What is the future of SME financing in India?

Did you know there were as many as 48.8 million SMEs in India, employing close to 40% of the Indian workforce? The SME sector is responsible for more than 45% of India’s industrial output, 40% of the country’s total exports and 1.3 billion jobs every year. These statistics were revealed in a report published by the Greyhound Knowledge Group in July 2014.

Small and Medium Enterprises form the backbone of any developing economy and India is no exception. However, despite being a significant contributor in driving GDP, the sector has experienced slow growth mainly due to various limiting factors. Easy access to SME loans provided by bigger, more established banks has breathed life into this sector.

 Why financing is critical for the SME sector ?

Finance has always been among the most critical as well as limiting factor in the growth of an SME. The want of funds brings about a host of challenges, such as inability to access the latest technology, lack of proper R&D and hiccups due to inadequate or improper infrastructure facilities, say experts at Aditya Birla Finance Limited.

The total financing demand gap in this sector is close to Rs.2.93 trillion, according to an article published in Business World in December 2015. Private Equity has been unsuccessful in raising sufficient amounts of funds for this sector. Banks and NBFCs have been gearing up post-2015 to provide SME financing.

Government Recognizes the Importance of SMEs

The launch of some government schemes has also paved the way for a brighter future. These scheme include Startup India, Skill India and Make in India. When PM Narendra Modi launched Startup India, he encouraged banks to provide loans to startups on flexible terms. Earlier, start-ups and newbies were unable to procure loans unless they had stable collateral. Also, the Startup India initiative has eliminated taxation during the initial years. This is because taxation was proving to be debilitating for firms still trying to get off the ground and gain a foothold in the market. Skill India, on the other hand, is expected to create an efficient and skilled labour force.

How the Indian Budget helped ?

Budget 2016 increased the limit or turnover under the pre-emptive taxation scheme from Rs.1 crore to Rs.2 crores. This has freed a huge number of entrepreneurs from maintaining account books and getting audits done. Also, capital gains tax for companies with a turnover of less than Rs.5 crores has been reduced to 29% plus surcharge and cess, noted an articles in The Times of India published in May 2016.

What causes SMEs to fail ?

The high rate of failure among SMEs has been due to the inability of the firms in this sector to obtain short-term SME financing, says a report published by the OECD (Organization for Economic Cooperation and Development). As in the case of large businesses, Small and Medium Enterprises also need to focus on good financial management. These businesses must develop keen insight into their working capital cycle, which refers to the movement of cash through the business.

 The success of any business depends as heavily on how efficiently it manages its working capital, as it does on the availability of finance.

While the overall profitability of a business is closely linked to the speed of its cash conversion cycle, SMEs often tend to overlook this aspect, which can threaten their very survival. Thus, access to flexible SME loans and the management of working capital have been identified by experts as the two main areas to focus on.

Posted by The Indian Economist