Credit guarantee: Examining the effectiveness

Libertarian economists have questioned and opposed the need for Government interventions in stimulating entrepreneurship. Whatever intellectual argument could be made on either side of economic philosophy, historical records show that quite a few public interventions, sometimes accidentally, have played a catalytic role in promoting enterprise creation and enterprise growth.

Recent research, including Harvard professor John Lerner's book Boulevard of Broken Dreams, provides interesting insights into critical role played by public subsidies and Government interventions even in the celebrated capitalistic story of Silicon Valley. But this does not take away the argument that for every successful Government intervention there have been many others that have terribly fallen short.

Some policy interventions, however, well intentioned they might be, if inadequately conceived, could even run the risk of irreversible distortions, causing more harm than good. A timely evaluation and refinement of policies and institutional support against their intended objectives are essential to avoid such pitfalls and take mid-course corrections. One such promising public intervention that needs a careful evaluation is the Credit Guarantee Scheme in the Indian context.

The backdrop

That markets supplying finance, unlike conventional markets, allocate funds through credit rationing, instead through a price mechanism due to information asymmetry was established way back in 1981 through a seminal research by Stiglitz and Weiss. It is this rationing phenomenon that has led to the unfortunate situation where banks are more inclined to fund entrepreneurs who have access to collateral.

The consequent “funding gap” not only hurts small entrepreneurs who have no access to collateral, but also the economy at large by weeding out many innovative ventures that otherwise hold promising high potential. Such a funding gap is far more consequential in the context of India's knowledge economy that is being built by first generation entrepreneurs.

It is this market failure that public credit guarantee schemes attempts to overcome, where essentially substantial risk of financing the venture is transferred to the Government. It is with this objective of making available collateral-free loans to more than 26 million micro and small enterprises that the CGMSE (Credit Guarantee Fund Scheme for Micro and Small Enterprises) fund was launched in 2000.

According to the Development Commissioner, MSME, the scheme, which began with a modest 951 approved proposals, crossed three lakh cumulative proposals aggregating to guarantee cover of over Rs 11,550 crore as of March 2010. Further, in the 24th ACSIC conference, it was highlighted that the scheme's cumulative approvals have crossed over 6.5 lakh, and the units covered under this scheme have claimed to have generated employment for more than 30 lakh persons, turnover of more than Rs 1.7 lakh crore and exports of over Rs 3,000 crore.

While these numbers seem impressive at the outset, the difficulty is in attributing the degree of financial additionality and economic impact solely to this intervention.

A case for re-examining

The question of how effective the credit guarantee intervention has been requires considering a broader context and more comprehensive set of evaluation parameters. To arrive at such an evaluation framework requires that the underlying policy objectives be clearly understood. It is only based on the objectives of the scheme – whether it intends to support first generation entrepreneurs in starting MSEs (Micro and Small Enterprises), strengthen the credit delivery system, enhance enterprise growth, increase employment, or any combination of above additionalities - that what can reasonably be expected becomes evident.

This process of systematic and timely evaluation and re-formulating the intervention to reflect the decade long experience, and changes in the entrepreneurial dynamics, opportunities and needs is far too neglected.

Also critical are tangible measures that underpin these objectives. Unfortunately, criteria for success are rarely straightforward and agreed upon. As a case in point, if the motivation of the CGMSE is to enhance access to finance to first generation entrepreneurs, then how does one measure financial additionality – enhanced access to loans to those who have no access to traditional sources of debt?

On the other hand, if the underlying objective is economic additionality, then how does one practically account for the complex link between job creation and unemployment, and how does one measure spillover effects? It is imperative for policy evaluators to be clear of not just the short-term objectives of the intervention, but also its ultimate aim.

In the case of CGMSE, though there have been some evaluations, there still remains some vital and hard questions that need serious consideration to make the scheme far more effective. When one looks at the impact of CGMSE on job creation the question to deliberate on is whether this quantum of outcome (an average of 5 new jobs created per MSE benefitted under the scheme) is substantial and justified in comparison to other interventions that could possibly result in larger job creation or reduction in unemployment for a similar outlay.

Is the effort intended to support subsistence enterprises, opportunity-based entrepreneurs or high-risk innovative enterprises? Is the fact that more than 80 per cent of approvals were for loan-size less than Rs 5 lakh disconcerting or rather encouraging from an intended policy objective stand?

From a design point of view, can the scheme self-sustain financially while scaling to meet the large potential need in the India's growth story? Similarly on the implementation front, various questions arise – outreach of the scheme, awareness quotient among aspiring and existing entrepreneurs, perception of member lending institutions, and ease of availing the scheme and settlement of claims in case of defaults.

Final comments

It must be emphasised that the attempt here is not to underplay the role the credit guarantee fund has played in the Indian context, but to highlight the critical need for comprehensive evaluation framework, timely assessment and refinements of any public intervention, however well intentioned they may be in promoting an entrepreneurial economy.

Such an assessment also enables an international benchmarking of design, implementation and impact. As OECD reports though many self-sustainable funds exist in many different countries, only a few have demonstrated sustainability, and financial and economic additionality through innovative approaches. Insights and best practices from international schemes, such as Korea's unique technology appraisal wing, Japan's two-tiered credit guarantee system and Malaysia's one-stop platform for SMEs to avail themselves of credit at competitive rates, needs to be distilled.

Lastly, designing an evaluation, one that not just assesses the design and implementation effectiveness of a policy intervention, but also questions the cardinal objective of the intervention, is a challenge. But a careful scrutiny and incorporating key lessons are imperative to avoid the typical pitfalls and ensure effectiveness. CGMSE, having been in existence for more than a decade now, has undoubtedly demonstrated the need for a public intervention to address market failures in enterprise financing.

But in the changing context of India's knowledge-based economy that is to be shaped by high-potential innovative enterprises, the time is now to re-assess the objectives of the credit guarantee scheme and to re-design an intervention that promotes such pervasive entrepreneurship.

(The author is Executive Director, Wadhwani Centre for Entrepreneurship Development, Indian School of Business, Hyderabad)