( Dr. A.S.Firoz is Chief  Economist at the Economic Research Unit of the
Joint Plant Committee and Convenor of Steel Exporters' Forum.)

Monetary and credit policy : lukewarm to SMEs.

By Dr. A.S. Firoz

The industrial development in India will remain patchy untill the banking sector in India becomes friendly with and pro-actively supportive to small and medium enterprises. Although well accepted in all circles, as a matter of  understanding, the fact remains that the country's small and medium industries are deprived of the real support of the banks and financial institutions.

Although the problem is in the arena of operation of the banks and their trust on the individual borrower, there should be a definite policy thrust to increase flow of funds to this critical sector in the economy which has enormous potential.

The Monetary and Credit Policy for 2001-02 does not look like anything more than a routine response to the current economic situation in the country. While the Reserve Bank of India remains still optimistic on the state of the economy, there is evidence in the report to show that the bank is not so strong on its positions. It says, "A realistic projection of the overall growth rate for the current year 2001-02 is presently difficult in view of uncertainty pertaining to the outlook for industrial growth. As mentioned above, the objective conditions for revival of growth are favourable, but the trend in growth of output and investment demand in the last quarter of the previous year has not been very encouraging."

The Bank has forecast that the economy would grow at 6 per cent this year. It has already brought down its projection from the earlier estimates of 6.5-7 per cent last year and 6-6.5 per cent projected in the mid term review in October last. The fact that some more recent estimates on the state of the economy are already out, the RBI projections may not remain so much important. All that one can say at that moment, given the recent statistics on economic and more specifically industrial growth, is that getting a 5.5 per cent growth rate will be a decent achievement. Therefore, 6 per cent and anything above it may turn out to be utterly unrealistic number.

What is important here is not what the RBI has to say on the economy. This is not different from what has already been brought out in scores of government reports. Its interpretation of the numbers is also not drastically different from others. In spite of having the commonly shared view on the state of the economy, the RBI could not take all that it could and in the process has fallen grossly short in responding to the need of the hour.

It is fairly clear that the RBI wants to increase flow of loans to the economy to drive investment up and give a boost to the sagging industrial production. The new policy allowing commercial banks to bring down interest rates below the Prime Lending Rate (PLR) on a case-to-case basis is one such example that shows that the Bank has not really grasped the problems in the industrial sector well. It is a good thing to do that, many well known risks in it notwithstanding. But the benefits of this will go only to those who are already strong and have high credit worthiness. The big corporates, responsible and trustworthy in the eyes of the lending banks, should be happy about it. This will help them in their requirement of working capital. It may also help them in restructuring their finances and get into consolidation through mergers and acquisitions. But the moot question is, do these corporates have enough good projects in hand ? Is it that a one or half a per cent higher interest rate was keeping them off from investing in new projects? No.

There are two issues in it.

One, the cost of capital, which is higher in India by global standards, puts the Indian businesses at a disadvantage. There is no doubt that this should be lowered to the extent possible. This depends on the demand and supply in the capital market and the efficiency of the banking system.

Two, investment depends on the real interest rate. If a decent corporate gets money at 13 per cent and the inflation rate is 5 per cent, the real interest rate on a thumb rule is 8 per cent. This itself is extremely high. Think about those small and medium players borrowing at 18-20 per cent even today from the organised banking sector! As the inflation is coming under control, the real interest rate is moving up making investment less and less attractive.

Naturally, there is a decline in industrial sector - more so in the traditional small and medium industries. The banks, under the fear of their non-performing assets rising to uncomfortable levels, concentrate on having safe hands for credit. The banks are bothered about getting regularly at least the interest on the loans, if the money lies with a big house with wider business activities. The merits of the projects that the loans are taken for are not always a major concern for the banks. This itself provides the ground conditions for big business houses to go for projects without going through the merits of those rigorously. This is not to question the credibility of big Indian business, but such tendencies seem common as the statistics show a very large number of failed projects even in the basket of the large and visibly successful corporates. Apart from the fact some such projects could have gone haywire for other reasons, the easy availability of funds also provide conditions for frequent failure.

This bias that results from the fear of Non Performing Assets (NPA) increasing on their account has affected the small and the medium sectors of the industry and services the most. A recent report shows that over 200,000 small and medium industries are sick and closed. Among many of the factors cited for that are the lack of capital for modernisation and the high cost of  working capital. Most such entrepreneurs enter the unorganised financial market or borrow from private finance companies at huge costs. There is no lack of small business projects, entrepreneurship and even guaranteed success. Yet, there is a lack of trust. This is systemic and no individual or a single agency can be blamed for that. There are crooks in the system - Dr. Jalan admits that. He also says that one has to live with it and learn from it. But coming on the way of the genuine to stop the crook is not always a bold policy.

There is a need to guard against investments turning bad. There should be well-defined actions and procedures for that. The government has already announced setting up of a 7 more debt recovery tribunals (DRTs)  this year  2001-02). There are already 22 such DTRs and five appellate tribunals. This step is expected to help the banks get their dues faster. The government is also contemplating bringing in a legislation to facilitate foreclosure and enforcement of securities in the case of default. This is fine. But tardy enforcement of even the existing provisions deny the banks of their dues.

The more important announcement of the RBI is that it will disclose the names of defaulters with more than Rs. 25 lakhs dues to the banks. There are some legal problems which the government can sort out by appropriate legislation. The step that the RBI has advised the banks to take the borrower's consent to disclosure of its name in case of default is one that would perhaps act as a safeguard against default. With the fear of the corporate image getting tarnished, the big houses will become more careful.

The RBI admits a drop in credit offtake in the last couple of months compared to the corresponding period last year. Investment is slowing down. If this is so, the country has bigger problems ahead. A good monsoon will not be enough for the economy to pull out of the current mess with slowdown in industry and services. The RBI must have appreciated that but should have identified the root of the current malaise and acted accordingly. Although it is not everything that is there in RBI's hands, the central bank of the country should have acted to provide a more definite direction.

It is not enough to lower interest rates and bring in measures to protect the banks. The banks will continue to operate in risky conditions. That is their business. But let the central bank take a larger view of the risk element in the context of the emerging opportunities in the country's SMEs and set up a workable plan for it. Credit flow to the sector has to expand. It is in the SMEs that lies the future of the Indian banks.

(The views expressed here are of the author.)