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Question of existence: Solvency and not liquidity should be the core of policy response for MSMEs


By Partha Chatterjee

That the Indian economy is in bad shape was known, the extent was revealed by the announcement that Indian GDP contracted by 23.9% in Q1 of FY 2020-21. The impact is being felt by every segment, across the length and the breadth of the country. However, the most impacted are probably the medium, small and micro scale enterprises (MSME) which form the very fabric of the Indian economy. They contribute 29% of India’s GDP and employ 11.1 crore people (NSS 73rd round, 2015-16).

This crisis is different. It is not just some sectors, it is not just a financial crisis, it is just not an issue of debt, demand shock or supply shock – it is all of those and more!

Yet, in many ways the government response in dealing with the economic crisis, particularly when it comes to MSMEs, does not seem to recognize that. The government has come up with different measures to support the MSMEs, and the overall economy, but a big focus has been increasing liquidity in the economy, both for monetary policy and fiscal policy. RBI has, and rightfully so, brought down the interest rate in the economy to a historical low. The Finance Minister has announced several schemes for the MSMES. Chief among them is the Rs. 3 lakh crore emergency credit line guarantee scheme (ECLGS), which is among the largest component of the financial package announced by the Government. It has also announced a subordinate debt provision of Rs. 20000 crore for stressed MSMEs. All this means is that the economy is flushed with liquidity. Loans are easier and cheaper to get than ever before. So, is it helping? The GDP numbers answer that question.

Why has this not been more effective? That is because right now the issue is not so much about liquidity, but that of solvency.

Consider the decision making process of doing business using some basic economics. There are two separate decisions involved. The first is to decide whether to be in business or not – the extensive margin. It involves two choices, first to enter the business and then to choose to continue or exit.

The second set of decisions, contingent on being in the business, involves running the business – how many people to employ, how much materials to buy, how much to invest, etc., – the intensive margin. How are these decisions taken? It is by weighing the expected revenue and the costs needed to generate that revenue. Low cost of borrowing helps to reduce the cost. However, that is only one side of the equation – what about the expected revenue?

This is where the massive problem is. If businesses do not believe that they can make significant revenues, then lowering costs will not help. If one side of the equation is zero, no matter how low the other side is, it will not help. That is exactly what is happening, businesses are closing down since they do not see a viable way to generate revenues anymore. Thus, liquidity may help businesses manage the stress to the intensive margin, it will not do much to mitigate the problem in the extensive margin. And, if businesses decide to close down, what use is a cheap loan to them.

The question is how can businesses be kept solvent? Looking at recent crisis and recoveries, like the great recession of 2008, may not give us much insight. It might be far more useful to go back and look at US recovery from the great depression, rebuilding and reconstruction of Europe and Japan post World War II and such episodes.

Several ideas are worth considering. The most well-known is creating public works programs which can be designed to let MSMEs participate. Can the planned new parliament building, for example, be built by MSMEs? Another idea worth considering is creating a reconstruction fund as was done in the US. This fund can take on long term risks and help bridge the financing gap for MSMEs on the verge of collapse. We will also have to urgently deal with market power as Japan dealt with Zaibatsus to increase competition and efficiency. MSMEs cannot operate if the market is dominated by one or two players with deep pockets. If these can be implemented, many more MSMEs will have a fighting chance to survive, and the economy to regain a high growth trajectory.

(Dr Partha Chatterjee is Dean of International Partnerships, Professor and Head, Department of Economic at Shiv Nadar University)





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