21 January 2020

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Role of government in MSME financing

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The Micro, Small and Medium Enterprises (MSMEs) continue to play a dominant role in driving the Indian economy with its total contribution of 8% towards the GDP. It has registered a growth rate of 10.8% and contributes around 40% towards total industrial production.

Despite its growing significance, it is severely constrained by many impediments, particularly institutional finance. Both central government and state governments have intensified their efforts to shore up institutional finance through creating exclusive financial institutions, enacting laws and devising policies and schemes. Generally, banks are reluctant to finance due to the following reasons.

  • Most of the enterprises do not produce collaterals to back the loans
  • Lack of adequate financial information due to non standardised financial statements submitted by the MSMEs
  • Inability of the banks to determine technical and managerial expertise of the borrowers. The practice of credit rating is not prevalent among the MSMEs.

Therefore, many measures adopted by governments ensure that the risks posed by the above shortfalls are adequately mitigated. Now, let us look at a few of those measures adopted.

Institutional mechanism:
Although the responsibility for implementing the policies rests with the state governments, the central government devises policies and monitors its implementation through its ministry, namely   The Ministry of Micro, Small and Medium Enterprises. The RBI also regulates the lending behaviour and pattern of the banks towards MSMEs by issuing guidelines from time to time. Apart from this, the central government has created exclusive financial institutions like SIDBI to cater to the financial needs of the industry. SIDBI is the primary national level financial body that provides assistances like venture capital, project finance, discounting and support for technology up gradation and modernisation.

Central government programmes:

Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE):
This scheme encourages banks to finance up to Rs.100 lakhs towards fund and non fund based needs of small and medium enterprises without collateral security and/or third party guarantees. Separate targets are set for each branch to encourage coverage under this scheme.

Credit Linked Capital Subsidy Scheme:
To facilitate technological up gradation in the government approved products/sub products, a capital subsidy of 15% or 15 lakhs (lowest of the two) is provided on the investment in eligible plant and machinery approved under this scheme. The investment is capped at 1 crore.

Financial procurement of raw materials and marketing activities:
National Small Industries Corporation (NSIC) facilitates procurement of raw materials for the MSMEs by making arrangements with wholesale manufactures. Apart from bill discounting and export assistance, it also provides financial assistance for payments to raw material suppliers and promotion of marketing activities.

Scheme for micro finance programme:
Under this scheme, the central government provides funds under ‘Portfolio Risk Fund’ (PRF) to SIDBI. The PRF is used to provide security deposits for loans from micro finance institutions (MFIs) and NGOs. The MFIs/NGOs share 25% of the security deposit and the rest 75% is from the funds under this scheme. Currently, SIDBI provides fixed deposit equal to 10% of the loan amount.

Venture capital:
To cater to the needs of high risk and high growth potential start ups, SIDBI Venture Capital Limited (SVCL) was established in 1999 by SIDBI. SVCL provides venture capital assistance through the following three funds in assistance with central ministries and public sector banks.

  • National Venture Fund for Software and Information Technology (NFSIT)
  • SME Growth Fund (SGF)
  • India Opportunities Fund (IOF)

BSE MSE Exchange:
To tap the equity markets for the expansion and growth needs of SMEs, the BSE MSE stock exchange was opened in 2011.

RBI guidelines:
RBI has prescribed the following guidelines to increase the flow of timely credit to MSMEs.

  • To ensure timely and sufficient credit to the sector, bank credit to micro small enterprises   has been categorized has priority sector lending in the year 2011, but medium enterprises have been barred from this category. This step allows earmarking a certain percentage of funds to micro units out the total funds allotted to the sector.
  • Banks have been mandated to provide collateral free loans up to 10 lakhs to all MSE borrowers.
  • Cluster based approach for financing SMEs
  • Specialized SME branches for lending in each district.
  • To promote credit flow, RBI has advised the banks to promote the practice of credit rating among the MSMEs by reputed institutions.
  • As per the recommendations of the Prime Minister’s Task Force on MSMEs, banks have been instructed to target a 20% year-on-year growth in credit to the micro and small enterprises.

Tax exemptions:Following tax exemptions have been provided to promote investments and profitability of the MSMEs.

  • SMEs are allowed excise duty exemptions for specified goods under General Excise Exemption Scheme of Central Excise Department.
  • Tax Holidays are provided for MSMEs in specific industries and units in underdeveloped states.

Apart from the above measures, the government strongly believes that there is still scope for improvement because SMEs get only 25% of their total funding from banks. Keeping this in view, both the central government and state governments are continuously reorienting their policies and strategies to augment the growing needs of the MSMEs.


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