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19 Jun 2019


Indian SMEs with credit exposures witnessed significant operational pressures in the financial years of FY17 and FY18. The twin events of demonetization and the introduction of GST that occurred between November 2016 and July 2017 had negative repercussions on the sector, which was caught off guard. The situation has led to severe liquidity pressure impacting working capital cycle of the SMEs wherein inventories piled up and debtor payments got delayed.

In order to understand the stresses involved, a sample of SMEs was studied; this sample included entities that are rated by SMERA (a division of Acuité Ratings and Research Limited). We assessed the transition between FY17 and FY18 of entities with revenue ranging between Rs. 20 crores and Rs. 80 crores.

We find that the average gross working capital (GWC) cycle for SMEs increased from levels of 200 days in FY17 to >300 days in FY18. The situation forced SMEs to hinge on higher credit exposure from banks which led to marginal spike in their debt to equity ratio (D/E), which went up from 1.5 times in FY17 to >2 times in FY18. It is worth noting that we have excluded companies under industries such as wholesale trading, financial services and construction related enterprises, which have elevated gross current asset (GCA) days and could possibly skew the results.

Also, even though the latest financial year’s audited data for the sector is not yet available - given a two to three quarter lag, it is worth considering that many public sector banks were classified under the Prompt Corrective Acton (PCA) framework. This resulted in higher borrowings from private banks as well as NBFCs, which lend at a higher rate. Moreover, as most of their assets were already charged to the existing bankers, SMEs had to resort to unsecured borrowings at a higher cost to meet their obligations. Consequently, SMEs’ profit after tax (PAT) margins as well as interest coverage ratio (ICR) could have been marginally hit as well.

On a positive note, we reckon that FY20 will bring some respite for SMEs by way of lower interest costs (after back to back Repo cuts) and policy stability. While the interest cost is a function of how much commercial banks ultimately pass though to the end consumer, the policy stability bit will come from the Government’s focus on the sector. Also, given the normalization seen in M3 and systemic liquidity, we expect a moderation in the sector’s working capital cycle that may not exceed the levels of 250-300 days in the current financial year.