The Indian government is in talks with foreign lenders to provide as much as $14.5 billion in credit to millions of its small firms, two officials said, in a sign the country's banking system may not be robust enough to do the job on its own.

The government is in discussions with multiple foreign lenders, including Germany's state-owned development bank KfW Group, the World Bank and some Canadian institutions to extend lines of credit to small enterprises, one of the officials, who did not want to be identified, told Reuters.

KfW's India office confirmed the discussions, though the main focus was on credit lines to support small businesses' solar power generation. “The talks were at an early stage,” KfW said.

The World Bank's India spokesperson did not reply to an email seeking comment.

State of Indian banks

The official said the government plans to source up to Rs 1 lakh crore of loans from foreign institutions because Indian banks were not in a position to provide enough capital for the small business sector, which is seen as critical to job creation.

“We are exploring, we are having discussions with various funding agencies if something can be done (for small and medium firms),” the second official said.

The officials did not provide full details of the discussions they are having with banks, or identify all those they are talking to, but said talks are at a very early stage.

“The Micro, Small and Medium enterprise (MSME) Ministry is discussing the proposal to pull in foreign banks with the Ministry of Finance, which will make a final call,” the second official said.

The push for foreign loans comes on the heels of the Indian government's announcement earlier this month that it plans to borrow about Rs 70,000 crore by issuing overseas sovereign bonds.

Kick-starting the economy

India's 63 million firms in the MSME sector are responsible for more than a quarter of the country's manufacturing and services output, and must be re-energised for Prime Minister Narendra Modi's government to kick-start the economy.

Gross domestic product growth fell to a five-year low of 5.8 per cent in the January-March quarter, well below the 8 per cent-plus rates that the government is targeting.

But credit availability for these firms, which also account for about 45 per cent of India's total exports, has worsened due to a liquidity crisis in the country's shadow banking industry that has seen big lenders struggling to remain solvent.

State-owned banks, which dominate the sector, have not been able to drive increased lending because they are burdened with more than $145 billion in bad loans. This has led to a severe credit squeeze for smaller firms. They pay up to 17 per cent annual interest on loans from banks, while the shadow banks, which are also known as non-banking financial companies (NBFCs) can charge as much as 20 per cent.

Last month, a study by a Reserve Bank of India panel said the overall deficit in credit for the MSME sector is estimated at about Rs 20 lakh crore to Rs 25 lakh crore.

Risky lending

But lending to such firms can be risky as some lack proper financial information, such as historical cash flow data, which makes challenging for banks to assess the credit risks.

“To mitigate such risks for foreign banks, the loans would be given sovereign guarantees and be routed through Indian government agencies such as the Small Industries Development Bank of India,” the first official said.