Arun Jaitley’s attack on the Reserve Bank of India is disingenuous. The finance minister this week criticised the central bank for failing to check indiscriminate bank lending from 2008 to 2014 which has now ripened into a bad loan crisis. The attack was accompanied by the government invoking never-used powers under the Reserve Bank Act to issue directions to the bank’s governor, Urjit Patel.
The government, exercising its powers under Section 7 of the Act, has sent multiple letters to Patel in recent weeks on issues ranging from liquidity for non-banking financial companies, or NBFCs, to capital requirement for weak banks and lending to small and medium enterprises, The Economic Times reported.
Inside the central bank, Jaitley’s sudden emphasis on smaller companies has been linked to the Bharatiya Janata Party government’s urgency to create jobs ahead of next year’s election. “The government obviously has set its goals for the 2019 general election and it is not helping that small and medium-scale businesses are getting affected due to cash crunch in the banking sector,” a Reserve Bank director told Mumbai Mirror. Matters have been compounded, the official said, by the IL&FS default, which has made banks wary of lending to NBFCs, a major source of credit for micro, small and medium enterprises, or MSMEs.
These enterprises, less mechanised than large companies, account for most of India’s manufacturing jobs. Hence, the finance minister’s focus on them. And yet, Jaitley’s attack is disingenuous for two reasons.
MSMEs were in trouble before BJP came to power
First, he oversimplifies why MSMEs are in trouble. Their problems run far deeper than inadequate credit.
From 2015 to 2017, Scroll.in’s Ear To The Ground project found MSMEs struggling in all six of the states it covered. Industrial units across Punjab – steel plants in Mandi Gobindgarh, sporting goods manufacturers in Jalandhar, textile units in Amritsar, bicycle-makers in Ludhiana – were shutting down or relocating to other states. In Odisha, industry was in doldrums as well. In the steel town of Rourkela, for instance, as many as 40 out of 50 induction furnaces, which make steel, had shuttered since 2012. In Tamil Nadu, businesses in Coimbatore and Tirupur complained of eroding competitiveness.
The immediate factors varied from state to state, from cluster to cluster. Manufacturing units in Punjab were struggling to compete with cheaper competition from other Indian states and China. One reason was the high cost of doing business, partly due to expensive electricity, with its improbable link to the collapse of tax collection in the state, and partly due to rent extraction by the previous Akali Dal government. In Odisha, irrational exuberance sparked by the global steel boom of the 2000s was one reason. Another was the government’s decision to export raw iron ore – instead of finished steel – during that period, nixing the growth plans of the state’s steelmakers. Subsequently, when the boom ended and China began exporting cheap steel, Indian steel companies prevailed upon the government to impose import tariffs. This, however, hurt a diverse array of small and medium enterprises making steel products for local and global markets. As the owner of a company that cut and shaped sheet metal for other industries in Coimbatore explained, “If I am a furniture shop making almirahs, the product gets costlier.” Engineering companies exporting finished products lost competitiveness as well.
Clearly, problems with India’s MSME sector go far beyond inadequate credit.
MSMEs were severely damaged after BJP came to power
If the MSME sector was tottering by the time Arun Jaitley became India’s finance minister, the next four and a half years felled it.
First came demonetisation. On November 8, 2016, the government suddenly announced that Rs 500 and Rs 1,000 notes were no longer legal tender. This created an unprecedented cash shortage in the country. As economic activity dropped, households and small businesses took a beating.
Less than a year later, on July 1, 2017, came another shock. The Goods and Services Tax was introduced even before the MSMEs’ turnovers had returned to pre-demonetisation levels. As Scroll.in reported from Gujarat at the time, India’s new tax regime for businesses favours formal economy players more than those in the informal economy – which is entirely made up of MSMEs. In South India, high tax slabs pushed MSMEs in the automotive cluster of Hosur into the red, forcing them to take bank loans to pay taxes.
While firms were still grappling with the new tax regime and figuring how to survive, there came the cash crunch of December 2017. As Scroll.in reported, multiple reasons were at work, including a collapse of the government’s cash distribution protocols. This hammered small businesses yet again. That is people like Jayaramaiah in Bagalur, a small town near Hosur. In the weeks after demonetisation, the volume of business at his hardware store had fallen to 20%. By July, it had climbed to 80% when the Goods and Services Tax again pushed it down to 40%-50%. By December, Jayaramaiah’s business volume had recovered to 80%-85% of the pre-demonetisation levels when the cash squeeze came and reduced it to half of the November 2016 levels.
Jaitley glossed over all this while excoriating the Reserve Bank for letting MSMEs down.
As rhetorical feints go, this one does not fare particularly well. “The government is trying to blame the RBI for its failures,” said the head of an MSME industry association in Tamil Nadu who asked not to be identified. “They are trying to divert attention from moves like demonetisation.”
To revive these enterprises, the government needed to take a far wider set of corrective measures. But in the last four and a half years, nothing substantive has been done.