Namrata Kath Hazarika | 30 Apr, 2012
In an exclusive interview with SME Times, D. R. Dogra, Managing Director & Chief Executive Officer, Credit Analysis & Research Ltd (CARE Ratings), said that performance of Indian small and medium enterprises (SMEs) was dull in the last financial year on account of the Reserve Bank of India's tight monetary policy, high costs of raw materials, commodity prices and interest rates.
Excerpts of the interview...
SME credit rating is a much needed concept for getting potential bank exposure. What is your take on this?
D.R Dogra: The purpose of credit rating is to balance the information asymmetry that exists in the market where the borrower knows about its own financial strength while the lender has limited recourse to such information in terms of statutory documents. A credit rating is based on intensive discussions with the borrower who is raising funds and uses all information and expertise to analyze the instrument to derive a rating symbol which tells the user the creditworthiness of the borrower. This said, when it comes to the SME segment, the level of information asymmetry is high since the access to information is limited. This is where a rating agency is able to add immense value by evaluating the credit worthiness of the unit. Today lending institutions could be wary of lending here because of the absence of credit information and the fact that there is a fear of NPAs resulting is inhibiting. These companies also have less access to the capital market. Hence, they have to borrow from the financial institutions which charge higher interest rates on account of the perceived risk. A credit rating bridges this information asymmetry and provides an additional tool to the lender to consider while making an evaluation. The government is aware of this shortcoming and has hence come up with schemes to encourage SMEs to get a credit rating.
How many SMEs have you rated in the last financial year?
D.R Dogra: SMEs formed a significant portion of the volume of ratings assigned by CARE during FY12 (refers to April 1, 2011 to March 31, 2012). CARE assigned various types of ratings to over 1,500 SMEs during FY12. While majority of the SMEs were assigned the Bank Loan Ratings (BLR) under the Basel-II framework, CARE also assigned the NSIC-CARE Performance & Credit Ratings to Micro & Small Enterprises (MSE) as well as CARE SME Ratings to many entities during the past financial year.
CARE assigned ratings to SMEs belonging to a wide spectrum of sectors with the major ones being textiles, metals, agro-commodities, food & food products, electrical & electronic components, paper products, rubber & plastic products, chemicals & pharmaceuticals, trading, construction,engineering, ceramic & sanitaryware, wood & wood products, logistics, warehousing and many more.
The wide spectrum of SMEs rated by CARE depicts the very diversity observed among the Indian SMEs which not only produce a wide array of products but also provide wide range of services.
How have been SMEs' performance?
D.R Dogra: The performance of the SMEs varied widely depending upon the sector-specific dynamics. During FY12, the ratings were assigned primarily considering the FY11 audited performance coupled with provisional quarterly/half-yearly/9-month figures for FY12 wherever available. Hence, the ratings largely reflect the financial performance of the sector achieved during FY11.
Broadly commodity prices and interest rates had an impact on the financials across the SME sector. While prices of many commodities continued to remain high during FY11 (in line with the inflationary scenario witnessed in the economy), the same affected the turnover as well as profitability of SMEs.
SMEs involved in the business of such commodities reported significant growth in their turnover on the back of rising prices. At the same time, profitability of many SMEs was negatively affected due to increase in raw material costs coupled with their limited ability to pass on the same to the customers. Increasing raw material costs also meant that the working capital requirements of SMEs went up due to need for purchase and storage of inventory at higher prices. This resulted in increase in the incremental working capital borrowings of many entities.
How do you observe the effects of RBI's monetary policy on performance of SMEs?
D.R Dogra: The Reserve Bank of India (RBI) has been pursuing a tight Monetary Policy for quite some time in order to contain the inflation situation. This has led to higher interest rates in the economy. Higher interest rates coupled with the need to fund incremental working capital requirements led to higher interest costs for SMEs and suppressed their net profit margins severely during FY11 and during FY12. Entities which supported their funding needs through own resources in the form of infusion of equity capital and/or unsecured loans from promoters managed to keep their bank borrowings at lower levels thereby incurring lower interest costs vis-à-vis others who resorted to bank borrowings. Such entities were viewed favourably from the ratings perspective.
Majority of the entities (over 70%) belonging to the SME space ended up getting a sub-investment grade rating on the Bank Loan Rating (BLR) scale. This primarily reflects the relatively weakened balance sheets of SMEs, their below average business risk profile and high degree of exposure to industry & macro-economic risks compared to the large corporates. However, deserving SMEs got better ratings on the BLR scale. Moreover, many SMEs managed to get an ‘average’ or ‘above-average’ rating on the NSIC-CARE MSE rating and CARE SME rating scales where the comparison was made within the SME universe.
Are SMEs' aware of the benefits of credit rating? How can we make this popular in India?
D.R Dogra: The SMEs are gradually moving towards this concept. As long as funding came from the entrepreneur or the other informal sources, they have not looked at the organized financial system. But, now with the scale of funding increasing, SMEs have to borrow funds from the banks, for which they do find a rating useful. Banks, who lend to SMEs as part of priority sector lending have also been encouraging them to get a rating while the government’s own schemes through the NSIC have provided another boost for getting such a rating. Therefore, we do see this concept becoming progressively popular as it is a win-win situation for both the borrower and lender.
To encourage the small and medium enterprises to obtain the ratings what kind of steps CARE is taking?
D.R Dogra: We at CARE are involved in conducting various awareness programmes and workshops either on our own or with banks and SME chambers of commerce. There is nothing better than having personal interaction with a group of SMEs in various parts of the country. These programmes are able to outline the fine prints of the use of a credit rating for SMEs and we have seen that the response has been encouraging. Therefore, the efforts taken by NSIC, banks and rating agencies like CARE have helped considerably to spread this concept across a wide spectrum of entrepreneurs.
Have you found any company involved in fraudulent activities?
D.R Dogra: These may have been some rare exceptions which happens in all segments and hence cannot be said to be specific to this segment .
Recently, the government has reduced the repo rate by 50 basis points. How do you project the growth that will take place in the economy?
D.R Dogra:The lowering of the repo rate is only one part of the story. Certainly if banks do lower their lending rates, it will be beneficial for the borrowers, especially SMEs. Today, SMEs borrow at a higher rates relative to the Large Medium Enterprises (LMEs) because of the perceived risk factor. Lower rates will benefit them the most as they also have less access to other avenues of finance such as capital markets or the ECB market. Growth however, will depend also on how demand pans out.
Consumption has to improve and government has to spend on infra projects. This is where the big impetus will come from. Also with our exports peaking last year, and the global economy in a state of flux, this component may not be an aggressive driver of the economy. Therefore, we need to monitor the progress in these areas.
Further, while the RBI has lowered rates, it has cautioned that we may not expect any more rate cuts, which means that it will be observing the movements in inflation before embarking on further cuts. Therefore, the final impact on growth will be gauged only after the inflation picture is clearer. I am looking at growth which is marginally higher than that in FY12, which is almost a status quo. We evidently need certain aggressive reforms in this context.
What is your message for the small and medium enterprises in India?
D.R Dogra: The first is that they need to look for optimal solutions for raising finance and should use all measures to lower cost of capital. Second, should invest in technology so that they overcome the challenge of use of low technology which is the case today. They need to combine this with the acquisition of skilled personnel for both finance and marketing. Third, they need to build scale to reap economies not just in terms of cost of operations but also finance. Fourth, they should concentrate on product improvisation because that it is the only way to compete domestically and at a later stage globally. Last, they also have to take some initiative in implementing sound business practices and continuously investing in good internal management systems: in accounting, planning, financial, operations and human resource management.
