Small and medium enterprises have been struggling to raise bank credit even as they have been powering India's manufacturing growth in recent years.
A rather peculiar aspect of India's growth structure under the new Gross Domestic Product series has been the stellar performance of the micro, small and medium enterprises (MSME) in the manufacturing segment.
With the bigger manufacturing companies struggling over the past few years, it was these smaller companies that provided the much needed fillip to manufacturing growth.
The Reserve Bank of India's analysis of the Ministry of Corporate Affairs database confirms this.
Gross value added (GVA) by these companies grew at a staggering 17.3 and 16.2 per cent in 2013-14 and 2014-15, respectively, dwarfing the value addition by their larger counterparts who grew at a modest 10.1 and 12 per cent over the same period.
But what is troubling is that bank credit to MSMEs has slowed quite sharply over these past few years.
After growing at a robust 15.5 per cent in 2013-14, gross bank credit to MSMEs slowed down to 6.8 per cent in 2014-15, thereafter contracting by 3.6 in 2015-16.
As bank credit is considered to be a leading indicator of growth, does this contraction signal a reversal in the fortunes of the MSME sector and, in turn, that of the manufacturing sector?
Or are these companies relying on other sources of funds to fuel their growth?
The contraction in bank credit can be attributed to the sluggish macro-economic environment and the sharp rise in the non-performing assets of banks.
This has led to banks becoming even more cautious, as a consequence of which lending to MSME's has been curbed.
"In such a scenario of mounting losses and sluggish economic growth, loans to the MSME sector have dried up as they are more vulnerable to become NPAs" says Madan Sabnavis, Chief Economist at CARE. Thus, for these smaller companies even obtaining working capital loans for carrying out daily operations would be difficult.
So how are these companies financing their operations?
One possible explanation could be that these smaller companies have been able to tap other sources of funding such as NBFC's, urban development banks and micro-finance companies.
But in the absence of reliable data on credit flows from these sources, it is difficult to know for sure.
Another explanation, perhaps a more likely one, is that these companies are increasingly retaining a larger portion of their profits to plough back into their business.
This trend is confirmed by RBI's analysis of the ministry of corporate affair's database which shows that retained profits of over 230,000 MSMEs grew at a staggering 14 per cent in 2014-15.
Analysts like Saikat Roy, at CARE, also believe that with bank credit to these companies slowing down, they are mostly relying on retained earnings to fuel their growth.
It is possible that this increase in retained earnings, which could have partly offset the decline in bank lending, helped finance their operations and drive growth in 2015-16.
While disaggregated data on GVA by the MSME sector and large companies is not available for 2015-16, it is likely that the MSME's continued their stellar performance aided by an increase in retained earnings.
This can be inferred from the fact that the Index of Industrial Production (IIP), which essentially tracks large companies, grew at a slower pace in 2015-16 as compared to 2014-15. IIP grew at 2.4 per cent in 2015-16 as compared to 2.8 per cent in 2014-15.
By comparison, GVA added by the entire manufacturing sector grew at 8.1 per cent at current prices in 2015-16.
Thus if the big companies were struggling then it is only logical that smaller companies would have pushed up growth.
But the question now is if bank credit continues to be sluggish then can these companies continue to rely on their own resources to fund their growth going forward?
As data on retained earnings for 2015-16 is not available, its difficult to know for sure.
But it is possible that as the price of raw materials fell sharply during 2015-16, profit growth would have edged further upwards.
This would have created space for these companies to retain an even larger share of profits to compensate for further declines in bank lending.
But with commodity prices firming up in 2016, earnings are likely take a hit in the absence of a significant boost to top line growth.
Thus it would be difficult for MSME's to rely on retained earnings going forward.