What Should India’s Package for Saving Small Businesses Look Like?

(Written by Chintan Vaishnav, Arvind Saraf for the The Wire, 17 Apr 2020)

COVID-19 has already set the scene for the biggest global recession since the 1930s. The IMF has coined it ‘The Great Lockdown’. For India, where the World Bank’s growth projection for FY’2021 was at a three-decade low of 1.5%-2.8%, the lockdown poses an even greater challenge.

The 40-day lockdown has stopped most economic activity. Trading has stopped beyond essential goods. Manufacturing has stopped since there is neither demand nor transport. Services such as tourism, hospitality, entertainment, restaurants have also halted. These three segments make up approximately 35% of our GDP. What does this mean for micro small and medium enterprises (MSMEs) in these sectors?

MSMEs are those enterprises that offer products or services on a smaller scale. They range in capital investment from Rs 25 lakhs to 10 crore, and include an individual local vendor to a small factory employing a few hundred people. Across India, 6.2 crore such businesses employ 12 crore people (40% of the workforce) and contribute 29% of GDP. They are an important part of raw material supply or final product distribution that most households transact with every day.

What makes MSMEs vulnerable to financial shocks such as a lockdown?

Let’s compare the business model of a typical MSME to a large business, say a small local kirana shop vs a large retail chain. Is the only difference the large retail chain has deeper pockets? There are at least four factors. MSMEs typically:

1. Aren’t very differentiated. One neighbourhood grocery store is not very different from another. This means they cannot raise prices and must keep margins low, often single-digit percentages. They stay viable only if the sales volume continues. Six weeks of lockdown has already taken away purported annual margins for those who aren’t open right now.
2. Buy on credit from their supplier. When one fails, this has a domino effect on its supplier.
3. Don’t have the “Work from home” option. A handloom business running a few machines, or a local salon can’t be run from home.
4. Lack exposure necessary to explore adjacent markets, including international or digital, that can leverage their existing expertise, investments, or team.

Thus, MSMEs can offer very little resilience in the face of such lockdowns in absence of a systematic intervention.

Why is an economic intervention required?

Clearly, the status quo is not an option. For instance, a 60% business loss in the current quarter, and 20% in the remaining three quarters leads to an annual revenue shrinkage of 30%. In the absence of any economic intervention, this requires cost-cutting by at least 25% to be viable. For an MSME, the biggest part of this cost is in people. As most employees are unskilled or semi-skilled, their salaries cannot take a haircut of more than 10% before becoming unattractive. The next best option may be to let them go and shut down.

The situation is most dire for micro-enterprises such as sole proprietorships or partnerships that make up 99.5% of all MSMEs. Their large-scale unemployment will likely thrust us down the recessionary spiral of demand reduction. The social impact of such unemployment is even harder to fathom, let alone afford.

What are some options available to prevent this big disaster for the small scale?

The government has announced a Rs 1.70 lakh crore ($23 billion) relief package in March 2020, largely focused on the most vulnerable sections (senior citizens, disabled, widows, and daily wage workers). Industry benefits are limited to waiving some utility payments, deferred taxes/payments, faster refunds of taxes, and easier access to credit. The package is less than 1% of our GDP, compared to the UK’s 15% of GDP, or the US’s package that ranged between $2 trillion-$4 trillion (up to 20% of the GDP).

Is this economic relief enough? Let us take a bottoms-up approach to the package, especially for the MSMEs in the badly impacted sectors. Consisting of short-term relief and mid-term structural interventions, they add up to 1.5% of GDP.

Possible short-term measures

These interventions are largely direct benefit transfers to the employers and employees to cover fixed costs to ensure viable business and employment.

1. Offer direct transfer of partial wages for retention for 3 months. It could be fixed to Rs 8,000 a month (or a large percentage of salary, subject to a maximum) directly transferred to the employees. For the 5 crore employed in the most impacted sectors, this adds to Rs 1.20 lakh crore. Employers may adjust this in their compensation, making it easier to retain them.
2. Offer a six-month interest waiver on any borrowings from financial institutions. MSMEs have a total of about Rs 15 lakh crore of fixed assets. Assuming a similar amount borrowed, at 1% monthly cost of capital this adds to Rs 0.90 lakh crores of interest waiver.
3. Plan an early and safe reopening to minimise economic losses by opening companies in a COVID-safe manner. This involves a best practice manual, training material covering safety kit (with sanitizers, masks) and local verification on compliance.

Possible mid-term measures

1. Placements and reskilling: Develop or tie-up with job portals and employment exchanges, to enable employees to be reskilled or find jobs in high-demand sectors. Companies like naukri.com and babajobs can work with MSMEs and the government to build this actively, possibly as part of their CSR initiative.
2. New Business Models: Invest on war footing to reorient SMEs to newer markets/product lines expecting growth (e.g., PPEs, hospital equipment), and train them to effectively use digital/e-commerce for expanding markets, including international. Government’s planned e-marketplace for MSMEs must be expedited.

These MSMEs have been viable businesses contributing to the government tax pool. Their struggle will have serious repercussions on unemployment — a recessionary spiral hard to escape. Now left to struggle due to factors beyond their control, a well-deserved support and help may give them a fair chance to be viable and prevent an economic disaster.

Can we do it before it’s too late?