Debt Restructuring: Boon Or Bane For India’s Small Businesses?

For India’s small businesses, debt restructuring can be a double-edged sword. But what options do they have?

An employee arranges bidi cigarettes into bundles at the Sarkar Bidi Factory in Kannauj, Uttar Pradesh, India. (Photographer: Udit Kulshrestha/Bloomberg)  
An employee arranges bidi cigarettes into bundles at the Sarkar Bidi Factory in Kannauj, Uttar Pradesh, India. (Photographer: Udit Kulshrestha/Bloomberg)  

India’s small businesses are facing fire from all sides. The economy is weak and so are sales. Large businesses are under pressure, leading to delayed payments for smaller units. The goods and services tax is adding to compliance costs.

To ease some of the pain being felt by micro, small and medium enterprises, the Reserve Bank of India recently extended a provision that allows one-time restructuring of loans. Any such restructuring concluded by December 2020 will not lead to the account being tagged as a non-performing asset, the central bank has said.

However, this restructuring relief, intended to help MSMEs, is a double-edged sword. Companies who opt for it see their credit rating impacted, interest rates shoot up and ability to take larger loans curtailed.

The issues causing stress for small businesses remain, even when restructuring is permitted and these units often face a further squeeze in credit because of restructuring, said Abhiman Das, professor at IIM Ahmedabad and member of an expert committee recently set up to examine issues plaguing MSMEs in India.

While restructuring isn’t the solution, it lets you live with the problem a little longer, Das said.

Why The Restructuring Relief

The RBI’s decision to extend the restructuring window followed concerns that a weak economy will hurt India’s already weak MSME sector. The restructuring relief has been provided to firms with a turnover of up to Rs 25 crore.

Default rates across MSMEs have been elevated for some time now, according to data from credit information bureau TransUnion CIBIL. They saw a further uptick in the fourth quarter of FY19, the data showed. According to the latest available data, default rates range from 8 percent for micro-enterprises to 18 percent for medium-sized enterprises with turnover of up to Rs 50 crore.

A committee intended to help MSMEs rectify financial stress and restructure debt set up by the RBI in 2016 has also continued to see high referrals.

In response to a Lok Sabha query on Feb. 6, 2020, the government said that 1.5 lakh SMEs were referred to the committee in the six months ended September 2018. The number fell marginally to 1.42 lakh in the six months till March 2019. Data beyond that isn’t available.

The central bank hasn’t released data on the number of firms that have availed its latest restructuring forbearance. According to Finance Minister Nirmala Sitharaman’s budget speech, five lakh MSMEs have benefited.

Fallout Of Debt Restructuring

The decision on whether to restructure debt is not an easy one for small businesses.

Restructuring does impact financial flexibility, and credit scores of small business take a beating, Suman Chowdhury, president at Acuite Ratings and Research, a credit rating agency for MSMEs.

One fallout of MSME debt restructuring is that the bank may not be willing to provide further funding to the account. Other lenders also often turn reluctant. Those who do lend may bump-up interest rates by 1-2 percentage points for restructured accounts, Chowdhury explained.

Chowdhury, however, added that the consequences may be worse if an SME account is tagged as non-performing. Business gets disrupted. So, there is a rationale for ensuring that facilities are restructured, Chowdhury said.

An executive director at a large state-run bank confirmed that interest rates for fresh lending to restructured MSMEs can go up by nearly 1.5-2 percentage points. As borrowing usually becomes more expensive, MSME entrepreneurs have been preferring to repay their outstanding dues through personal lending, rather than restructuring loans. However, in cases where the outstanding dues are too high, borrowers may not have much of a choice, the banker said.

Anil Bharadwaj, secretary general at the Federation of Indian Micro and Small & Medium Enterprises, acknowledges that debt restructuring doesn’t always help. Even apart from the stigma of financial failure, widely prevalent in the Indian economy, restructuring is unlikely to resolve the core issues facing small businesses.

At times of stress, small businesses also often fail to service other liabilities. “Considering that restructuring is usually long-drawn, other creditors can take possession of assets in the intermittent period. Even if that does not happen, a bank restructuring may just be one aspect,” Bharadwaj said. “Other aspects remain unresolved. So, restructuring is usually a failure.”

Restructuring can help when the MSME can quickly find a way to pay its statutory dues, Bharadwaj said.

Alternatives To Restructuring

While allowing restructuring of loans without a downgrade to the category of non-performing loans, known as forbearance, has been the go-to solution for regulators for years, are there other options to provide relief to small businesses?

According to Das, prioritising financing of trade receivables via platforms like TReDS can be an alternative to debt restructuring. Considering the issue of delayed payments, a large chunk of the problem could be resolved by on-boarding more firms and increasing trading on TReDS, he said. So, far these platforms have seen tepid volumes, possibly because of know-your-customer requirements, said Das.

Newer models of assessing small businesses will also help in ensuring that one-time restructuring doesn’t impact its borrowing costs for a long time to come.

Banks continue to prioritise a firm’s credit scores even though they require a firm to submit various other documents. Now, new-age financiers are experimenting with different business models to assess a firm’s cash flow, Das said.

Chowdhury said that restructuring forbearance may still be needed in the event of a cyclical downtrend in the economy. “If these loans are not restructured and are allowed to become NPAs, there can be broader economic consequences,” he said. “That said, the concern of evergreening cannot be ignored.”