Finance for Microenterprises

Nature of MSME

The Micro, Small and Medium Enterprises (MSME) are estimated to contribute 8% of India’s GDP, 45% of the manufactured output and 40% of its exports. India is estimated to have more than 26 million MSMEs. While a few of the MSMEs operate as registered entities (with at-least minimal registration required as per the taxation laws) a large majority of them operate as very small unregistered proprietary concerns owned by micro entrepreneurs.

The financial needs of these enterprises have not been adequately addressed by formal financial institutions. An important reason that makes lenders reluctant is the inability of the entrepreneurs to provide collateral. While MFIs provide collateral free loans to the poor, these loans are inadequate to fulfill the needs of micro enterprises. Moreover guarantee mechanisms such as joint liability groups seldom work effectively in the case of microenterprise loans.  

Plain Collateral Free Debt May Not be the Solution

There have been pilots which have involved provision of collateral free credit to informal-semiformal enterprises. In one such pilot in 2009, which involved Satin Credit Care Network (an MFI operating in Delhi), SIDBI and GIZ (technical assistance arm of the German Federal Government), loans in the range of Rs 50,000 and Rs 500,000 were provided to 48 entrepreneurs in the Delhi cloth cluster. A report prepared by M2i, “Financial Inclusion of Microenterprises in the Informal Sector – Missing Middle” documents the experience of this pilot. One of the important findings of the pilot was that while over a period of time the loans were being repaid, at any given point in time some of the loans appeared irregular. Irregular cash-flows of the borrowers made it difficult for such enterprises to make regular repayments of loans.

Solution Must Look For Risk Capital

In order to address this lack of finance for microenterprises it becomes important to look beyond plain credit. An effective financial solution will be the one that takes into account the irregular nature of cashflows of microenterprises. It is here that a mechanism which provides equity like capital to these enterprises can fundamentally shift the way these enterprises are perceived by the financial sector. Many microenterprises have highly profitable and scalable business models. However, they are unable to scale-up their businesses in the absence of equity capital. There are other constraints too, which provision of equity can address:

1.      Inability to obtain appropriate registrations under labour, environment, tax and corporate laws

2.      Lack of management capacity which leads to bad accounting and control

Equity investments in such enterprises can be a highly rewarding proposition with benefits to all stake holders. The entrepreneur can potentially get rich and generate numerous jobs. The government stands to gain from the formalization of these enterprises. Cynics will argue that private equity investments are a costly affair and small value transactions in informal enterprises in a retail model is not feasible. Professor Mohammed Yunus helped disprove similar notions regarding banking services to the poor two decades ago. Perhaps the time has come to use innovative financing mechanisms to help the informal sector join the mainstream economy.