Mains Paper 3: Economic Development
Prelims level: MSMEs
Mains level: Credit stimulus for MSMEs
• The Centre has announced an important credit stimulus package for micro, small, and medium enterprises (MSMEs).
• Among the many sops doled out under the new scheme, Prime Minister Narendra Modi has promised the sanction of business loans of up to ₹1 crore within a time frame of 59 minutes, in order to encourage faster credit flow to MSMEs.
• These companies will also receive an interest subvention of 2% under the scheme and support from public sector units, which will now be mandated to make at least 25% of their overall purchases from MSMEs.
MSMEs contribution in economy
• It is worth noting that MSMEs, which account for 30% of India’s gross domestic product (GDP), were hit hard by the twin shocks of demonetisation and the implementation of the Goods and Services Tax over the last couple of years.
• In the aftermath of the IL&FS crisis, which has affected the amount of lending done by non-banking financial companies to the MSME sector.
• The government would be looking at the scheme as a tool to improve credit flow and the pace of job creation in the economy.
• The Reserve Bank of India in August 2018, however, showed that growth in credit flow to MSMEs had recovered to pre-demonetisation levels by the April-June quarter, just before the liquidity crisis.
Important highlights of this scheme
• The scheme has signs of state-led economic planning written all over it.
• The biggest risk of a credit stimulus is the misallocation of productive economic resources.
• Pumping extra credit into MSMEs now may well lead to a temporary boom and enable a feel-good atmosphere in the run-up to elections, but it can lead to a painful bust when the stimulus ends some day.
• Another unintended consequence is the likely deterioration in credit standards as financial institutions are pushed to lend aggressively to MSMEs.
• Efforts to expedite business loan approvals may be welcome from the point of view of growth and job creation, but they rarely end well when motivated by political reasons.
• The Prime Minister’s latest credit scheme is no different from the MUDRA loan scheme, which has been troubled by soaring bad loans.
• In September, former RBI Governor Raghuram Rajan had warned that loans extended under the MUDRA scheme could turn out to be the source of the next financial crisis.
• Care needs to be taken to see that the new MSME loan scheme does not pose a similar risk in the future.
• The demand that PSUs must procure a quarter of their inputs from MSMEs could breed further inefficiency in the economy.
• The MSME loan scheme is yet another example of how bad economics can make for good politics.