The mandate issued by the Association of Mutual Funds in India and the Securities and Exchanges Board of India, asking members to conduct monthly stress tests for mutual funds, reflects a proactive stance towards addressing concerns of potential market instability, particularly in the small-cap and mid-cap segments. Stress tests evaluate a fund's capacity to handle significant liquidation of holdings in their portfolios. While some funds exhibited efficient performance, the collective assessment indicated that top small-cap funds would require a longer duration for liquidation, potentially impacting investor confidence.
This development takes on added significance when viewed in the context of investments by mutual funds in the micro, small, and medium enterprises1 ("MSME") sector. Such investments typically target enterprises /MSMEs with positive cash flow or a clear trajectory towards achieving it, coupled with robust growth prospects and potential for enhanced profitability margins. However, the prevailing challenges in the MSME sector, such as cash flow constraints and delayed payments, prevents them from meeting their financial obligations which in turn affects their creditworthiness. Low creditworthiness casts a shadow on stress tests by funds investing in these enterprises. Consequently, the attractiveness of investments in MSMEs may be compromised, signalling a broader concern for investors and stakeholders alike. These findings highlight the pressing need for strategic interventions to revitalize the MSME sector, which serves as a cornerstone of economic development and employment generation.
With its rapid expansion, the MSME segment is poised to play a significant role in realizing India's ambitious vision of attaining a five trillion dollar economy. As of now, the Ministry of MSME reported an impressive registration of over 2.75 crores MSMEs on the Udyam Registration portal2. However, despite the immense growth potential, MSMEs grapple with cash flow challenges and liquidity constraints directly impacting their business operations and financial stability. Recognizing the challenges, the Government has undertaken various initiatives to address the challenges faced by MSMEs. Some of these initiatives have been discussed below briefly:
- Payment Cycle: The enactment of the Micro, Small and Medium Enterprises Development Act in2006 ("MSMED Act") aimed to provide a conducive environment for the natural progression of small and medium enterprises through targeted policy interventions and a robust legal framework. Central to this legislation is the mandate to the customers/buyers to make timely payment for goods and services rendered by micro and small enterprises ("MSEs"), stipulating a maximum payment period of forty-five (45) days from the actual due date3. Additionally, any delayed payments are subject to compound interest, set at three (3) times the bank rate notified by the Reserve Bank of India ("RBI")4. To fortify this measure, the Government also introduced changes to the Income Tax Act, 1961, which mandated that if payment to MSEs is not made within the stipulated timeline of forty-five (45) days, a buyer/ customer cannot deduct such payment as expense from its taxable income, leading to payment of higher taxes5. These initiatives ensure that MSMEs receive payments promptly from its buyers fostering stable cash flow and reducing financial vulnerabilities.
- Dispute Resolution: The Ministry of MSME
launched the Samadhan Portal, to facilitate MSEs to file any
grievances related to delayed payments and monitoring outstanding
dues to MSEs from buyers of goods and services. The state
governments are empowered to establish a Micro and Small Enterprise
Facilitation Council ("MSEFC") process
all grievances filed on the Portal.
Any MSE with a valid Udhyam registration can apply for assistance on the Portal to prove their claim. Once filed, the application is automatically forwarded to the MSEFC of the respective State. Upon receiving such application, the MSEFC examines the application and issues notices to the buyer who has not paid for the goods or services supplied by a complainant MSE, to make payment of the amount due along with applicable interest. If after receipt of such notice, the buyer does not make the payment within the time period mentioned in the notice, the MSEFC initiates resolution through conciliation either by itself or through relevant institutions. Where conciliation initiated is unsuccessful and stands terminated without any settlement between the parties, the dispute is referred to arbitration6. Every reference made to MSEFC must be decided within ninety (90) days from the date of making such a reference.7
- Trade Receivables: The RBI, in an attempt to
foster economic growth, employment, and financial inclusion,
introduced TReDS – Trade Receivables Discounting System.
TReDS serves as an institutional infrastructure, offering MSMEs
financing against the security of receivables, discounting bills/
invoices, and so on to generate necessary liquidity for businesses.
These receivables may be due from corporate and other buyers,
including government departments, and public sector undertakings.
TReDS allows participants to upload, accept, discount, trade, and
settle invoices raised by MSME. It enables the conversion of
invoices or bills into factoring units and facilitates
buyers' acceptance within specified time limits. TReDS also
handles discounting, rating, re-discounting, notifications,
reporting, and settlement obligations. Under the regulatory
framework established by the Payment and Settlement Systems Act
2007, TReDS functions as an authorized payment system with only
RBI-authorized entities as buyers.
The RBI, in its Annual Report (2023-2024), announced initiatives to expand the scope of the TReDs platform to improve the cash flows for MSMEs, which included permitting insurance for transactions, increasing the pool of financiers and enabling a secondary market for factoring units. This digital solution has processed approximately seventy-five thousand (75,000) factoring units financed at a value of over sixteen thousand crores as of June 20248.
Every year, the Union Government takes initiatives to augment the growth and sustainability of MSMEs. For instance in this year's Budget, in order to improve access to credit and liquidity for MSMEs, the Government has proposed, inter-alia, to introduce a new credit guarantee scheme for purchase of equipment without collateral or third-party guarantee and a credit support scheme to help MSMEs during stress period. These initiatives highlight the Government's unwavering commitment to enhance the sector's vitality. A thriving MSME sector will provide mutual funds with a more stable and attractive investment landscape. Therefore, the success of MSME-focused initiatives shall not only augur well for the growth and prosperity of small businesses but also positively influence the performance and resilience of mutual funds in the long run. TransUnion Cibil reported that of the six hundred and thirty (630) lakh MSME corporates in India, only two hundred and fifty (250) lakhs are included in the formal credit ecosystem. It suggested that financial institutions must focus on bridging this gap and tap into this vast segment by identifying deserving MSMEs, connecting with them and customizing credit products for their requirements9. This would accentuate the outlook of MSMEs for mutual fund investments. Through strategic interventions and collaboration among stakeholders, policymakers can continue to support MSMEs, ultimately contributing to the vibrancy and sustainability of the economy.
Footnotes
1 The Central Government vide notification S.O. 1702(E). dated June 1st, 2020 notified the following criteria for classification of micro, small and medium enterprises, namely:—
- a micro enterprise, where the investment in Plant and Machinery or Equipment does not exceed one crore rupees and turnover does not exceed five crore rupees;
- a small enterprise, where the investment in Plant and Machinery or Equipment does not exceed ten crore rupees and turnover does not exceed fifty crore rupees;
- a medium enterprise, where the investment in Plant and Machinery or Equipment does not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.
2 The Udhyam Registration allows any person who intends to establish a micro, small or medium enterprise to file Udyam Registration online on the Udyam Registration portal, based on self-declaration with no requirement to upload documents, papers, certificates or proof.
3 Section 15, MSMED Act
4 Section 16, MSMED Act
5 Section 43B sub-clause (h), Income Tax Act, 1961
6 Conciliation and arbitration proceedings must be conducted as per the provisions of Part III of the Arbitration and Conciliation Act, 1996
7 Section 18, MSMED Act
8 https://www.rbi.org.in/Scripts/TReDSStatisticsView.aspx
9 Reference: https://www.transunioncibil.com/content/dam/transunion-cibil/business/collateral/report/msme-report-feb-2024.pdf
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