know more, follow him on LinkedIn: https://www.linkedin.com/in/subhash-garg-2241682/)

Uncovering the state of India’s financial sector

The global outburst of the COVID-19 pandemic has put an end to some de facto relationships, such as countries’ reliance on America, and shifting the geopolitical paradigm towards the Eastern economies. It has revealed that the infrastructural facilities available are futile until and unless the countries are efficiently utilizing them. China is supplying materials to all the countries today, even though it is interpreted as political propaganda. Time has truly tested the priorities of governments when it comes to choosing between the economy and the lives of humanity.

India has taken a commendable stance by enforcing the strictest and longest lockdown ever witnessed by any country. It has even surpassed developed countries like Italy and China. However, this alone will not ensure the success story of India.

India’s fiscal balance of both the center and the state stood at -7.4% in FY 20. The Government is already dealing with a debt heavy balance sheet. Nonetheless, it has made the undaunted decision to provide a financial stimulus package worth approximately 3% of our nation’s GDP, to ease the economic burden of the epidemic. Presently, only a handful of industries have been left unscathed by the crisis – the Insurance sector, the Healthcare sector, and the Telecom sector. In order to prepare the country for the post-pandemic situation, there needs to be a cleansing of the current financial services situation in the country, as this would have the most significant role in normalizing the economy when the lockdown ends.

In its attempt to do just that, the RBI introduced a slew of measures to provide relief to the financial sector, paying special attention to NBFCs and NBFC-MFIs. In India, NBFCs indisputably play a quintessential role in the financial inclusion vision of our Prime minister. However, the liquidity crunch faced by NBFCs has long haunted our economy, ever since the IL&FS crisis broke out in September 2018. Post the turmoil; banks have been wary of extending credit to this shadow-banking member. Moreover, the current wave of measures also proves to be inadequate in solving the liquidity problems that are being faced by this segment. The RBI has introduced a moratorium period of 3 months as a relief to the borrowers. This is problematic for NBFCs as they have no option but to grant this moratorium as most of their repayments take place in liquid cash, which currently isn’t feasible. However, flipping the coin, banks have not passed an order to grant this same moratorium to NBFCs. This situation leads to NBFCs not receiving any payments but yet having to make payments. They are also borrowers from mutual fund houses (MFs) and MFs have also been constantly reducing their exposure to NBFCs. As per a Credit Suisse Report, Fund houses have reduced their exposure to NBFCs by as much as 14% in March 2020 alone.

The micro finance institutions (MFIs) are another valuable segment of this sector. As per the data collected from SIDBI, the MFIs have been responsible for extending credit to 64 million individuals, who fall outside the reach of traditional banking. They have provided a rock sold support to low income families and boast a loan portfolio of USD 1.785 trillion as on November 2019. They will play an even more significant role post the lockdown as a number of individuals from tier 2 and tier 3 cities are dependent on these MFIs.

The Covid-19 crisis is posing a tough time for MFIs because the current lockdown has hit the vulnerable section of the society the most, and this section happens to be the customer base of MFIs. Hence, loan repayments are a far-fetched dream for these institutions. Moreover, MFIs employ around 2 lakh people who are primarily involved in field visits. Hence, one of the major concerns of high operational cost persist, as they cannot cut down the salary of individuals who are connecting these institutions to their borrowers. The acquisition of customers by MFIs happens mainly through door-to-door strategies and maintaining personal touch with customers. Therefore unlike banks and big NBFCs who can expand their loan book even during a lockdown by leveraging their tech-savvy target group, MFIs don’t have that option. A majority of the small and mid-sized MFIs borrow from NBFCs, which are further dependent on banks, and well, the moratorium issue has already been stated above.

According to a research conducted by ICRA, if MFIs are not provided a cushion to defer their payments to the lenders -mainly banks and NBFCs- their liquidity coverage would fall below 1, as can be seen in the table below.

Table 1, source: ICRA

The much awaited, Rs. 50,000 Crore TLTRO(Targeted Long Term Repo Operations) provided by the RBI is yet to prove its worth as the central bank isn’t essentially lending directly to NBFCs and MFIs but rather relying on banks to do so. As events unfold, it is being revealed how the banks are reacting to the second version of TLTRO. The first tranche of the offer by RBI has received bids worth Rs. 12850 Crore, which is only 50% of the Rs. 25000 crore. Below is a snapshot of the same.

Chart 1, source: Edelweiss

Private sector banks have stayed completely away from the bids. Banks are currently maintaining a united goal of sticking to their existing loan portfolio and staying away from fresh exposures, which might increase their NPAs. The risk aversion of banks can be clearly seen as they are parking more than Rs. 7 trillion liquidity surplus with the RBI even after a 115 basis point reduction in reverse repo rate, but are shying away from extending credit to the shadow banking sector. This is partly because banks are facing difficulties to find investment grade paper for categories of NBFCs under Rs. 500 crore and would be willing to lend more if no such category restriction was mandated. However removing these restrictions will defeat the whole purpose of lending to the not-so-big NBFCs.

We are still yet to see how the RBI’s measure of extending Rs. 25,000 crore to NABARD, Rs. 15,000 crore to SIDBI and Rs. 10,000 crore to NHB will play its cards in meeting their sectoral needs. In order for SIDBI to grant loans, there are two set criteria: a minimum investment grade of BBB is required as on 31st March, and the loan needs to be repaid in 90 days. These two criteria will automatically remove a good number of MFIs from the eligibility list. According to a recent report by the Micro Finance Institutions Network (MFIN), only 60% of the 52 MFIs in the country have an investment grade rating (BBB or above). Additionally, only 23 MFIs are eligible for the refinancing offered by NABARD.

The Financial sector is a sector, which is indispensable to save both the lives and livelihoods of the citizens of India. With the kind of problems stated above, if the remaining measures by the central bank prove tepid as well, it is clear that the RBI would have to find a way to directly step in to provide relief to NBFCs and MFIs. One should not forget that the country was witnessing a slowdown much before the pandemic struck, hence all efforts should be directed towards not entering the post-lockdown in a worse (if not better) condition than the country was in before the lockdown. A healthy and smooth functioning of the financial sector is imperative for India to achieve this goal.

Written By – Anjali Agarwal (Editor, TJEF)

HELICOPTER MONEY – Do we have an option?

Recently, we saw a TV channel in Karnataka, telecasting a program called Helicopter Drop. The channel reported that the central government has planned to drop cash from helicopters all over the country as a relief measure in the COVID-19 crisis. The channel was issued a show-cause notice from Press Information Bureau (PIB) for spreading such misleading information and creating unrest.

All this havoc was caused due to a misconception of the term ‘Helicopter Money’ or ‘Helicopter Drop’.

So, what exactly is it?

Helicopter money basically indicates printing large sum of money. It is an unconventional economic tool carried out by the distribution of newly printed money to recover an economy which is entering recession. The government of a country directs the central bank to increase the money supply by pumping in freshly printed cash, which reaches citizens by direct government transfer in most cases. This, according to many economists, boosts consumer spending, helping the economy to revive (we know that the share of ‘Consumption’ factor in India’s GDP is a whopping 59%). This situation is analogous to a helicopter dropping huge chunks of cash over the public, hence the name.

This is same as ‘Quantitative Easing’, isn’t it?

Well… not exactly! Both ‘Quantitative Easing’ and ‘Helicopter Money’ involves printing a lot of cash. But, in Quantitative Easing, the central bank uses this cash to purchase government bonds. Since bonds are debt instruments, the government is expected to repay the amount at maturity. Whereas in a Helicopter Money exercise, there is no such repayment.

What is the necessity now?

We already had a bleak economic outlook forecasted for this year. With weeks of slumped production due to lockdown and an anticipated stagewise relaxation of lockdown, the economy could be pushed down the cliff.

The government, along with The Reserve Bank of India, is planning for a series of measures. The reduction of interest rates and tax exemptions could benefit the businesses. However, before considering all the economic aspects, we must ensure that there is enough cash in the hands of people who used to rely on daily wages. We must not head to a situation where more people die of hunger than the virus. In that way, an upward push in the money supply seems to be the only option.

While nations around the globe are proclaiming 10-15% of their GDP in the stimulus packages, our actions seem quite modest. In this fight against the novel virus, we are aware that the government has no other choice but to increase its expenditures. On the contrary, the revenue streams are getting slender. This make it obvious that the fiscal deficit is going to take a hit. So, the action of helicopter drop would also be a method of monetizing this deficit.

Great then!! Are there any roadblocks?

The greatest and most obvious risk is that of inflation. With an excess of money flowing in the market, coupled with a stagnant production, could lead to hike in the prices. Also, we are not an economy where the inflation levels are much lower. These conditions increase the danger of a stagflation.

Another potential hazard is the loss of investor confidence due to a devalued currency. Investors may lose their interest in an economy where the currency is not stable, unlike USD or EUR. They will eventually pull out their money out of the system, leading to a worsening fiscal condition. However, India’s G-Secs is not very accessible to foreign investors. So, this risk is mitigable.

There is also a slight risk of citizens not spending the transferred amount. If the beneficiaries choose to pay off debts or save money that have been transferred, there could be a dilution of purpose of boosting GDP.

While analysing all these aspects, we must remember the fact that we do not have many alternatives to choose from. The RBI could either carry on with the ‘Helicopter Drop’ action as suggested by many economists or deal the situation with open market operations. What the government chooses to do is something we have to wait and watch.

Written By – Nagarajan P (Editor, TJEF)

Removal of Dividend Distribution Tax

The recent decision by the government to remove Dividend Distribution Tax means that the shareholders will now have to pay the tax on dividends they receive. How unfair is it to the shareholders? Or is it really? Let’s dive in.

In India, there is a tax that is imposed by the government on the companies that paid dividends to its shareholders. Although it’s not taxable in the hands of the shareholders, ultimately their share of profits become less. When the company is paying tax for its shareholders, all the shareholders have been charged a flat rate of 20.56% irrespective of their economic status.

Let us examine how the reform (removal of Dividend Distribution Tax (DDT)) changes things.

From April 1, 2020, the companies would not be charged the DDT when they distribute the dividend. It will be the shareholders who receive the payment, on whom the tax will be imposed. Let’s just suppose, Hari and Krishna were two shareholders and they’ll receive their part of dividends from the full amount that the company had set aside for dividends. No tax has been charged on the amount set aside. It will be Hari and Krishna who’ll be paying the tax now. Here is where things become interesting and fair. The same tax percentage will be charged on the dividends received as is defined by the tax slab they fall in according to the income earned. Both the shareholders will now pay a different percentage of tax on the dividend received.

Suppose Hari belonged to the lower income group with under Rs 2 lakh income. He comes under the tax slab of 0% and therefore is not liable to pay the tax on dividends received. So, on dividend declaration of Rs 100 previously Hari was getting Rs79.44 at 20.56% DDT due to indirect incidence of DDT. But now he’ll be getting full Rs 100 and won’t be taxed.

A screenshot of a cell phone

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The table suggests that shareholder in the tax bracket of 20% or below are sure to gain from removal of DDT

On the other hand, Krishna who is high net worth individual and falls in the highest tax slab of 30% (can go up to 43%) will be paying that much percent on the dividends received as well. Along with High Net Worth Individuals(HNI), Promoters of the corporations we talked about earlier will also stand to lose due to this new regime. The one who earns more is taxed more. Progressive taxation at its best. To escape the increased incidence of taxes the HNI’s can invest in Mutual Funds (MNC fund or PSU fund). The HNI’s will get the benefit of pass-through dividends as Mutual Fund’s income is not taxed.

Another stakeholder is the company that is paying Hari and Krishna their dividend. With DDT the company had to deal with several compliances that go along with taxes and incur additional expenses. For example, the company had to deposit DDT within 14 days of declaration or distribution of dividends whichever is earlier. Otherwise, interest is charged on DDT with a rate of 1%.

With the removal of DDT, the onus of paying tax lies on the individual shareholder. Company is free from that burden. Therefore, it becomes easy for it to operate. This will help the ease of doing business in the economy and more companies from foreign markets will find the country attractive to work in.

When the company used to pay the Tax for its shareholders, even though they received reduced income, Foreign investors couldn’t claim Tax credits in their home country. With the Tax incidence now lying directly on the Foreign investors, they are liable to claim Tax credits. This makes their investment in India more lucrative. Hence with the removal of DDT, we will see more Foreign Portfolio Investment (FPI’s) coming in.

As for the government, removal of DDT is a step in the direction of improving the ease of doing in India, something that the government has been targeting from all fronts. The only catch here for the government is that it must forgo Rs 25000 crores of its revenue after the removal of DDT. Economic slowdown followed by a reduction in corporate taxes has already plummeted government’s reserves and now we see the elimination of DDT. But on the flip side, the removal of DDT is directly boosting the income of the Indian middle class. Hence as their purchasing power rises, so does the demand in the market. Therefore, removal of DDT can be the Government’s attempt at curbing Demand-side aspects of the economic slowdown.

Looking at the impact of the removal of DDT on each stakeholder:

  • Retail/ small Investors: One of the by-products from the removal of DDT is to increase the participation of retail investors in capital markets. Small investors are sure to be the ones who are going to be benefitted by this step of Government.
  • HNI’s and Promoters: This is the only segment that will be negatively affected by the removal of DDT. However, on flipside by investing in Mutual Funds, they can minimize the loss. That’s another impact of the removal of DDT, promotion of Mutual Funds.
  • Foreign Investors: They will be able to claim their tax credits in their home country. Hence there won’t be cascading of the Tax and they’ll stand to earn more from India making it a Favourable destination to invest.
  • Companies: The High dividend-paying companies would have to worry about the compliances for paying the dividend. Hence it will be easier for them to work in India.
  • Government: Only the time will tell if the government can meet its objective of
  • Short Term: Aiding the demand-side factors of economic slowdown. Increasing the purchasing power of the middle-class people of India.
  • Long Term: To make India a profitable place for Foreign investors to invest in. Making the Indian Tax system just and transparent.

In all, removal of DDT is a major step and has the potential to solve a lot of problems.

Written By – Ritwik Garg

A work-from-home economy

It’s 9.30 am on a Monday morning. You finish your breakfast and walk towards the kitchen to dispose your plate. As you do, you catch a quick glimpse outside through the window – the streets are deserted, save for a few lone vehicles making their way to a friends’ or relatives’.  You open the window and all you hear is the sound of the wind lashing against your windowpane. What’s more, the temperature seems to have fallen by a noticeable amount. As you slide the window shut, you can’t help but smile as a cool breeze brushes past your cheek. You try to recall – when was the last time you experienced such pleasant weather at 9.30 am in the peak of summer? Probably never, unless you consider the times you reached office early and sat in one of the meeting rooms, whose air conditioners were programmed to operate at a set temperature. You chuckle at the thought of comparing the weather to your office’s air conditioner. Just then, the doorbell rings, interrupting your thoughts. It’s probably the neighbors, whom you have known since your childhood and with whom you have been meaning to plan a road trip to a nearby city. You greet them with open arms and offer them some tea. After a brief discussion, you walk them to their doorstep and bid adieu.

You remember that it is the time of the year which you have been preparing for profusely – the day of the appraisal meeting. As you power on your laptop and log into skype, you collect your thoughts and revise some key figures in your head that are sure to reflect your performance over the past few quarters. You seem confident that you have not missed anything. The meeting goes better than you had perceived, and you promise to treat yourself by going to that fancy Chinese restaurant in South Bombay for lunch. The one that you always put off going to because of its sheer distance from your office and the heavy traffic that always ensued. You calculate that it is located at double the distance from your house, but you are sure that it would take you at most half the time to get there. You leave that thought for later as you get down to work. After marking your attendance in the online attendance software, you reply to some emails from your boss and a few clients.

The next three hours rush by and as you’re about to break for lunch, you hear a nightingale singing by your window. These birds come out during the day? Doesn’t matter. You take in the melody and ask your parents if they would like to join you for lunch. They gladly oblige. You fetch your car keys and tell them where you’ll are headed. As you make your way out of your building gate, you put down the windows of your car and allow the fresh air to greet you. The air seems to carry with it a pleasant scent, now that it is almost entirely deprived of carbon monoxide and other pollutants generated by our species. The only sounds that can be heard are that of a handful of stray engines whizzing past you on perhaps similar expeditions, and of birds chirping. You smile as your parents draw a comparison to their childhood days when traffic was contained, and pollution was not such a nuisance. It takes you no more than 25 minutes to cover the 21 kms between your house and the Chinese place. Now that’s a record.

You enter the restaurant and request your parents to place the order, while you reply to a message on your office Whatsapp group. It appears that an intern would be joining your team from tomorrow and you are due to take her interview on skype today evening. As you reply with a thumbs up, you over-hear a conversation from the adjacent table. A family of 4 trying to decide the venue of their vacation the following weekend. And during this off season! It’s probably the concept of work-from-home that has empowered families like these to plan such delightful trips. The word ‘home’ in ‘work-from-home’ does not necessarily mean one’s own home. So long as you have your laptop in person and a decent internet connection, your home could be on a bench by the lake for all you know! Lunch arrives without much delay and after having a sumptuous meal and thanking the waiter for his service, you drive back home with your parents snoring on the backseat. You play some music, so you don’t doze off yourself.

The next 3 hours rush by at your work-from -home workstation and finally you receive a reminder of the skype call you have with the intern. You have 20 minutes until the call, so you decide to treat yourself to a cup of ginger tea from downstairs. While you cross the park, you spot a father playing frisbee with his infant daughter while his laptop rest on a nearby bench. Just as he tends to his laptop, the mother serves as his replacement. The child is happy as ever. After your short break, you find yourself face to face with a lady in her mid-twenties, and who is due to intern at your organization starting the following day. After a brief meeting, you get back to shooting some emails and scheduling some client meetings, which would customarily take place at Mainland China or a Starbucks outlet depending on the time of the day.

You decide to call it a day when the clock strikes seven. Tonight, you would be joining your cousins for dinner on the terrace of their new home in Navi Mumbai. The distance, although in excess of 30 kms, doesn’t bother you much since you know the journey would take no more than 30minutes. After dressing for the occasion, you drive your car out of the garage and pick up a box of sweets from the nearby sweet shop. At 8 pm, you find yourself sitting on the terrace of an elegantly lavished house in Khargar (Navi Mumbai). As you congratulate your cousin and make your way to a table by the warm fireplace, you smile and wave at some known faces. As you sit by the terrace wall facing the street, Your cousin is the first to speak. “It’s quite nice this way, isn’t it? I have all the time in the world to devote to matters of interest and I can even afford to meet my parents in Pune every weekend!”. “It most certainly is”, you agree. You think back 1 year from the current date and reflect on how things came to be this way.

The COVID-19 outbreak, in all its viciousness, seemed to have played a vital role in the scheme of things. Shortly after the viral outbreak had been officially declared as contained by the WHO, major signatories of the Paris agreement – an agreement within the United Nations Framework Convention on Climate Change (UNFCCC) had got together and signed a deal to employ work-from-home in their respective unions with immediate effect. This had been done in close consultation with the WHO, which pointed out that global ambient air quality had drastically improved on account of the viral outbreak while there was a steep drop in PM10 levels worldwide. Drawing a conclusion based on this observation, the United Nations calculated that the majority of the significant emitters would be able to meet the Paris Agreement deadline in half the time, perhaps lesser! The signatories had approved, and the agreement was ratified without much delay.  The greatest pandemic of the 21st century appears to have come with a subtle message – “Preserve planet Earth!” Because without it, there would be no such thing as you or I. And frankly, who better to teach us this lesson than the oldest inhabitants of our planet?

Written By – Shomit Sengupta