India needs to increase her savings rate to up her investment rate. (PTI photo)
At the outset some facts about Indian economy. Approximately two-thirds of India’s GDP originates from what is loosely called informal sector. Importantly, 90 per cent of our non-farm work force are employed here. This is one of the highest in the world. Yet, this informal sector rarely gets policy traction.
The reason for the same is not far to seek. By it very design informal sector always remains below the radar of Indian establishment. That probably explains why two-thirds of Indian economy are underfinanced by our formal financial sector including banks.
Of the balance one-third, at least 20 per cent is accounted for by both Central and State Governments with the residuary balance of 10 or 12 per cent of the GDP contributed by the corporate sector. And this residuary fraction is termed as formal sector – one that hogs policy attention.
What is worse is this residuary corporate sector that has over the years become a benchmark when it comes to policy intervention for our establishment. More to the point – despite less than two per cent of the GDP contributed by an elite club of 30 companies who constitute the Bombay Stock Exchange sensex, our fixation to Sensex is phenomenal.
Inexplicable, isn’t it? In this connection a report of global bank Credit Suisse in 2013 on the Indian economy titled India’s better half – India’s informal economy had made the following pertinent observations:
- • The intuitive habit of drawing macroeconomic conclusions from the corporate feedback [and vice versa] is fraught with risk.
- • This makes GDP calculation as much an exercise in estimation as reporting.
- • The high share of informal economy [among the highest globally] is a structural problem, as it drives low tax revenues and deters individual risk-taking, given the lack of a safety net
- • But we also believe the recent rapid productivity gains are mostly in this informal economy, and do not fully appear in GDP growth data yet. When a new series starts next year, we estimate GDP can rise by almost 15 per cent, implying 2005-2013 CAGR was 1.8 per cent higher, at 9.8 per cent.
- • By definition, informal economic activity does not pay taxes, has limited access to formal credit [our interactions with CSO suggest only 18 per cent of credit to SMEs in India is formal], and workers in these economies lack normal measures of labour protection.
Professor R Vaidyanathan of IIM, Banglore who has made signal service to the nation on this subject attributes the growth of Indian economy in past two decade to partnership and proprietorship [P&P] firms or the small and medium enterprises [MSME] in service activities and not due to reforms carried out by the Government.
Ironically, this remarkable contribution of MSME sector has not been documented by the Government, much less appreciated. The reason for the same is obvious – the MSME sector – read informal – is short on glamour quotient while corporate sector – read formal – has abundant of it.
For this reason and this reason alone successive Central Governments have been obsessed with the “glamourous” organised sector disregarding the “non-glamourous” yet significant unorganised sector.” And believe me it is a cosy club out there that disregards the informal sector and this includes the policy framers, bureaucracy, media, intelligentsia and of course our economists.
Do we realise its importance?
The Credit Suisse report clearly demonstrates that much of Indian economy is even beyond the formal survey of the Indian establishment. While that indeed makes a case of under-reporting of our GDP the fact remains that large swathes of Indian economy are out of bounds for policy intervention by the Government. Surely that is disturbing!
Where is the question of intervention by the Government when this sector is not even recognised by it? Do we realise the chasm between the Government and the governed? Do we understand the gravity of the situation?
It is estimated that there are over 5.77 crores MSME enterprises all over India. As already pointed out they contribute approximately one-half of our GDP. Estimates also suggest that nearly 46 million people are employed in such units and as much as 24 million are self-employed. Put pithily informal sector is the real sector and the corporate the shadow.
What is interesting is that the 62 per cent of these units are owned by Scheduled Castes, Scheduled Tribes and Other Backward castes. Yet, less than 15 per cent of the credit requirement of the MSME sector is funded by State-run banks. [Source: Various Government websites].
The next obvious question – if Banks are not funding these units then who is funding them and at what cost? The answer to the question is one of the most heartrending aspects of Indian economy. This absence of formal lending mechanism naturally lends itself to an exploitation by usurious money lenders, often with political patronage.
It may not be out of place the non-banking finance companies [NBFC] that traditionally financed this sector [barring exceptions] sadly has been forced to exit in the face of a hostile policy regime unleashed by RBI. As NBFC exited financing the MSMEs no other institutional mechanism has replaced it. That explains why the informal sector remains under financed and is exploited.
Experts like Prof Vaidyanathan point out at times these units borrow Rs 90 in the morning and return Rs 100 in the evening – i.e. they pay an effective interest rates in excess of 3650 per cent per year. Despite such stark realities economists believe that quarter percent interest reduction will all it take to revive the Indian economy!
Needed a finance mechanism
At the core of our problem is that we tend to fix targets for our banks to fund this sector and simultaneously bring about international prudential norms. This is akin to mixing oil with water and if experiences of the past is anything to go by – banks are a poor delivery mechanism when it comes to address the needs of our MSME sector.
Simultaneously, non-banking sector is unable to fund this informal sector at efficient rates and has more often than not been found to lend at usurious rates. Naturally, we need to figure out something spectacularly new. Budget 2014 precisely promised a new financial mechanism only to keep it unfulfilled even at this point in time. The time to effectuate the promise is just now.
How about a Sarvodaya Development Bank? How about a Bank exclusively aimed at funding MSME sector? The Union Government can float this institution with a capital of Rs 20,000 crores and fund a sum of Rs 10,000 crores to retain 51 percent control. The balance must be funded by players from within the MSME sector.
Importantly, to bring about a sense of ownership – shareholding must be widely disbursed –possibly 1 shares at Rs 1000 to over 10 crore people who own or work in such enterprises.
These shares should not be transferable for the next ten or twenty years. That would raise a sum of Rs 10,000 crores and give a sense of ownership to these people. Ideally, this bank must be having one branch in every district of the country.
Also those who deposit into this bank could be entitled to an additional interest rate of 1 per cent. That would ensure copious flow of deposits to fund lending activities of this bank. The idea is also to simultaneously inculcate the habit of savings to people who have remained outside the purview of banking sector.
Remember India needs to increase her savings rate to up her investment rate. Should this not be the ideal platform to do so?
Crucially, lending must be governed by principles of mutuality that govern our chit fund companies – where borrowers need to be scanned and approved by a pre-determined self-evaluating mechanism. The obvious idea is to ensure the interplay of social norms and traditional practices delivered through a formal lending process with the active participation of the Government.
Another dimension to this is that the bank should enter into a tripartite agreement with corporates and technical institutions that could impart further training to potential borrowers. The corporate social responsibility program must mandate India’s top corporates to run such skilled institutions across the country. The skill development programme of the Union Government must be integrated to this bank.
The skill development program needs to be tied to a funding mechanism as much as the later the former. This in my considered view is an ideal win-win situation.
It may not be out of place to mention that the Bank must ensure no laxity in repayment.
Schemes that have been designed till date for weaker sections of our population have tended to encourage financial indiscipline. The Sarvodaya bank should not do so. On the contrary this bank must usher in best global practices and ensure strict monitoring of all borrower accounts but with a local and personal touch.
Finance to MSME is one big yet unglamorous way to trigger our economy. A bank that specifically targets this MSME is the need of the hour. Simultaneously it must encourage savings amongst this section. Mandarins in North Block are well aware of all this and much more.
Will Budget 2015 do the needful?