Every nudge by the Reserve Bank of India to make lenders take credit risk has fallen flat. Small Indian companies getting decimated by the world’s harshest coronavirus lockdown can finally see a ray of hope

by Andy Mukherjee

Details are still sketchy, but the Indian government plans to backstop banks if they increase overdraft limits by 20%, providing Rs 3 lakh crore ($39 billion) of new working capital to smaller enterprises, Bloomberg News has reported. A state-sponsored fund will absorb losses.

Seeing how the U.S. Small Business Administration’s paycheck protection program has been overwhelmed by demand, India needs to match urgency with careful design. My colleague Shuli Ren has noted how Chinese business owners have diverted anti-virus funding to property or wealth management products. This could happen in India, too. Yet it would be a bigger mistake to dither indefinitely because some fiscal assistance may be misused.

Three out of four Indian employees work casually for others or at family firms and farms. It’s perfectly normal for even white-collar workers to get paid in cash with no social security. Migrant blue-collar workers are either walking hundreds of kilometres back to their villages or have already returned, scared and scarred, from the cities. If broad-based help isn’t offered to small businesses, the strides the country has taken in lifting hundreds of millions out of poverty over the last 30 years might be at risk.

Since the goal is to protect workers by giving employers an incentive to pay them, hitting that objective in a highly informal economy is the first challenge. The second is channelling credit when banks, nonbank financiers and debt mutual funds — like the six local Franklin Templeton entities put into suspended animation last week — are gripped by a mistrust of borrowers that predates the pandemic. Fiscal fear-mongering is the third obstacle.

I’m assuming the state-backed advances would be offered at a concessional rate, with the interest subsidy borne in the union budget. Banks would make loans for a fee, and turn them over to the guarantee fund, which would issue bonds to fund the purchase. Since non-payments will be made good by New Delhi, the bonds can be sovereign-backed. Who will buy them? Even if foreign investors don’t bite because of nervousness about the rupee, local banks are flush with liquidity. State Bank of India will still make money even if a customer defaults, if it sells its exposure to the fund in exchange for special sovereign bonds.

Every nudge by the Reserve Bank of India to make lenders take credit risk has fallen flat because they want the sovereign to lead. That’s where the guarantee comes in. At 1.4% of GDP, taxpayers’ exposure isn’t minor. Yet the backstop won’t meet pent-up demand. Amplifying its effect, and ensuring that banks don’t just throw money at politically connected borrowers, will require lenders to keep some skin in the game. Say the fund buys $80 of every $100 of risk, leaving $20 with banks. Just as with the U.S. protection program, lenders ought to be able to get cheap term loans from the RBI to finance their portion.

Small firms’ working capital needs swell because large customers, including the government, take too long to pay. A parallel push to get all vendor bills on a discounting platform will improve cash flows. To ensure that the extra credit actually reaches workers, New Delhi may have to defray a part of the wage bill for some time. Businesses taking the help would demonstrate regular payments into social security accounts, topped up by the government. This expensive separate arrangement might require the central bank to fund it by printing new money. With the jobless rate in excess of 23%, this isn’t a time to worry about losing India’s investment-grade sovereign rating. The country’s chances of slipping into junk-bond status are low this year anyway.

Prime Minister Narendra Modi has given little indication that he wants to be India’s version of President Franklin D. Roosevelt. But migrant workers tossed out of cities with no food, shelter or transport won’t return without a New Deal: nest eggs for old age and healthcare. China’s hukou — or city permits — discriminate against rural workers. In India, where urbanization and labour mobility are weapons against built-in caste prejudice, a lifeline to small businesses is an economic and a moral imperative. As long as the recipients become the building blocks of universal social security, it will be $39 billion well spent.