The government may have sanctioned a Rs 3 lakh line of credit—backed by a sovereign guarantee—but the fact is the sector is owed as much if not more.

An analysis by CRISIL has highlighted the plight of MSMEs, saying they face an existential crisis, and pointing out that micro and small units may not be able to cope with transient working capital challenges as easily as their medium and larger peers. There is no doubt the disruption from the pandemic will hit MSMEs the hardest. Indeed, the drop in revenues of 17-21%, and the contraction in operating margins of 200-300 basis points to 4-5% appear to be somewhat optimistic. The operating profits for a group of 535 companies crashed nearly 40% year-on-year (y-o-y) in Q4FY20 while the profit before tax plunged 65% y-o-y. That is despite only 10 days of a shutdown in the quarter. To be sure, the earnings were hit by the collapse in commodity prices for a Vedanta and by a sharp dip in China demand for a Tata Motors. But, even adjusting for these factors, the stress is huge—evidently, the cumulative effect of weakening demand several quarters before Q4FY20.

Economist Pronab Sen recently pointed out the severe damage done to the informal and SME sectors post-demonetisation, and GST has started showing up in corporate results through its effect on incomes and demand. Sen observed that while the informal sector does have a certain degree of resilience because of its ability to work through social networks and renegotiating informal contracts, its earnings tend to decline, sometimes sharply. The corporate sector, he said, has greater staying power, but is not immune to the demand destruction that takes place because of the problems faced by the informal and SME sectors.

Unless they are provided some more financial support, the MSMEs are going to see further pain. The government may have sanctioned a Rs 3 lakh line of credit—backed by a sovereign guarantee—but the fact is the sector is owed as much if not more. The government must clear its dues because OEMs are unlikely to pay vendors when they themselves are strapped for cash. Unless their cash flow situation improves immediately, MSMEs are going to end up defaulting to lenders. CRISIL estimates the average interest service coverage ratio could slide to 1-1.5 times from 2.4 times seen between fiscals 2017 and 2020, even after factoring in the benefit of a moratorium on interest payments announced by the Reserve Bank of India (RBI). In the absence of a moratorium, the ratio would have dipped to below 1. Many micro units, which account for about a third of the total MSME debt, could become insolvent.

Unfortunately, the Rs 3 lakh crore package and the collateral-free Mudra loans may not be enough to help these units to stay afloat until demand picks up. Although economic activity is slowly picking up pace, it is going to be a while before there is a reversion to the mean; Nomura economist Sonal Varma forecasts India will clock in a -6.1% in FY21 with every quarter reporting negative growth. This would suggest that even the best and the biggest of companies are going to struggle; in the March quarter—with just ten days of a shutdown—revenues for India Inc were down 6% y-o-y; one can only imagine the destruction in smaller businesses. Unless lenders are lenient, resuscitating many of the units would be very difficult, and one can expect large job losses.