IBC: A driver of debt recoveries

Employing over 100 million people and contributing 28.77% to the nation’s GDP, the Micro, Small & Medium Enterprises (MSMEs) have established themselves as one of the key growth drivers of the Indian economy. The sector, a symbol of economic prosperity, adds 45% to industrial output and 40% to exports, denoting its indispensability. An engine for growth, MSMEs form the backbone of the Indian economy. Hence, safeguarding their interests and addressing concerns that might hinder their seamless functioning, while imparting growth impetus through favourable policies, should be a priority for policy makers.

One of the key criteria to determine the financial health of the MSME sector is to analyse the ease of access to working capital or the lack of it. In India, the gap in access to working capital in the MSME sector has been gradually widening, implying that, in order for businesses to run even their day to day operations, they need to borrow funds from private lenders. The key reason for this enlarging chasm is the inordinate delay in realisation of bills and receivables, particularly from large corporate customers. Further, availability of timely finance at competitive interest rates is another daunting challenge. As a result of these obstacles, MSMEs counter financial hardships and liquidity constraints that severely affect the sustainability of their operations and they even run the risk of being declared non-performing assets (NPAs) which can further lead them to the insolvency and bankruptcy.

The IBC Code, which was conceived and rolled out as a one-stop solution for addressing defaults in the banking system, may be working well for successful resolution in case of large companies but it is often perceived as a hindrance in the way MSMEs function. One of the key issues that need to be addressed by the government under the code is the treatment of MSMEs during the resolution process. As per current law, there is no clear demarcation between MSMEs and other operational creditors who are all clubbed into a single category for payment of the liquidation value. However, there have been cases wherein the liquidation value is negligible and this essentially means that MSMEs practically get nothing and continue to operate in a precarious environment despite the IBC Code.

According to the Micro, Small & Medium Enterprises Development (MSMED) Act, in case of delayed payments, MSMEs are guaranteed principal amount along with interest of more than 45 days for the delivery of goods or services at three times the bank rate. However, this guaranteed amount is completely annulled by any resolution plan as only liquidation value is guaranteed. While the Insolvency and Bankruptcy Code is a strong framework to minimise the cost and time in attaining liquidation, the Central government needs to introduce modifications or amendments to the code when applying it to MSMEs. The government can perhaps look to create a separate category for MSMEs and set a floor as part of the recovery process so that companies operating in this segment get at least some minimum chunk of their dues. Currently, whenever a company is liquidated as part of the resolution process, its MSME creditors are the worst hit since their MSMEs are likely to have a sizeable exposure to that company. For example, a MSME supplier with a 25 crore Rs. turnover may have a 5-7 crore rupee exposure to a large defaulting company and a complete write off of this amount will surely destabilise the operations of this small player.

The government needs to address this issue and ensure that MSMEs, which are the bedrock of India’s manufacturing, must get preference during liquidation so that they do not themselves turn insolvent. The government has already addressed some other key concerns when earlier this year, it allowed promoters of micro, small and medium enterprises to bid for their own companies. Under the amended Code, promoters can bid for their own assets unless they are wilful defaulters or there is a disqualification related to their default. This will ensure that promoters who have lost their companies due to extraneous circumstances can get back their firms.

Overall, while the policy makers are moving in a favourable direction for MSMEs, promising them a level playing field, the rate at which policy reforms are introduced need to be given a thrust. This will help laying a strong foundation for a sector that is referred to as the backbone of Indian economy.

The author is director, external affairs, Power2SME. Views are personal