MSME.9.5This post provides preliminary reactions to a Consultative Paper on National MSME policy which was solicited by the Development Commissioner, MSME.  Given my expertise, it only addresses the financial aspects of MSME development in India. It is well known that micro- and small enterprises seek informal sources of financing and their organizational structure (of sole proprietorships) is such that financing tends to be much more in the form of debt rather than equity.  Whatever collateral that is provided often takes the form of pawning personal valuables and is difficult to identify, especially for the service segment of these businesses. Without adequate collateral, formal institutional finance is understandably reluctant to participate. To address this, CERSAI has begun to maintain a collateral registry.  In turn, the entrepreneurs themselves do not have the expertise in record-keeping and book-keeping, to meet institutional guidelines. Indeed, enterprise size and structure are likely to be such that the costs of compliance would make the businesses themselves unviable. Programs such as credit linked capital subsidies (CLCS) largely for the manufacturing segment and credit guarantee schemes (CGTMSE) been proposed to address these concerns. Even credit ratings are 75% subsidized, and presumably assist businesses that can continue to be viable with financing, since they wouldn’t subject themselves to outsider scrutiny otherwise. Still, only a small fraction of entrepreneurs approach and a still smaller fraction obtain institutional funds while the majority rely substantially on informal financing sources.

Government interventions are targeted at making the MSME environment more palatable to institutional finance. Corresponding efforts to support the entrepreneur in the areas of skill development, connection to end-user markets and the adoption of technology have also been proposed. One aspect that has not achieved much attention is improving entrepreneur financial literacy. Developing such financial literacy would involve: a) ) teaching entrepreneurs the value of record-keeping, financial planning, forecasting, and the revolving nature of working capital needs; b) making entrepreneurs aware of how access to formal finance might benefit the business and; c) helping entrepreneurs understand what causes financial sickness and how they can recover from such distress. One would expect entrepreneurs to have some schooling and therefore the ability to comprehend basic financial concepts. In designing literacy programs the challenge is of course to find the right local language teachers, perhaps involving their more successful peers in delivering such education. It seems that basic training of this nature would be one way to bring down the costs of complying with the requirements for accessing institutional finance.

S.G. Badrinath, Centre for Capital Markets, IIM-Bangalore,  January 13, 2015.