Loans to MSMEs Decline Despite Credit Guarantees

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India’s policymakers want to reduce the suffering of the economy with specific credit for small businesses that contribute around 25% of gross domestic product (GDP). The government’s credit guarantee schemes and the Reserve Bank of India (RBI) forbearance measures all aim to push lenders to increase cheaper credit to micro, small and medium enterprises (MSMEs).

But the banks are the horses who refuse to drink this water even though they have been trained and forced to do so. In fact, if the contraction of bank credit to MSMEs is something to do, the schemes do not have a big impact.

Bank of America research analysts say this does not bode well for an economic recovery. “The decline in credit flows continues to indicate a GDP contraction of 11% in the September quarter and 7.5% in FY21 due to the Covid-19 shock,” Bank of America said in a note dated 2 September.

In July, loans to MSMEs were down 4.96% year-on-year, according to RBI data. Indeed, on a cumulative basis for year 21, the contraction is 10.5%. The pain seems more acute as a moratorium on repayments had been in effect since April and 65% of MSME loans were under moratorium that month. The proportion of loans on moratorium has since declined, but MSME loans continue to represent a larger share in the overall loan portfolio covered by repayment leave.

Certainly, the emergency line of credit guarantee system where the government provides a 100% credit guarantee has seen disbursements of 1.1 trillion through August, according to data provided by the government. This is 63% of the 3 trillion expected when this program went live in May. Despite these disbursements, the overall flow of credit remains a trickle.

If this indicates that small businesses still do not have easier and cheaper access to credit, it is also partly due to their refusal to borrow. Hardest hit by the pandemic and the lockdown that follows, small businesses have no idea what their future income or cash flow will be. If direct government support is the only way out, it can be hard to come by given a crippled budget situation.

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