Empowering MSMEs - Overall Flow of Finance to the MSME Sector - Part 1

MSME – Sector Overview

Part 1

Empowering MSMEs Role of Banks & Financial Institutions, IT, Skill Development & Rating Agencies

MSME – Sector Overview

Indian economy is dominated by a vibrant set of enterprises, which are prestigiously known as Micro, Small and Medium Enterprises (MSMEs) for their scale of operations. The role of MSMEs in economic and social development of country is widely acknowledged. They are nurseries for entrepreneurship, often driven by individual creativity and innovation, and make significant contribution to country’s GDP, manufacturing output, exports and employment generation. The labour-capital ratio in MSMEs is much higher than in larger industries. Moreover, MSMEs are better dispersed and are important for achieving the national objective of growth with equity and inclusion.

MSME – Sector Overview

Looking to the significance of SME sector, it is estimated that if India wishes to have growth rate of 8-10% for the next couple of decades, it needs a strong SME sector, without which it would be difficult to realize. In this backdrop, MSME is considered to be fast growing sector of economy. The sector is gaining more importance to realize theme of 12th Five Year Plan (2012-2017) approach paper “faster, sustainable & more inclusive growth”. So, this sector offers opportunities of entrepreneurship to younger generation, new areas of MDPs for management institutes, business prospects to lending institutions, issues to regulators & policy makers and areas of research to scholars for making the sector more vibrant and faster.

MSME – Sector Overview

Today there are about 36 million MSMEs in the country and this sector has shown an average growth of 18% over the last five years. However, only 1.5 million MSMEs are in registered segment while the remaining 24.5 million that constitute 94% of the units are in unregistered segment. MSMEs are broadly classified into two sector i.e. manufacturing and services. The units engaged in manufacturing or producing and providing or rendering of services has been defined as micro, small & medium under MSMED Act on basis of original investment in plant & machinery and equipment.

MSME – Sector Overview

The latest 4th all India Census of MSME sector has revealed that of the total working enterprises, 95.05% belong to micro enterprises, 4.74% to small enterprises and balance 0.21% are medium enterprises. Also it is observed that 45.38% enterprises are operating in rural areas. Though MSE sector, micro in particular, is of great importance in respect to generating employment and contributing inclusive growth of the economy, this segment of industry is deeply credit constrained.

Role of Banks and Financial Institutions in Financing MSMEs

The overall demand for finances in the MSME sector is estimated to be INR 32.5 trillion. The majority of these are in the form of debt. The demand for debt varies among enterprises in the sector, with different expectations and capabilities. The micro and small sub-segments together account for the majority of the debt demand. As they mostly operate in industries such as retail trade, repair and maintenance, restaurants and textiles and have a significant demand for working capital. The average credit requirement for Small enterprises is estimated to be INR 4-4.5 million and cash continues to be a preferred form of transactions. Medium enterprises are more structured and have a predictable demand for debt and prefer formal source of finance. The average credit size is higher.

Overall Flow of Finance to the MSME Sector

Major reforms for the MSME sector have taken place in the form of introduction of schemes which have benefitted the flow of credit to the sector Working with the assumption that all finance demand by the MSME sector is met by either formal or informal sources, the estimate for overall supply of finance to the MSME sector is INR 32.5 trillion ($650 billion). This comprises informal finance, self-finance and finance from the formal financial sector. However, what is characteristic of the finance flow is that informal sources and self-finance together make up most of the finance channelled into the sector. An estimated INR 25.5 trillion ($510 billion), or nearly 78 percent of the sector’s debt demand, is fed by these two sources, while formal sources cater to just over 22 percent of the demand at INR 7 trillion ($140 billion).

Overall Flow of Finance to the MSME Sector

Overall Flow of Finance to the MSME Sector

Formal sources of finance, i.e. banks and non-banking institutions, account for INR 6.97 trillion ($139.4 billion) of the overall formal finance supply, and commercial banks are the largest formal sources of finance, primarily providing debt capital to the MSMEs . The study estimates that the supply of formal equity to the sector is INR 0.03 trillion ($0.6 billion) .The study estimates that informal sources account for an estimated INR 24.4 trillion ($488 billion) in finance to the sector. Informal sources include both institutional sources such as moneylenders and chit funds, and noninstitutional sources such as family, friends, and family business. In addition, entrepreneurs also leverage personal resources and contribute equity to the enterprise. Self-equity contributions are estimated to account for INR 1.1 trillion ($22 billion) of finance flow into the sector.

Flow of MSME Debt Finance from the Formal Financial Sector

The MSME sector receives INR 6.97 trillion ($139.4 billion) debt from banking and non-banking institutions. Banks and government financing agencies constitute the largest share of formal debt to the MSME sector, and are estimated to provide INR 6.4 trillion ($128 billion) to these enterprises. The balance INR 0.57 trillion ($11.4 billion) of formal debt is supplied by non-banking finance companies (NBFCs). Unlike in many developing countries in Latin America where large banks are down-scaling to serve the Small and Medium Enterprise (SME) market, in India large banks have been the largest formal source of finance to MSMEs for decades. It is surprisingly noticed that about 5% MSMEs have been covered by institutional funding given and approximately 95% of units remains to be brought into banking fold

Flow of MSME Debt Finance from the Formal Financial Sector

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