A res­cue plan for liq­uid­ity-hit MSMEs

DeMo and GST have wrongly crim­i­nalised un­ac­counted MSME funds, which lie frozen in banks. These funds should be re­leased

The Hindu Business Line - - THINK - BHAWARLAL CHANDAK M MOORTHY

The epochal GST was ex­pected to boost man­u­fac­tur­ing, capex, em­ploy­ment, tax rev­enue and for­mal­i­sa­tion of the in­for­mal sec­tor. How­ever, these ob­jec­tives re­main mostly un­re­alised due to dis­rup­tions in cir­cu­la­tion of un­ac­counted/in­for­mal busi­ness cap­i­tal/work­ing funds fol­low­ing de­mon­eti­sa­tion and GST.

His­tory shows that ma­jor macroe­co­nomic dis­tur­bances are as­so­ci­ated with dis­rup­tions in fi­nan­cial flows. Slow­down caused by such dis­rup­tions are painful and long drawn out. Wide­spread in­ter-firm pay­ment de­lays/de­faults and low bank credit con­fi­dence trans­mit liq­uid­ity shocks across busi­nesses.

Firms and farms are ex­pe­ri­enc­ing a liq­uid­ity grid­lock-led re­ces­sion­ary trend de­spite the vol­ume of cur­rency in cir­cu­la­tion, bank credit and de­posits be­ing higher than their pre-de­mon­eti­sa­tion lev­els.

Nar­row liq­uid­ity view

The gen­eral un­der­stand­ing of liq­uid­ity is bank-cen­tric. How­ever, over 94 lakh busi­ness units’ in­come tax re­turn data for FY 2014 show banks’ fi­nanc­ing cov­ered about one-third of their to­tal turnover. Tak­ing into ac­count turnover of firms be­low the tax­able slab and un­ac­counted trans­ac­tions, more than two-thirds of busi­ness fi­nanc­ing is through non­bank fi­nance chan­nels (NFCs).

Anec­do­tally, only 5-10 per cent of MSMEs avail them­selves of bank credit. NFCs are lender­sof-last-re­sort for MSMEs/ un­or­gan­ised busi­nesses.

Banks’ ex­cess liq­uid­ity hold­ing in SLR, large fi­nan­cial in­vest­ment/liq­uid­ity hold­back by fi­nan­cially sound firms, and flight to safety and se­cu­rity have cre­ated a liq­uid­ity mis­match in the fi­nan­cial sys­tem. This ag­gra­vates the liq­uid­ity cri­sis.

As such, bank-cen­tric liq­uid­i­tyen­hanc­ing mea­sures alone have very lim­ited im­pact.

GST im­pact

will The com­mon ex­pla­na­tion of­fered by busi­nesses for the wide­spread slow­down is acute short­age of liq­uid­ity in terms of for­mal busi­ness cap­i­tal to fi­nance GST trans­ac­tions. Avail­able, un­ac­counted busi­ness cap­i­tal can­not fi­nance these.

This mis­match aris­ing from dis­rup­tion in cir­cu­la­tion of un­ac­counted busi­ness cap­i­tal/funds is cre­at­ing un­prece­dented liq­uid­ity cri­sis across busi­nesses. This cap­i­tal car­ries the stigma of black money. Its use in for­mal trans­ac­tions car­ries risk and fear of in­come tax scru­tiny, ha­rass­ment and ret­ro­spec­tive tax.

Fi­nanc­ing of nu­mer­ous day-to­day for­mal busi­ness trans­ac­tions has been hit. This as­pect should have been con­sid­ered while im­ple­ment­ing GST. Un­re­al­is­tic treat­ment of this cap­i­tal on par with black money un­der vol­un­tary in­come dis­clo­sure schemes dis­in­cen­tivised its con­ver­sion into for­mal money. Who will pay high penalty rates for the sur­vival/liveli­hood cap­i­tal, so es­sen­tial to run a busi­ness?

Many small firms ac­cu­mu­late busi­ness cap­i­tal over the years out of in­comes which may fall be­low the tax-pay­ing slab. Tax-eva­sion at the in­di­vid­ual busi­ness level be­comes a ne­ces­sity due to pre­vail­ing in­dus­try prac­tices and tax eva­sion by com­peti­tors.

But rather than earn­ing higher un­ac­counted in­come, stiff com­pe­ti­tion gen­er­ally forces the en­tre­pre­neur to pass on gains from tax eva­sion into lower prices. In gen­eral, MSMEs/small traders don’t earn a fair eco­nomic re­turn on the present value of their in­vest­ment.

Fur­ther, dur­ing de­mon­eti­sa­tion, a part of un­ac­counted busi­ness cap­i­tal got de­posited in bank ac­counts with re­laxed KYC norms. Now, with with­drawal re­quir­ing full KYC com­pli­ance and sub­se­quent mon­i­tor­ing, in­clud­ing a trail of its uses, by Full cir­cu­lar­ity of busi­ness funds needs to be re­stored

in­come tax au­thor­i­ties, there have been other con­se­quences. A part of this busi­ness cap­i­tal re­mains in­vested in bank de­posits. This adds to re­duc­tion in funds’ avail­abil­ity for busi­nesses.

A way out

The Prime Min­is­ter’s re­peated call for for­mal­i­sa­tion of MSMEs, his sup­port mis­sion for the un­or­gan­ised sec­tor and as­sur­ance against non­scrutiny of their past busi­ness records can work only if the con­ver­sion of this un­ac­counted cap­i­tal but earned from le­git­i­mate busi­ness ac­tiv­i­ties is for­malised with a low penalty.

It is an im­per­a­tive for pol­i­cy­mak­ers to ap­pre­ci­ate that this money can­not be treated at par with black in­come gen­er­ated through a dubious man­ner, or by in­dulging in anti-so­cial/anti-na­tional ac­tiv­i­ties. Low penalty is thus jus­ti­fied. Most busi­nesses pre­fer to do clean and has­sle-free busi­ness un­der GST. Restor­ing full cir­cu­lar­ity of busi­ness funds in­creases ve­loc­ity of money. This boosts liq­uid­ity, busi­nesses’ con­fi­dence and ac­tiv­i­ties.

With­out this, busi­nesses face a re­ces­sion

trig­gered by a liq­uid­ity crunch. How­ever, sur­vival in­stinct forces busi­nesses to game the GST sys­tem. This has al­ready started. It dents GST’s ob­jec­tives of for­mal­i­sa­tion of trans­ac­tions and higher tax rev­enue.

Draft pro­posal

* Con­ver­sion of busi­ness cap­i­tal in the forms of un­ac­counted cash/ bank de­posits into for­mal funds may be al­lowed to GST-reg­is­tered firms only with 10-20 per cent pro­gres­sive penalty struc­ture.

* Con­ver­sion may be re­stricted to de­posits up to ₹2 crore. This may fa­cil­i­tate a busi­ness to have an an­nual turnover of ₹8-10 crore with four to five work­ing cap­i­tal cy­cles in a year. It may cover a ma­jor­ity of the firms.

* Nitty-grit­ties of the scheme, penalty rates and con­ver­sion amount can be fine-tuned/changed af­ter dis­cus­sions with trade and in­dus­try. This will enor­mously help busi­nesses to in­crease their busi­ness un­der GST.

* Em­ploy­ment will in­crease. Tax rev­enue may sur­pass the es­ti­mates. It must be re­called that in the past this money was used in fi­nanc­ing eco­nomic ac­tiv­i­ties.

To bring in­for­mal busi­nesses un­der GST, it would be prac­ti­cal to have such a scheme with the fol­low­ing indica­tive con­di­tions:

* All the un­ac­counted funds/cash hold­ings/bank de­posits of a busi­ness need to be de­posited in a des­ig­nated cur­rent ac­count of a bank linked to busi­ness ac­tiv­i­ties un­der GST;

* The de­posit can be used for busi­ness trans­ac­tions only;

* A graded penalty up­front on the to­tal de­clared de­posits/cash may be im­posed; ex­am­ple, 10 per cent up to ₹50 lakh and 20 per cent for ₹50 lakh to ₹2 crore.

No doubt, some black money may flow in un­der the scheme. How­ever, the sav­ing grace is that this money will then be used for pro­duc­tive pur­poses. It may be con­sid­ered a small evil to achieve larger na­tional goals in terms of busi­ness growth, em­ploy­ment and for­mal­i­sa­tion of busi­ness trans­ac­tions.

Ad­van­tages of the move

* The sup­ply chain fi­nanc­ing net­work can be boosted with­out loss of time.

* Trans­mis­sion of liq­uid­ity and late pay­ment shocks are con­trolled.

* Re­vival of the un­or­gan­ised sec­tor will be faster, steady and ef­fi­cient.

* In­creased funds flow helps in bet­ter farm prices. Ear­lier use of in­for­mal funds in pur­chas­ing of farm out­put by mil­lions of traders/grain mer­chants dur­ing har­vest time and sell­ing these dur­ing lean sea­son did help in hold­ing the price-line.

* GST rev­enue will leapfrog with steady growth in turnover.

* For­mal­i­sa­tion of busi­ness trans­ac­tions will be easy, faster and wide­spread.

* Higher growth will mit­i­gate NPA prob­lems and lead to bet­ter NPA as­set value.

* Dras­tic re­duc­tion in trans­ac­tion ve­loc­ity of money leads to wide­spread de­pres­sion. This will be re­versed.

The writer is a for­mer deputy gen­eral man­ager, SIDBI

Way ahead

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