Tariff War Escalation Puts Billions in MSME, Mid-Corporate Loans at Risk, Warns India Ratings

Escalating global trade tensions and a worsening operating environment could jeopardise a significant volume of loans extended to vulnerable micro, small, and medium enterprises (MSMEs) and mid-sized corporations, according to a recent assessment by domestic rating agency India Ratings. The agency estimates that loans totalling approximately Rs 21,800 crore borrowed by entities deemed high-risk within these segments face potential distress as economic headwinds intensify. The analysis highlights the growing susceptibility of MSMEs, particularly those operating in sectors highly exposed to the effects of the tariff war, such as chemicals, textiles, steel, and industrial machinery. These industries are expected to bear the brunt of disrupted trade flows and altered global demand patterns. A comprehensive study conducted by India Ratings, encompassing nearly 1,900 listed and unlisted MSMEs and over 1,000 mid-sized corporations, reveals a notable disparity in financial resilience. Mid-corporates generally exhibit stronger financial health and thus possess a greater capacity to withstand unexpected economic shocks compared to their smaller counterparts. This is attributed to their more robust financial indicators. Delving into the risk profiles, the study found that 6% of the examined MSMEs fall into a high-risk category. These businesses are characterised by a low interest coverage ratio, signifying limited ability to meet debt obligations, and high leverage levels. Collectively, the outstanding debt for these high-risk MSMEs stands at approximately Rs 8,100 crore, representing a considerable 16% of the total debt held by the MSME cohort analysed by the agency. While mid-corporates appear more resilient, 5% of those surveyed are still classified as high-risk. As of the close of the financial year 2024, these vulnerable mid-sized companies held outstanding debt of around Rs 13,700 crore, accounting for 11% of the total debt within the studied mid-corporate segment. The rating agency's findings as of March 31, 2024, underscore the prevalent stress among MSMEs, with nearly a quarter of them (23%) demonstrating an interest coverage ratio below 1.1 times. This contrasts sharply with mid-corporates, where only 11% exhibited similar levels of stress. Experts note that MSMEs typically face more significant challenges related to managing day-to-day working capital needs rather than large-scale capital investments. Securing adequate and affordable financing for these operational requirements remains a key hurdle. While there has been a modest uptick in capital expenditure by MSMEs since the COVID-19 pandemic, it still trails historical levels. The persistent weakness in MSME debt servicing capacity and an increasing number of loss-making entities further highlight their vulnerability to external disruptions. India Ratings cautioned that external factors, including subdued consumer spending and a broader global economic slowdown, exacerbated by the intensified tariff conflict, are likely to worsen the operational and credit challenges confronting MSMEs. The study also indicated that around half of the examined MSMEs are operating with a low return on equity, reflecting a decade of limited capital expenditure. Despite government initiatives aimed at stimulating investment through interest subvention and credit-linked subsidy schemes, their impact on boosting MSME capital expenditure over the past three years has been only marginal. The rating agency concluded that the prospect of a slowdown in both international and domestic demand, fueled by the escalating trade tensions, remains a significant deterrent for MSMEs considering further capital investments.