FM Sitharaman’s package 1: Everything you wanted to know

The FM unveiled the first tranche of Prime Minister Modi’s special economic package of 20 lakh crore. The first set is worth Rs.6 lakh crore (Rs 594,250 crore to be exact). The FM is expected to make a series of announcements for the rest of the package over the coming days.

[You may read- What does Modi’s 20 lakh crore package mean? & The second tranche of the Modi’s package]

The first tranche of the PM’s package is mainly focused on ensuring the flow of credit to MSMEs. The economic package was long-awaited to help the cash-starved small businesses to stay afloat.

[You may read: Impact of COVID-19 on MSMEs]

Before discussing the measures announced, let us understand what’s meant by loan guarantees given by the Government, and how it works.

Loans guarantee is basically a guarantee given to lending institutions like banks that if a borrower defaults, the Government will repay the loan. If the guarantee is 100 %, the Government will pay the loan amount fully. If the guarantee is 10 %, the Government will pay 10 % of the loan amount or the first 10 % of the loans extended.

The RBI had already taken monetary policy measures to ease liquidity in the system, but banks were not willing to lend to MSMEs, as they were worried about defaults. Therefore, the Government decided to guarantee loans to kick-start lending in the economy.

Loan guarantees will not lead to an immediate fiscal outgo. It will be spread over the years. Also, it is a contingent liability, that is, the Government will have to pay only in case of default.

[You may also read: RBI cuts reverse repo to combat COVID 19]

Now, we’ll come to the granular details of the package. The relief measures announced for MSMEs are:

• For standard MSMEs (not in trouble before COVID-19 disrupted operations): 100 % guarantee to collateral-free loans worth Rs. 3 lakh crore. This guarantee would be provided to MSMEs that already have an outstanding loan of Rs 25 crore and a turnover of less than Rs 100 crore. The amount of loan provided to an MSME will be 20 % of their outstanding loan amount. The loans will have a tenure of 4 years and a moratorium of 12 months on principal payments (repayment starts only after 12 months). The loan should be taken before October 31, 2020. This will help 45 lakh MSMEs.
• For stressed MSMEs or NPAs/ loan defaulters: Partial guarantee to loans worth Rs.20000 crore. The Government will set up credit guarantee fund trust and provide Rs.4000 crore for this purpose. This will benefit 2 lakh MSMEs.
• The Government will also create a ‘fund of funds’ of Rs.50000 crore to infuse capital (equity) into viable MSMEs. The Government will put in Rs.10000 crore. The rest of the amount will be provided by institutes like LIC, SBI, etc.
• The definition of MSMEs changed: Earlier, the MSMEs were defined on the basis of investments done, now the revised definitions will also include the turnover of the company. Moreover, the threshold for investment has been increased. The distinction between the manufacturing and services sectors has also been done away with. It will provide an incentive for MSMEs to scale up without worrying about losing the benefit of MSME once they increase in size.

• Clear all pending dues of MSMEs by Government and Central PSUs in 45 days
• For govt procurement, no global tenders would be floated for procurement up to Rs.200 crore. This would benefit MSMEs.
• Facilitate E-market linkages of MSMEs since trade fairs and exhibitions will not possible this year.

The Government also took steps to ease liquidity constraints of financial intermediaries like Non-Bank Financial Corporations (NBFCs), Housing Finance Companies (HFCs) and Micro-finance institutions (MFIs), to help them extend loans: [You may also read: Impact of COVID-19 on NBFCs]

• A special liquidity scheme worth Rs.30000 crore which will provide a 100 % guarantee for investments made in investment-grade debt (high credit rating) of NBFCs, HFCs, and MFIs. It includes investments made in the primary market and the secondary market. [You may read: What is primary and secondary market?]
• A partial credit guarantee scheme 2 (20 % guarantee) worth Rs.45000 crore for investment in debt of low credit-rating of NBFCs, HFCs, and MFIs. 20 % guarantee means only the first 20 % loss will be borne by the Government.
• Existing partial credit guarantee scheme will be extended to cover borrowings such as primary issuance of bonds/ Commercial papers (CPs) of such low-rated entities

Other measures unveiled were

• Lowering the rate of Tax Deducted at Source (TDS) by 25 %. This will not impact Government finances, but increase disposable income (Rs.50000 crore) in the hands of the people. [TDS is paid to the Government and adjusted against final tax liability, which will remain the same]
• The Government will contribute to the Employees Provident Fund Organisation (EPFO) for certain enterprises for another 3 months (June-August) (It will cost Rs.2500 crore)
• The EPF contributions for the rest will be reduced from 12 % to 10 %. It will increase disposable income without putting any financial burden on the Government.
• State-owned power lenders will inject Rs.90000 crore to financially stressed state power distribution companies (DISCOMs) so that they can repay their debts to power generation companies (GENCOs). These loans will have to be guaranteed by the states. [You may read: Why did the Government infuse Rs.90000 crore in the power distribution sector?]
• 6 months extension of the contracts with central undertakings allowed.
• The real estate sector is allowed to invoke Force Majeure for projects started on or before March 25. It means they can get out of their contractual obligations citing coronavirus pandemic induced disruptions as the reason.

Overall, the package has been great for MSMEs in terms of access to finance, but some MSMEs were asking for direct handouts from the Government to pay for wages etc.

Apart from that, the loan guarantees should boost lending to the sector. But, loan guarantees could create a moral hazard problem. This is because the banks will not do due diligence as they are assured of repayment. Also, MSMEs have no incentive to pay back.

To end this post, we take a look at the direct fiscal cost of this package worth Rs.5.94 lakh crore in the near term.

Add the PF amount of Rs 2,500 crore…. the Rs 10,000 crore contribution to the Fund of Funds, and the Rs 4,000 crore for the credit guarantee fund for stressed MSMEs, and the actual fiscal hit in the near term is just about Rs 16,500 crore.

Finally, if one were to add this 5.94 lakh crore with fiscal and monetary measures of Rs. 7.94 lakh crore already done earlier, we get 13.88 lakh crore. So that’s about 14 lakh crore out of 20 lakh crore economic package already accounted for.

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