Swaminathan J: Local to global - the role of the financial sector in
MSME's development
Speech by Mr Swaminathan J, Deputy Governor of the Reserve Bank of India, at the
Annual Day of the Foreign Exchange Dealers Association of India (FEDAI), Mumbai, 21
August 2024.
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Distinguished guests, ladies, and gentlemen. A very good evening to all of you.
It is a great honour to speak to this august gathering on FEDAI's Annual Day. Through
its tireless efforts in clarifying the complexities of inter-bank foreign exchange business
and serving as a crucial voice with regulators, FEDAI has played a pivotal role in
shaping the rules of foreign exchange business in India. So, when Mr. Sindhwani, Chief
Executive invited me to this event, I knew it was an opportunity I could not miss.
As we celebrate FEDAI's achievements, it is also an opportune moment to reflect on
the broader vision for India's economic future. In 2022, as our nation commemorated 75
years of independence, the Hon'ble Prime Minister outlined five key resolves for the
country, one of which was the ambitious goal of transforming India into a developed
nation by 2047. Realising this vision will require a unified effort across all sectors, with
Micro Small and Medium Enterprises (MSMEs) playing a pivotal role in driving
economic output and boosting exports. MSMEs, often referred to as the backbone of
our economy, hold immense potential to become national champions-potential that
remains largely untapped. With this in mind, I have chosen the theme 'Local to Global:
The Role of the Financial Sector in India's Development' for my address today.
The Role of MSMEs in India's Economic Growth
a vast network of approximately 63 million units, MSMEs contribute nearly
onethird of the nation's GDP and account for around 40 per cent of its manufacturing output
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More importantly, it is the MSME sector's ability to foster entrepreneurship and create
substantial employment opportunities -the key factors in realising India's demographic
dividend. Additionally, as critical ancillary units, MSMEs support larger industries and
significantly contribute to the secondary and tertiary sectors. With millions of jobs
generated, the MSME sector stands as one of the most significant sources of
employment in India, underscoring its importance in sustaining livelihoods and driving
inclusive growth.
The MSME sector's impact extends beyond domestic boundaries. In the realm of
international trade, these enterprises have proven their competitiveness, contributing
more than 40 per cent to India's exports. This growing presence in global markets
reflects the increasing acceptance and demand for Indian MSME products and
services, positioning the sector as a key player in enhancing India's global economic
footprint.
Despite these achievements, the sector faces significant challenges, notably the issue
of the "missing middle". While micro-enterprises make up most of the MSME
employment, they often struggle to transition into small or medium-sized firms. This
limitation hampers their ability to achieve economies of scale, invest in fixed assets, and
adopt innovative technologies. In my address today, I will focus on these challenges
and explore how the financial sector can play a crucial role in addressing them, thereby
supporting the growth and development of MSMEs into larger corporations.
Challenges Faced by MSMEs
Let me discuss a few challenges that MSMEs face today. I am sure you are aware of
most of them, so I will limit myself to briefly stating four key issues.
Access to finance
The first issue is access to affordable finance. Credit is crucial for the growth of
MSMEs, and affordable funds can boost their competitiveness. Banks often use
assetbased lending, which relies on collateral rather than cash flow. However, many MSMEs
lack adequate assets for collateralization, particularly for working capital needs, often
leaving smaller businesses excluded from funding opportunities from the formal banking
sector. Further, as many MSMEs mainly operate in the informal space, assessing their
creditworthiness can be difficult due to information asymmetry, particularly with respect
to the financial performance of their businesses. Although initiatives like GST and digital
payments aim to facilitate digitisation among MSMEs, the adoption of formal digital
documentation methods remains limited, which impedes an efficient credit underwriting
process.
Delayed payments
Secondly, MSMEs commonly encounter a persistent issue of delayed payments. The
delay in receiving payments prolongs their operating cycles and diminishes their
capacity to fulfil existing orders or secure new ones. Despite the existence of statutory
provisions which entail penalties for delayed payments by buyers, MSMEs often refrain
from invoking these provisions. Their reluctance stems from a combination of weak
bargaining power and the fear of losing future business opportunities.
Infrastructure bottlenecks
Thirdly, despite attempts to enhance infrastructure, MSME clusters, especially micro
enterprises, lack vital support systems. This deficiency not only obstructs their
day-today operations but also hinders their future growth potential. Developing MSME clusters
can provide shared infrastructure, services, and access to larger markets, which can
significantly enhance their growth potential.
Requirements of Compliance
As businesses transition from an informal to a formal entity, they encounter significant
rise in regulatory obligations and cost of compliance. Sometimes these requirements
involve the interpretation of laws, knowledge of compliance procedures, etc. Instances
of difficulties with financing entities are not uncommon as the MSMEs attempt to scale
up. The Government and Regulators have been taking various initiatives to reduce
difficulties and ease the cost of doing business.
The Financial Sector's Role in Empowering MSMEs
Having discussed some of the key challenges being faced by the MSME sector, taking
advantage of the large audience that is present here from the financial sector, I would
like to highlight some of the ways in which we can support its growth and development.
Digitisation and Innovative financing solutions
With more MSMEs adopting digital payment systems, mobile banking, and online
accounting tools, the resultant digital footprint allows financial institutions to gather more
accurate and comprehensive data on an MSME's financial health, transaction history,
and cash flow patterns.
We have seen significant traction towards end-to-end digitalisation of credit delivery in
the past few years, largely in Retail and to some extent in MSME sector. I would urge
bankers to explore these opportunities further for greater digitalisation of their
transactions with MSMEs. Digital applications and platforms reduce the paperwork and
administrative burden associated with traditional lending, and also brings in complete
transparency. By using digital tools for application processing, verification, and
disbursement, financial institutions can expedite approval times and significantly lower
the costs of availing credit.
The data derived from the enlarged digital footprint would enable a better risk
assessment and the development of customized financing products. Indeed, extending
finance after a proper understanding of the cash flows of MSMEs, including factoring in
the possible delayed payments from their buyers, will ensure a proper reading of the
actual working capital cycle and ensure adequate financing. Inadequate understanding
of the actual cash flows and its timings may result in the repayment schedules not
keeping up with the reality.
On its part, the RBI has taken various initiatives to promote innovation in financing to
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MSMEs. Recently, the third cohort of the RBI Regulatory Sandbox was dedicated for
MSME lending, where five ideas were found viable. Earlier, to address the issue of
delayed payments to MSMEs, RBI had initiated the Trade Receivables Discounting
System (TReDS) in 2014. The scheme facilitates the financing of trade receivables of
MSMEs from corporate and other buyers, including government departments and
Public Sector undertakings (PSUs) through multiple financiers electronically. While
there has been an uptick in transactions in the last couple of years, there is a long way
to go in onboarding by more corporate buyers and MSME sellers on the platform to
reap its full potential. RBI is engaging with the Government on this aspect, I would also
urge bankers to leverage their corporate relationships to encourage larger corporates to
get themselves onboarded on the TReDs platforms.
Capacity building and financial literacy
Apart from access to finance and digital tools, enhancing financial literacy among
MSMEs is equally important. Many small business owners lack the knowledge and
skills to effectively manage their finances, which can hinder their growth.
While RBI has been facilitating capacity building on MSME finance for bankers under
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the NAMCABs programme, I believe the financial sector can play a vital role in
providing capacity-building programs tailored to the needs of MSMEs.
These programs could include training on financial management, understanding credit
and forex products, and using digital tools effectively. By equipping MSMEs with the
right knowledge and skills, we can help them make informed financial decisions,
optimise their operations, and reduce the risk of default. Partnerships between financial
institutions, government agencies, and industry bodies can ensure that these
capacitybuilding initiatives reach the businesses that need them most.
As you may be aware, the Government of India has adopted the Cluster Development
approach as a key strategy for enhancing the productivity and competitiveness as well
as capacity building of Micro and Small Enterprises (MSEs). In this connection, RBI has
advised convenors of all State Level Bankers' Committees (SLBC) to incorporate credit
requirements of these identified clusters in their Annual Credit Plans. To further support
this initiative, I would request banks to consider opening more MSE-focused branch
offices preferably with forex facility, within these clusters. These specialised branches
will not only facilitate easier access to credit for MSEs but will also serve as Counselling
Centres, offering tailored financial advice and capacity-building services to these
enterprises.
Boosting MSME Exports
The financial sector can play a crucial role in boosting MSME exports by offering
targeted support and tailored services that address the unique challenges these
businesses face in the global market.
Beyond traditional products like pre- and post-shipment finance, factoring, and invoice
discounting, the sector can significantly aid MSMEs in managing risks through export
credit insurance and currency risk hedging solutions. These financial instruments not
only protect against payment defaults and currency fluctuations but also provide
MSMEs with the confidence to explore and expand into new international markets.
Current regulations mandate that forex needs, including cash and hedging products,
must be met through authorised dealers, with scheduled commercial banks playing a
dominant role. These banks, holding a privileged position, have a fiduciary duty to act
fairly and transparently, particularly with smaller clients like MSMEs.
The introduction of the FX-Retail platform in 2019 aimed to enhance transparency and
fairness in retail foreign exchange transactions has seen only a limited success. I would
request banks to take proactive steps to increase awareness and facilitate higher
customer participation on the FX-Retail platform.
Sensitivity towards the sector
Finally, considering the key role that MSMEs play in the economy, the financial sector
should adopt a more sensitive and empathetic approach towards them. While financial
discipline is crucial, the unique challenges faced by MSMEs-such as low capital base,
lack of scale, cash flow constraints from delayed payments, fluctuating market
conditions, and external economic pressures-necessitate a more nuanced approach to
assessment as well as follow up.
While timely repayment of dues is crucial to maintain the health of the financial system,
financial institutions should focus on deploying supportive measures such as
restructuring options, grace periods, and tailored repayment plans that give MSMEs the
breathing space they need to recover and get back on track while encountering difficult
situations.
Collaboration and dialogue between lenders and borrowers can help create solutions
that protect both the financial interests of the lender and the viability of the MSMEs.
Conclusion
In conclusion, the journey of India's economic transformation cannot be complete
without the robust development of our MSME sector. MSMEs are not just the backbone
of our economy-they are the engines of growth, innovation, and employment. However,
for these enterprises to truly thrive and scale up, the financial sector must step up with
innovative solutions, sensitivity, and a forward-looking approach. This is not just about
providing credit; its about enabling these enterprises to compete globally, drive exports,
and contribute to the nation's goal of becoming a developed economy by 2047. While
financial instruments and support mechanisms are crucial, the way we engage with the
MSME sector-our sensitivity to their challenges and our commitment to their
successwill ultimately determine the strength and sustainability of this partnership.
With this I thank FEDAI for inviting me and wish it continued success in its role as a
catalyst for the smooth functioning of foreign exchange markets through close
coordination with stakeholders. Thank you all for your attention.
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As per press release dated December 11, 2023 by the Ministry of Micro, Small and
Medium Enterprises, the share of MSME Gross Value Added (GVA) in all India Gross
Domestic Product (GDP) was 29.15 per cent for FY 2021-22 and the share of MSME
manufacturing GVA in all India Manufacturing GVA was 40.83 per cent for the same
period. The percentage share of Export of MSME related products in All India Exports
was 43.59 per cent for FY 2022-23.
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The RBI has put in place an enabling framework for Regulatory Sandbox to facilitate
live testing of new products or services in a controlled/test regulatory environment for
which regulators may (or may not) permit certain regulatory relaxations for the limited
purpose of the testing. There have been five cohorts under the framework since its
issuance in August 2019.
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National Mission for Capacity Building of Bankers (NAMCABs)