India’s new COVID MSME package: critical assistance or token gesture?

India’s second economic stimulus to tackle the aftershocks of the COVID-19 outbreak is finally here. On May 12, Prime Minister Narendra Modi announced a much-anticipated extension to the initial March 27 stimulus package. Modi has broadly pledged to devote nearly 10% of India’s gross domestic product for FY2020 – $ 256 billion – to economic relief measures for the construction of an “Atmanirbhar Bharat” or of a “self-sufficient India” in the aftermath of the pandemic. The Prime Minister cleverly left it to listeners to glean that the $ 256 billion figure would not be just new spending, and included the nearly $ 109 billion (43% of total) in fiscal and monetary policy measures. already implemented during the first relaunch. .

It was up to Finance Minister Nirmala Sitharaman to broadcast accordingly and provide the missing pieces of the latest spending initiatives, which, she explained, would be delivered in installments. Sitharaman prefaced his remarks by touting the resounding success of the initial $ 22 billion fiscal stimulus, consisting mainly of cash transfers and food rations for poor families and women directly affected by the lockdown. She seemed more hesitant, however, as she attributed the same applause to the injection of $ 87 billion of cheap liquidity into the financial system by the Reserve Bank of India (RBI) to stimulate lending to micro, small and medium enterprises (MSMEs). ), the main job creator in the country. As might be expected, the RBI’s aggressive stance on monetary policy has barely dented lending to MSMEs so far. Parking excess liquidity in financial institutions and expecting them to absorb all of the credit risk by lending these funds to cash-strapped MSMEs at a time when capital is scarce has been proven. be a failure. Instead, financial institutions diverted excess liquidity from much riskier MSME asset pools and placed it in safer, more profitable, and higher-rated corporate securities.

With the RBI’s monetary boost proving to be a damp firecracker and growing public anger over the anguish of poor migrant workers fleeing unemployment caused by a prolonged lockdown, the finance minister unveiled a 55-dollar spending program. billion dollars specifically aimed at reviving MSMEs and stemming job losses. At the heart, and by far the largest part of this package (73%), are $ 40 billion unsecured automatic loans for MSMEs, aimed at 4.5 million struggling small businesses – or what the finance minister called non-performing – with revenues of less than $ 13 million and outstanding loans of at least $ 3 million.

The program, which will last until the end of October, will offer fully government guaranteed loans for four years with a twelve-month moratorium on principal payments. Fully guaranteeing loans to non-performing businesses is a failure. Taking zero risk will only cause lenders to refinance – at full cost to the public purse – the past loan losses of these small borrowers, and use the remaining portion of that program to blithely, without considering the credit implications, to build up. a portfolio of standard sub-enterprise assets. With full recourse to the sovereign and without collateral, the bill for defaults on most of these low-quality borrowers will almost certainly have to be borne by the state.

The remaining $ 15 billion (27%) of the MSME bailout mainly focuses on liquidity support initiatives to help struggling non-bank financial corporations (NBFCs), which typically have large MSME portfolios. A $ 6 billion (40% of $ 15 billion) partial credit guarantee program was created to encourage banks to buy quality debt securities from NBFCs, with the government taking an initial loss of 20%. However, for this type of capital market solution to work, it would take an active secondary market for banks to trade this paper in order to manage their liquidity risk, which is currently absent. Another special $ 4.0 billion (27% of $ 15 billion) liquidity program is also being launched to help NBFCs, housing companies and mutual funds, but details on how this will be intermediaries have not yet been revealed.

Other spending initiatives include capital funding for financially troubled businesses. There is an additional support of $ 2.6 billion (17 percent of the $ 15 billion), with an initial loss of 20 percent borne by the government, in the form of subordinated debt to be provided by banks to 200,000. MSMEs to improve their debt ratios. Equity financing of $ 1.3 billion (9% of the $ 15 billion) is also expected to be made available to viable businesses through a fund of funds for MSMEs. The need for this line of equity is unclear as viable companies are generally able to attract private sources of equity on their own. Other relief measures for MSMEs include $ 1.2 billion (7% of $ 15 billion) in contingency fund contribution cuts to increase workers’ take-home pay and tax support for employee contributions extended for three months.

In the end, a $ 55 billion aid plan for the country’s largest employer, less than half the balance sheet of a major Indian bank, appears little more than symbolic. Its centerpiece, the loan guarantee program, which shifts full responsibility for loan losses from eligible borrowers to the Treasury, appears ill-conceived, however, at a time when the government struggles to contain the budget deficit. Structuring the program to cover the credit and performance risks of the MSME loan portfolios of financial institutions through participation or risk sharing would have been a smarter choice for the government. With lenders having skin in the game, expected credit losses would be lower with funds more wisely deployed to save viable and restructured businesses. The government could further optimize its risk-adjusted return and expand the target market for borrowers under this program by leveraging highly rated third-party sponsors, such as multilateral institutions, to share credit risk.

For besieged lenders, the last mile challenge of any government-sponsored program lies in its implementation. Very clear and detailed rules on the recovery of bad debts must be developed upstream, in the event of borrower default and lenders wish to exercise their right of recourse. If there are delays or refusals due to bureaucracy, financial institutions will avoid any government credit enhancement program, and struggling MSME borrowers will have to look elsewhere.

Ketki Bhagwati is Senior Advisor at the South Asia Center of the Atlantic Council.

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Image: A man wearing a protective mask walks past the Bombay Stock Exchange (BSE) building in Mumbai, India, March 13, 2020. REUTERS / Francis Mascarenhas

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