Following PM Narendra Modi's announcement of a $290-billion package to revive the Covid-19-hit economy, the Indian Finance Minister Nirmala Sitharaman set out to revive the main engines of the Indian economy, increase demand, promote self-reliance and create the right conditions for foreign companies leaving China to invest in India.
Announcing a set of bold measures to revive the micro, small and medium enterprises (MSMEs), generate demand in the economy, promote self-reliance, provide relief to employees at the lower end of the income spectrum, boost the non-bank financial services sector and ailing power distribution companies, Indian Finance Minister Nirmala Sitharaman unveiled the first part of the $290-billion stimulus package that Prime Minister Narendra Modi had promised yesterday. A back of the envelope calculation shows that Sitharaman has used up about $75 billion, or a quarter of the fiscal ammunition that Modi had given her to fight the economic crisis arising from the Covid-19 pandemic.
Revitalising the MSME sector
Jettisoning the incremental approach adopted so far by the government to help India's struggling MSME sector, which accounts for 30 per cent of India's GDP, 50 per cent of exports and almost 40 per cent of employment, Sitharaman announced six booster doses to revitalise this sector.
The biggest of these is the move to provide more than $40 billion as collateral free loans for MSMEs to help ease their credit woes. These credit lines, both the principal and the interest, will be 100 per cent guaranteed by the government. An estimated 4.5 million units will benefit. These loans will have a tenure of four years and there will be a 12-month moratorium on repayment of the principal amount.
The MSME sector is the largest employer in India's manufacturing sector and has been facing a liquidity crisis for several quarters that has severely constrained its functioning. This move will smoothen the flow of credit to this sector and help it return to good health.
" Strengthening the MSME sector will result in the many large US, European, Japanese and Korean companies looking to invest in India being able to bring some of their core suppliers with them. This will become another “pull factor” when these companies consider new destinations for their investments."
Another move to improve the flow of liquidity to the MSME sector seems to have passed under the radar. Sitharaman announced that all central and state public sector units would clear all their pending dues to MSMEs within 45 days. This announcement, largely consigned to the fine print of news reports on the subject, could be the real gamechanger. According to analysts, this will release an estimated $55-60 billion of liquidity to the sector.
The two measures - the collateral-free loan guaranteed by the government and the inflow of pending dues - will provide about $100 billion in liquidity to the MSME sector. This is expected to help it return to good health, protect employment and facilitate an economic recovery.
"The biggest incentive is the move to provide more than $40 billion as collateral free loans for MSMEs to help ease their credit woes. These credit lines, both the principal and the interest, will be 100 per cent guaranteed by the government. An estimated 4.5 million units will benefit."
Many MSMEs are stressed, have defaulted on their loans and are on the verge of collapse. To help nurse them back to life, the Finance Minister has proposed a subordinate debt provision of about $3 billion. This will help 200,000 MSMEs, save millions of jobs and pre-empt a deterioration of bank balance sheets.
For healthy MSMEs that are finding it difficult to source funds for their activities, the government will set up a fund of funds with a corpus of $7 billion, of which it will contribute 20 per cent. These funds will be utilised by MSMEs to expand capacity and even list on the stock markets if they so desire.
In India, MSMEs are given various tax, procedural and statutory benefits denied to larger companies. This creates a perverse incentive to businesses to remain small in order to partake of those benefits. Alternatively, business owners incorporate multiple companies to stay within the limits mandated for MSMEs.
MSMEs were defined by the investment they made in plant and machinery. This has been revised upward and new criteria - turnover - introduced to given them much greater freedom. The revised norms are as follows:
Then MSMEs in the services sector had a much lower threshold than those in the manufacturing sector. This artificial and arbitrary distinction has now been removed and both bought at par for the purpose of classification.
This will enable MSMEs to have stronger balance sheets and allow them to expand much more than earlier without worrying about losing any benefits.
The Government of India and the country's 28 states and eight Union Territories buy goods and services worth billions of dollars every year. To encourage self-reliance to promote the MSME sector, Sitharaman announced that global tenders will be banned for supply contracts of up to $30 million.
And finally, she said every MSME will be given an e-market linkage as regular marketing opportunities such as trade fairs and trade summits will be few and far between for several quarters to come.
Sitharaman announced that all central and state public sector units would clear all their pending dues to MSMEs within 45 days. This announcement could be the real gamechanger. According to analysts, this will release an estimated $55-60 billion of liquidity to the sector.
Sitharaman also announce a slew of measures to provide additional funds - purchasing power in economist lingo - in the hands of people at the lower end of the income spectrum by easing their retirement fund contribution rules and by picking up the tab for some classes of employees.
She also committed to guarantee a part of the credit provided by India's beleaguered non-banking finance companies (NBFCs) that are the main source of finance for many individuals and non-prime corporate customers as well as establishments in the unorganised sector.
There were also measures to help India's financially stressed power distribution companies and put an additional $7 billion in the hands of middle-class taxpayers by cutting tax deducted at source by 25 per cent.
Why foreign investors should be interested
All these reforms announced by the Finance Minister are focused strongly on the domestic constituency. But they will facilitate the entry into India of several foreign investors that are looking for alternatives to China. How
Strengthening the MSME sector will result in the many large US, European, Japanese and Korean companies looking to invest in India being able to bring some of their core suppliers with them. This will become another “pull factor” when these companies consider new destinations for their investments.
This first cut of the Modi government's stimulus-cum-reforms package will add to India's attractiveness as an investment location for companies leaving China.
The next installments of the package will be unveiled over the next few days.