TJEF Volume 4 Issue 2

The current recession faced by global economy is considered to be more destructive than the Global Financial Crisis, 2007-with a baseline forecast of 5.2% sis, contraction in global GDP in 2020. With US elections around the corner, a weakening dollar, chaos around the UAE Israel deal, Fed’s new plans of lifting inflation, disruptions in the worldwide supply chain- the global scenario is sturdily uncertain and predicting the road ahead is getting even more challenging.

The current state has revealed the structural problems pre-existing in the structural Indian economy. Whilst the current scenario demands an increased focus on health infrastructure, India’s health care infrastructure, expenditure as a % of GDP is abysmally low. The economy is expected to grow at 1.5% to 2% for FY 21, as per IMF and World Bank estimates. In the tepid demand scenario, the inflation is skyrocketing at 6.9% in the month of July. India has also been only one of the few economies facing PMI shrinkage in July, compared to a month ago. age

The sectors, which have gained out of the new normal, constitute of technology, pharmaceuticals, agriculture and FMCG catering to essentials. Financial institutions will bear the longest grunt of the crisis, with shadow banking crisis only worsening. The current scenario reveals a rather weak correlation between the stock markets and the economy-with Nifty reaching the overbought zone during the crisis.

Hence, in the next volume of the issue, we tried to cover various facets of the banking sector, the dire state of corruption in India and the inefficiency of the stock markets. TJEF has always aimed at presenting well-curated content from a bunch of ing enthusiasts possessing the right acumen for our reader base.

I would like to take this opportunity to appreciate the efforts put in by all the students to write for the journal.

Keep reading and keep the curiosity flowing!

Please find the link to the PDF version of the journal

https://tapmiedu-my.sharepoint.com/:b:/g/personal/tjef_tapmi_edu_in/Eeu5K4aKMvZLmrtxCecGCWcBFv7mTjipHHYYrh3kebqFmw?e=jTk07r

Anjali Agarwal, TJEF Editor

The Increasing Difference

Do you have any idea how much an average Indian farmer earns? Or what an average Indian earns? Okay let us divide the economy of India into major sectors- Agriculture, Industry and Services. If we divide our $3.2 trillion nominal GDP ($11.2 trillion by Purchasing Power Parity) in these segments we will find Agriculture contributes about 15%. It is okay – even agriculture contributes only 1% of US GDP. But in India this sector employs 50% of the adult workforce. Just to reiterate- half of the India’s families are dependent on agriculture but they have only 15% share in the country’s annual income.

1950 to the second decade of 21st Century – One Sector has always been failing

Now coming to the question, how much exactly an average farmer earns? It is approximately ₹100,000/annually per household. Considering an average family has 5 people it is ₹20,000 per person and it only converts to less than a couple thousand rupees per month per person.

Maybe a brief idea about the growth rate of different Indian sectors might help us understand the vulnerable state of this agriculture sector. The agriculture sector which employs nearly 50% of Indian population grew at less than 2% whereas the Services sector grew at about 10% to make the aggregate to grow at 6-7% for the last 2 decades.

So fundamentally we will have to understand when we say a nation is growing at a certain rate, how uniform is that growth, who all are contributing to the growth, who are the outliers and who are out of the race? The GDP per capita (Nominal or PPP) can yet not define the real central tendency being highly influenced by the outliers. The median income level can somewhat account for the overall development along with certain other parameters including Mass Literacy or Infant Mortality Rate (basic hospital infrastructure and ordinary citizen’s access to the same).

Talking about the outliers –the promoters of Nifty 50 and top companies in the countries. But isn’t it obvious that they should have majority wealth to say- they only provide majority of jobs in the country and serve as real assets to the country? Isn’t it same for almost all rich to poor countries? The simple answer is “Yes”. But there’s a very big ‘but’. Is this at all a healthy growth? In capitalism it is. I mean how can Mukesh Ambani help own approximately 50% of RIL from the very start and RIL is today valued at $200b not by him but by the people of the world. The same goes for Jeff Bezos or Bill Gates – it’s the people of the world who value the businesses at more than $1.5 trillion.

But if the top billionaires literally add hundreds of billions of dollars to their total wealth in this horrible performing year of 2020 as Bernie Sanders complain about, what exactly does this mean? We are moving towards more financial extremism. If in 2010 someone said the total wealth of top 10 billionaires is equivalent to the bottom half of world population wealth; in 2030 it can a single person! Or even another way of thinking it – if Amazon’s annual median pay ($29,000) is equivalent to its CEO’s 9 seconds worth of income by 2030 it could actually be a second or two!

                                Source: Fast Company

Ensuring uniformity of growth is no one’s responsibility and when you have the large tech giants as publicly listed companies wherein no in is stopping a poor person to buy into their portfolio, why is it even a concern? Why and how should the government interfere? No one literally stopped a poor farmer to invest in Reliance Industries IPO on BSE and grow at almost the same rate as Ambani. It is he – who chose to invest in this own farming business and obviously lost to the growth race to the billionaires.  In all fairness many of these self-made billionaires have created such a humongous wealth they themselves never could’ve imagined in making so!

But is there actually any way that can help to keep a balance? Maybe a wealth tax for inheritance? Of course, many of these billionaires do pledge to give away a part of their wealth in charity and involve in several philanthropic activities like Facebook founder and CEO Zuckerberg pledging to give away 99% of his wealth or Bill Gates over a period of his life (Bill and Melinda Gates foundation) has given away $100b+. In Indian context we have Wipro’s Azim Premji, the MP Birla foundation, Tatas, Ambanis and Adanis amongst many others. The biggest concern in this context is absorption of the wealth in the society and if that one-time transfer can be capitalized to make a full-time employment opportunity.

                                The Philanthropy that matters

The only thing in this context is connection. A big business in any country not only provides job opportunities for thousands but enable thousands of other businesses to thrive amongst others. Think about an IT corridor- OMR in Chennai. Is it only the IT employees that benefit? What about the hundreds of snacks shop, hundreds of PGs, the huge demand in the local transportation, poll tax by government – and the list goes on and on. To see closely it is only a few tech giants indirectly employing so many. But what if a group of people is repeatedly cut off from this growth trajectory through generations? This is very important for us to understand – even if I agree a very small snacks shop is a beneficiary of TCS (his small shop beside the office); not everyone is having the opportunity to make that small shop also. If anyway the small businesses can somehow connect with the giant conglomerates it’ll be a great thing – but somehow a very good proportion of people stay out of the race permanently and neither is there any opportunity to connect in foreseeable future.

There is nothing wrong in capitalism if that capitalism can influence and benefit a good proportion of people in a particular geography. If it cannot do so – it will account for growth in GDP figures but that’s not “development”. And that “Increasing Mismatch” can be fixed with sustainable development and not only growth – not to mention growth is a huge component in the developmental process!    

From Debjit Pal : Editor – TAPMI Journal of Economics and Finance

The Story of Indian Pharmaceutical Industry

During the 1970s, the Indian Pharmaceutical market was nowhere on the map. But is now one of the emerging world leaders. Infact, it is called “the Pharmacy of the World”. Generic drugs comprise the largest segment nearly 71%, over the counter and patented drugs account for the remaining 21 and 9%, respectively. The Indian Pharmaceutical industry brings in a revenue of 38 million USD annually, making it the third largest in the world by volume and the eleventh by value. There is a total of around 3000 pharma companies and 10500 manufacturing units that are currently operational in India. The transition has been gradual but not without its pitfalls. There have been several factors that have influenced the evolution of the Indian Pharma industry.

Since the advent of the first pharmaceutical company in the early 1900s in Calcutta, there have been four periods for evolution for the Indian Pharma sector.

  • The 1900s were still dominated by the foreign players, post 1970 era saw a few changes in patent acts, it focused more on process patents and did not cover the products. This led to many players in the market take the opportunity to reverse engineer the drugs without having to pay royalty to the patent holders. This period saw a 10-fold rise in number of pharma companies in the country. Accompanied by the exodus of foreign players, the domestic generic pharma industry had an increased market share in generic drugs.
  • The early 2000s, saw these companies expanding their capacity even globally. The export market received many Indian entrants. The pharma export growth gained momentum, with the liberalization of the Indian economy that opened gates for privatization and globalization.
  • 2005 however saw a minor upheaval in the sector due to a change in the patents act that abolished process patenting and started product patents. This forced the pharma companies to shift focus from generics to R&D for new drugs components or API and other Biopharmaceutical products.

 The key segments in the pharmaceutical business in 2019 were:

  • API
  • Formulation manufacturers
  • Biotechnology sector
  • Contract Research and Manufacturing Services.

Figure 2: The Indian pharma industry YoY sales growth

The industry has seen a steep decline from 2007 due to increasing market volatility and even though there have been good phases, the growth still continues to remain volatile even to this day.

There are several reasons that contribute to the market volatility.

  • Emerging competition in the generic drug market from other countries have caused a substantial price erosion for generics and thus have caused significant drops in the pharma revenue.
  • Strict regulatory guidelines for manufacturing, quality control measures. There has been a substantial growth in the number of warning letters that the USFDA has given out to companies in the past few years.
  • The 2017 GST regime caused higher production costs and reduced profit margins.
  • Domestic price caps introduced by NPPA on drugs have caused these companies to reduce their production by considerable margins.
  • Increase in API costs have caused formulation prices to go up. India currently imports about 60% API from other countries for drug manufacturing and the increases prices have thus caused a steep decline in the profit margins.

But the industry has also started changing its outlook and have taken steps to combat the hurdles that lie ahead. Generic drug manufacturers are exiting non-profitable portfolios and looking for alternatives and new innovation strategies.

  • Focusing on differentiated complex generics because they are difficult to develop, face lesser competition and thus yield higher profit margins than normal generics. Regulatory bodies are also likely to prefer complex generics over old-school generics.
  • Specialty drugs are high on pharma launch agendas. They are high value drugs that aid in the treatment of chronic, complex of rare diseases. There is a 50% predicted growth in the market spend for specialty drugs.
  • One of the major focus areas in the current market are APIs. In-house API manufacturing is gaining momentum. Indian API exports have increased by 11% in 2019 and the global API market is predicted to reach USD 245 billion by 2024.
  • All the above shifts in the trends for pharma manufacturing has led to steep rise in R and D investments.

The companies are strategizing for long term value creation, focussing on effective cost optimization and building a robust culture of quality and excellence in regulatory compliance. These are key aspects to sustainable growth in the sector. All strategies are focussed on growth, which is a long-term goal. They aim at steady increase in the global footprint of the industry.

From Deyasmriti Nandi : Editor – TAPMI Journal of Economics and Finance

The Case for an IT Boom

I remember Jeffery Gundlach quoting Ernest Hemingway, ‘How did you go bankrupt? Two ways. Gradually, then suddenly’. This quote is deceivingly insightful. It shows how change takes place, small changes occur with the minimal impact until the cumulative effect reaches a critical point where the entire framework disintegrates and settles at a new equilibrium.

The quote seems apt for the world’s journey to its digital future, being accelerated by the pandemic. The groundwork for this new digital reality has been in progress ever since the mass production of computers and more so since the internet revolution. Being born in the early 90s in India, it’s truly astonishing to reflect upon how the digital world has slowly taken predominance in our lives from the time of the dial-up internet connection and computers being more of a novelty item to the smartphone-dependent world of today. The pandemic will now accelerate this trend even more with trends like work from home and e-commerce becoming the new normal, making parts of the old economy redundant. This has profound implications for sectoral returns in the coming decades, with few sectors disproportionately outperforming others.

The first IT boom in India happened in the late ’90s when the market realized the potential of Indian IT firms to capitalize on the world’s need to migrate business functions on to the computer. It has been 20 years since then and a lot has changed. The Indian IT industry has grown substantially. Just as an example, Infosys which had a revenue of less than Rs.2000cr in FY 2000 had Rs90,000cr revenue in FY 2020. Contrast this with HUL, a current market darling, which had revenue around Rs 11000cr in FY2000 and Rs.40000cr in FY 2020 barely keeping up with inflation. Both companies command similar markets caps around Rs 4.5 lakh crore, but Infosys trades 25x trailing earnings compared to HUL’s 65x.

The Indian IT sector despite its mighty financial performance through the last decades has not been a darling of the markets as it could not for obvious reasons sustain the growth rates during the early stages of the industry. Barring brief periods of outperformance as a defensive sector, it has barely been in the limelight. I remember around 3-4 years back when NASSCOM projected a 7% handle for industry revenue growth, investors were all ready to write off the industry as having limited growth potential. This dismal outlook for growth is precisely the reason for the underwhelming valuations for the IT industry compared to other sectors. The pandemic has broken this narrative and the market is slowly recognizing the fact the Indian IT industry barely into its 4th decade has plenty of gas left in the tank.

I enumerate the factors that I believe will lead to a massive re-rating for the Indian IT industry in the post COVID world

  1. The Indian IT industry at under $200 billion still is just a fraction of the near $3trillion global industry. There is tremendous scope for increasing market share with all factors that aided the industry’s growth thus far remaining intact.
  2. The pandemic has given a boost to the industry with enterprises worldwide being forced to strengthen their IT architecture and capabilities and this will be a persistent trend.
  3. The domestic market will grow to outpace Indian GDP growth and will be a significant contributor to revenue growth in the next decade.
  4. The market will realize the staunch nature of the earnings strength of quality IT firms. Customers find it difficult to switch vendors as the cost of migration outweighs any potential savings of lower pricing, hence protecting revenue and margins.
  5. There is no reason to believe that the total earnings of an Infosys for the next 30 years will be any less than HUL for the next 30 years and hence they should have similar valuations. The market will soon realize this fact and reprice accordingly.
  6. The level of Global debt means that the system cannot support ‘normal’ interest rates and global central bankers are sure to embrace dovish policy for the foreseeable future giving a great tailwind for stock valuation.
  7. The sector should be an outperformer just by the process of elimination with most other sectors still reeling from the impact of the pandemic and the road to recovery remaining murky for most. Some industries like Aviation and Hotels may not fully recover any time soon, as even after the pandemic ends, the behavioural change will ensure business travel is significantly scaled back denting a significant blow to revenues.
  8. Most Fund houses have been underweight the sector and thus once the sectors start outperforming, they will be forced to chase the sector to avoid underperforming the benchmarks. This fund rotation will be a great driver for outperformance
  9. More often than not, markets tend to have excesses at the later stages of secular trends and this will give outsized returns for anyone able to exit the trend in a timely fashion.

The above-detailed points and few others not mentioned will lead to a boom in the Indian IT stocks given stagnant or rising markets according to my judgment. The risk/reward for the sector seems very attractive as very little of the above narrative has been priced in. Even if the narrative fails, there will be a minimal loss since the present prices have not discounted for it. Let us wait for time to give the final verdict.

Written By – Nitin Mathew (BKFS, PGP 2)

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/)