How to facilitate capital raising for the 60 million Indian MSMEs who contribute 30% of GDP

To mark International MSME Day on June 27, Ficci organized a conference to recognize the contribution of MSMEs to the sustainable development of the economy and on how capital markets can help the sector to achieve its growth aspirations.

With a contribution of around 30% to the country’s GDP and employing around 110 million people, the 60 million MSMEs in India are a very important component of the economy. As many of these MSMEs struggle to recover from the severe impact of the pandemic, capital markets may present them with potential opportunities to raise capital, both in debt and equity. However, MSMEs are often constrained by lack of access to credit and lack of knowledge of various capital market products.

Working capital requirements for MSMEs

Usually, MSMEs are part of the larger business ecosystem – as a distributor of goods or as a supplier of raw materials. Updating the invoices of large companies is an integral part of financing the working capital of these MSMEs. To facilitate the discounting of MSME invoices from business buyers via multiple financiers, the TReDS platform has been set up. This institutionalized mechanism for discounting invoices on TReDS involves three participants – the MSME supplier, the corporate buyer and the financier.

The invoice is downloaded either by the buyer or by the supplier, depending on the discount method, and is approved by the other party. Once the invoice is approved, the platform’s financiers start bidding on the invoice. The supplier accepts the offer and the amount of the discount is credited to their account the next day.

With the TReDS system, access to working capital financing has become much easier. This unique platform for sellers, buyers and financiers guarantees easy access to funds at a competitive discount rate, without much paperwork, in an online mode with transparent data flow.

However, it is important to push for the massive adoption of this platform among large companies and MSMEs. Ease of access and understanding of the platform can be improved on several levels if TReDS is hosted on a stock exchange platform, which is popular and accessible to millions of people. Of course, the controls around its use, the payment and reimbursement mechanisms will have to be considered.

Capital increase by MSMEs

Since MSMEs are an important part of the economy, the Bombay Stock Exchange and the National Stock Exchange have created an independent platform for raising capital and trading in shares of MSMEs. Sebi has also published specific registration guidelines for MSMEs. This offers entrepreneurs and investors a more conducive environment with relaxed regulations. The platform allows to list the MSMEs in the unorganized sector scattered all over India, in a regulated and organized sector.

Companies with a minimum post-issue capital of Rs 1 crore and a maximum of Rs 25 crore are eligible for an MPME IPO in India. The business or general partnership / sole proprietorship / LLP / business, which has been converted to a business, must have a combined track record of at least three years. In the event that it has not yet completed its operations for 3 years, it must have been financed by banks or financial institutions or the central or state government or the group company must be listed for at least 2 years.

At present, 340 MSMEs are registered with ESB and 200 with ESN. Together they have raised over Rs 6,600 crore and the current market cap is over Rs 29,000 crore. Interestingly, 106 companies have grown significantly and migrated to the main exchange.

As can be seen from the above, these are indeed good platforms available to provide debt and equity financing to MSMEs. Even at the regulatory level, part of the financing of MSMEs by banks is treated as a priority sector loan. This facilitates the availability of credit for MSMEs, thus meeting their debt needs.

In the future, given the importance of MSMEs in the overall economy, it might be useful to consider an extension of the concept of priority sector to the equity segment as well. With the mutual fund industry growing rapidly and accounting for almost 20% of the banking industry, a similar priority sector concept for mutual funds to invest in MSME stocks will help the MSME sector. This would encourage MFs to set up dedicated MSME programs, greatly increasing the flow of equity to the MSME sector.

The MSME sector is an essential part of the economy and, apart from various financial support programs during the pandemic, it will be useful to create innovative institutional mechanisms to continuously support the growth of this sector on a sustainable basis.