Think Micro

BY Dominick Rodrigues27 April 2016 3:00 PM GMT

India is the fourth largest economy in the world, after the United States of America, European Union and China and is estimated to register a growth rate of 7.4% in fiscal 2015, as compared to a growth of 5.1% and 6.9% respectively in fiscal 2013 and fiscal 2014. Fiscal 2015 has witnessed key policy reforms, aimed at aiding growth revival and surmounting the structural constraints in the economy. In the recent past, the economy faced testing times with issues like lower growth, high levels of inflation and widening current account deficit; escalated by an unsupportive external environment. Growth is back, with its desirable concomitants of mild inflation and manageable current account balance with stable rupee and rising foreign exchange reserves, signaling improvements in macro-economic stability, according to the Macro Economic Framework Statement, 2015-16.

India is home to 21% of the world’s unbanked adults and about two-thirds of South Asia’s. Between the year 2011 and 2014, India’s account penetration increased from 35% to 53%. However, India’s account penetration is still low at 53% when compared to other BRICS countries. According to Global Findex Database, a mere 15% of adults reported using an account to make or receive payments.

Non-Banking Financial Company – Factors (NBFC-Factors): NBFC-Factor is non-deposit taking NBFC engaged in the principal business of factoring. The financial assets in the factoring business should constitute at least 50% of its total assets and its income derived from factoring business should not be less than 50% of its gross income. Financing needs in India have risen with the notable growth recorded by the economy over the past decade. NBFCs have played a major role in meeting this need, complementing banks and other financial institutions. To their credit, NBFCs help fill the gaps in availability of financial services with respect to products as well as customer and geographical segments. A strong linkage at the grassroots level makes them a critical cog in catering to the unbanked masses in rural and semi-urban reaches, thereby enabling the government and regulators to achieve the mission of financial inclusion. NBFCs’ loans outstanding grew at approximately 21% in between fiscal 2010 and fiscal 2015, and as of March 2015, they accounted for almost 18% of the overall systemic credit.

NBFCs typically have several advantages over banks due to their focus on niche segment, expertise in the specific asset classes, and deeper penetration in the rural and unbanked markets. NBFC Sector – Trends, Regulatory Framework and way Forward, December 2014, CARE Ratings by virtue of access to low cost funds and extensive branch network, banks compete with NB FCs, especially on the cost front. However, with their strategic presence in lending segments as well as geographies, NBFCs have carved out a niche for themselves to effectively compete with banks. Currently NBFCs only dominate construction equipment finance, while they are slowly gaining market share in housing, and LAP. CRISIL Research expects the loan book of NBFCs to post 15-17% CAGR between fiscal 2015 and fiscal 2017. So far, NBFCs have gained market share at the expense of banks owing to focused lending, widening reach and resource raising ability. However, going forward, the growth is expected to moderate significantly given a slew of regulations in terms of convergence with banks. Further, with slowing corporate demand for loans, banks have shifted their focus to retail assets. As a result, the pace of growth in NBFCs’ market share in most of the segments will slow down compared with the past. While the traditional vehicle financing business is expected to achieve stable growth, NBFCs are also actively looking at relatively untapped segments such as structured finance, unsecured business loans for growth and diversification. As per CRISIL Research’s view, low penetration in Tier-II and Tier-III cities, product and process innovation, and continued focus on core businesses will be the key enablers for steady growth amidst regulatory overhaul, especially in the retail finance segments (gold, microfinance, housing finance, auto finance).

Microfinance is seen as an important tool for poverty alleviation and over the years, MFIs have placed themselves as fulfilling this developmental goal. The microfinance movement was initiated by NABARD in collaboration with Banks and Non-Government Organizations (“NGOs”) for unbanked population known as Self Help Group (“SHG”) – bank linkage program in 1992. The program was a government-initiated program with refinancing to banks from NABARD. SHG bank linkage program involved NGOs to form SHGs and train them. Each SHG typically consists of a group of women/men members interested in accessing financial services including savings, credit insurance etc. Post the training, NGOs provided SHGs access to funds by linking them to banks which provided financial services (including thrift, credit, etc.) to them directly. NGOs’ role was to ensure financial discipline of the SHGs. Besides this, there were state government-run SHG programmes. Thus, microfinance in this phase was government-driven.

The microfinance sector started evolving with private sector participation leading to formation of microfinance institutions (MFIs.). The MFIs accessed bulk funds from banks and did on-lending to the end borrowers (either SHG members or JLG members ). From thereon, the microfinance activities were being implemented by the two channels including MFI model and SHG bank linkage model.

The RBI granted priority sector status to bank loans advanced MFIs in 2000-01, following which, the microfinance sector witnessed rapid growth in the value of outstanding loans. The growth was mainly driven by the MFIs due to large scale availability of funding in terms of both debt and equity. The gross loan portfolio (“GLP”) grew at a CAGR of almost 50% from Rs. 71 billion in fiscal 2008 to around Rs. 235 billion in fiscal 2011. Andhra Pradesh (“AP”) was the largest state in terms of MFIs’ outstanding loans, accounting for around 30% of the overall market in fiscal 2011. The AP state Government ordinance in fiscal 2011 adversely impacted the business models of MFIs by impairing their growth, asset quality, profitability and solvency. The ordinance was an outcome of concerns regarding the usurious interest rates charged by MFIs and coercive collection mechanisms deployed by MFIs, in the event of default. This ordinance put in place extremely stringent operating guidelines, resulting in 34% shrinkage of AP portfolio and ultimately leading to a y-o-y decline of almost 14% in the industry in fiscal 2012.

Further, after the RBI released guidelines for MFIs in 2011, for–profit MFIs were to function as microfinance NBFCs, whereas non-for-profit institutions could operate through trusts or section 25 companies. NBFCs-MFI constitute a dominant share in the Indian microfinance industry of 88% .

Unorganised or informal sector constitutes a pivotal part of the Indian economy. More than 90% of the workforce and about 50% of the national product are accounted for by the informal economy. Before the first five-year-plan began in 1951, almost all financial needs of rural sector vis-à-vis agriculture were provided by moneylenders. At that time, the RBI was very active in pursuing cooperative movements through a variety of initiatives. Despite all those efforts, the provision of credit through cooperatives and commercial banks were to the extent of about 4% of the total outstanding debt as at the end of June 1951.

Those in the rural credit market prefer to use informal sources of credit, despite the fact that the interest rates are much higher. Informal sources do not insist on punctual repayments as banks or cooperative societies do. Usually, it is possible to obtain loans for such purposes as marriage and litigation only from informal sources. There are generally no intricate and complicated rules governing the granting of loans by the village moneylenders and informal sources are willing to lend money more freely without collateral and on the borrower’s mere promise to repay.

In recent years, the informal credit has certainly declined as a percentage of total debt, and both professional and agricultural moneylenders have reduced their share over time. The decline in the share of moneylenders reflects in part the Government’s efforts to register and regulate professional moneylenders.

The RBI guidelines have been instrumental in restoring confidence in lenders and investors, improving the inflow of both equity and debt to the sector. The Government, in Budget 2016, announced that it would set up the Micro Units Development and Refinance Agency (MUDRA), which will be a major driver for the MFI industry by serving as a regulator for MFIs and providing them refinancing services through a corpus of Rs 200 billion, while financing cooperative banks, MFIs, regional rural banks etc.

Banks have a strong presence in the microfinance industry directly and indirectly, and find it more comfortable to lend to marginal borrowers through MFIs -- which have thus increased their market share from 38% in fiscal 2013 to 49% in fiscal 2015.

MFIs are exposed to unique set of risks and challenges, owing to their business model and nature of customer base. They lend to typical low-income households, living in rural and semi-urban areas. Occurrence of natural calamities like droughts and floods – especially affecting agriculture which forms a source of livelihood for majority of the rural population -- pose a major threat to MFIs. Cash is the most widely-used channel for majority of transactions between MFIs and borrower, leading to risk of borrowers losing cash in transit during repayment (due to fraud or theft by third parties). Also, with MFIs requiring robust monitoring mechanisms, the emergence of credit bureaus has made it easier to keep track of borrowers and their credit histories.

The Indian automobile industry is one of the largest in the world and the share of roads in total freight movement stands at 63.2% in billion tonne/km through Commercial Vehicles. Large logistics providers redistribute freight from hubs using LCVs for last mile transportation within a smaller radius. Although penetration of the Indian CV industry remains low at five CVs per 1000 population – compared to 388 (USA), 121 (Japan) and 86 (Thailand) – long-term CV demand will be driven by industrial and agricultural production, freight movement, rising share of roadways in freight movement and changes in freight rates.

Equitas Holdings Limited, a diversified financial services provider focusing on micro and small enterprises (MSEs), came out on April 5, 2016 with a public issue of equity shares at Rs 109 to Rs 110 per share aggregating Rs 720 crores to service the used commercial vehicles market. P N Vasudevan, MD, said “In an industry witnessing frauds, our company is efficient and fraud-free. We were in microfinance and diversified into used commercial vehicles sector -- where 2/3^rd of this market is not serviced by anybody – besides housing and SME finances. We are into pavement-dwellers rehabilitation, besides 5% company profits going to Equitas Trust to benefit 500 hospitals and train 400,000 people.”

Financial penetration in CV sector is high with over 97% of new CVs and 90% of Used CVs purchased by transporters through financial institutions. Buyers of used CVs are usually SFOs and FTUs. The used CV finance market witnessed high growth from 2004 to 2014 due to financers keen in lending to this fragmented and highly-unorganised credit-starved segment in the wake of demand for used CVs rising with growing use of the hub and spoke model.

The industry is witnessing a period of sluggish growth due to cascading impact of a slowing economy on transporters and fleet operators. LFOs, who generally go for replacement of fleet after 4-5 years, are delaying purchases due to lack of visibility of contracts and existing unutilized capacity, while average age of CV fleet for LFOs is increasing to five years from normal four years. The impact of this trend is an expected slowdown in CV stock addition.

Small and Medium Enterprises (SMEs) are critical to the nation’s economy by contributing significantly to India’s domestic production. The NSSO Survey of 2013 estimated 57.70 million small business units running manufacturing, trading or services activities including shopkeepers, fruit/vegetable vendors, truck and taxi operators, foodservice units, repair shops, machine operators, small industries, artisans, food processors, street vendors and many others. However, a major obstacle in SME development is inability to access timely and adequate finance, and they largely depend on borrowed funds from banks and financial institutions. There is an urgent need to regenerate SME financing as SMEs have been the +Greenfield+ for nurturing entrepreneurial talent. Also, globally, 2 billion adults remain unbanked and South Asia is home to about 625 million adults without an account -- of which India is home to 21% globally and two-thirds in South Asia.

The India logistics industry was valued at US$ 130 million in 2013 and comprises: freight and passenger transportation (road, rail and water); and warehousing and cold storage. Domestic freight transportation services involve movement of goods within India and modes of surface transport include: railways, roads, coastal and pipelines. Over the years, roadways have captured a significant share of freight due to faster service and point-to-point connectivity.

During fiscal 2015 to 2020, road freight traffic is expected to post a CAGR of 8-9% and will be driven by increased non-bulk traffic and development of road infrastructure. In this period, bulk traffic is expected to lead rail freight traffic, but growth is expected to be relatively lower at 5-7% owing to non-availability of wagons and railway infrastructure over the medium term. Commissioning of Eastern (Delhi-Kolkata) and Western (Delhi-Mumbai) dedicated freight corridors, which will account for around 20% of total freight carried in India, is expected to stabilize the rail share in total freight traffic from fiscal 2020. Since fiscal 2000, road freight has increased from 467 BTKM to 1,250 BTKM in fiscal 2012, at a CAGR of 8.6% and is estimated to have grown to 1,315 BTKM in 2012-13. According to Ministry of Road Transport and Highways, road freight is expected to reach 1.835 BTKMs by fiscal 2017.

Rapid growth in industries like automobiles, pharmaceuticals, fast-moving consumer goods and retail ha significantly increased demand for movement of consumer and capital goods across the country, from entry ports to manufacturing or distribution locations or from manufacturers and distributors to consumers and exit ports. Volume of freight traffic is positively related to a country’s GDP whose increase witness volume goods movement growth through all modes. During 2007-2012, agriculture and manufacturing GDP increased from US$ 263.6 billion to US$ 290.7 billion at constant prices. The corresponding increase in freight traffic was from 1.3 trillion tone kilometers (TTH) to 2.1 TTK. With growing integration of India’s economy with the world, its trade has grown at CAGR 20% from US$ 57 billion in 1998 to US$ 862 billion in 2013. The initiative to construct a trilateral highway connecting India, Myanmar and Thailand represents an important step in establishment of connectivity between India and Southeast Asian countries.

Think Micro

Dominick Rodrigues

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