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What Needs to Be Done to Strengthen MSMEs, the Economy's 'Backbone'

What Needs to Be Done to Strengthen MSMEs, the Economy's 'Backbone'

MSMEs have been lionised as the ‘backbone’ of India’s economy. Yet they are always the hardest hit in a crisis. A series of concrete steps is needed to make the country’s spine much stronger than it is now.

Standing Tall Standing Tall

The micro, small and medium enterprises (MSMEs) in the country go by many sobriquets such as “engine of growth”, “powerhouse of the economy” and many more. That’s not surprising considering they have over 63 million units employing over 110 million people and are a significant contributor to India’s economic growth with over 30 per cent contribution to the GDP and over 48 per cent to exports. Around 95 per cent of all industrial units forming a part of this sector constitute a cornerstone for economic prosperity in our society.

However, MSME is the only sector that took back-to-back beatings in the last few years. “First, it was demonetisation, then implementation of GST and now the ongoing pandemic has broken the spine of the sector,” says S.N. Mishra, Founder and CEO of Microtech Industries, a small enterprise which is a pioneer in low-grade voltage equipment in Haryana.

According to Asian Development Bank Institute’s working paper, ‘MSMEs in Developing Asia’, the sector experienced considerably reduced employment and sales revenues in the first few months after the outbreak of the Covid-19 pandemic. “MSMEs were disproportionately affected by the pandemic. Raw material costs have shot up 30-50 per cent in a year while businesses are still trying to recover to pre-pandemic levels. Most businesses just don’t have the capital to bridge a 50 per cent increase in their input costs,” says Hardika Shah, Founder and CEO, Kinara Capital.

But still, the MSME sector will play an instrumental role in driving India’s growth. “MSMEs will lead the development and industrialisation of underdeveloped regions. [They] are poised to establish themselves in globally competitive markets through initiatives such as the Global Bharat programme which provides MSMEs with access to the global marketplace, digital skilling initiatives and affordable enterprise technologies,” says Arvind Sharma, Partner, Shardul Amarchand Mangaldas & Co.

However, the sector can get a boost only if perennial problems like difficulty in accessing capital, compliance burden, etc., are addressed and a concrete solution for all is provided, says Dev P. Goyal, Managing Director of Conquerent Control Systems and Co-chair of the MSME cell at the PHD Chamber of Commerce of India (PHDCCI). Echoing this view, Mishra says the potential in the sector is immense if tapped rightly. Mishra says boosting exports and modernising MSMEs would be key for the sector to contribute to India’s growth story.

Access to Capital

“The liquidity crunch has posed a question of survival for MSMEs,” says Ajay Sahai, Director and CEO of Federation of Indian Export Organisations (FIEO). Indian MSMEs rely on unsecured loans and take few long-term loans for capex. The National Institute of Rural Development and Panchayati Raj in a recent report mentions that nine out of 10 MSMEs depend on informal sources (mostly unsecured loans) for their working capital and term loans.

According to MicroSave Consulting, a global consulting firm, the overall demand for credit is estimated to be Rs 105.49 lakh crore. However, formal sources meet less than one-sixth of this demand at Rs 16.94 lakh crore, 27 per cent of which is directed to micro, 40 per cent to small, and 33 per cent to medium enterprises.

“The problem of access to capital can only be resolved at the cluster and firm level rather than coming out with attractive macro-level schemes,” says K. Rangarajan, Professor, Head-Centre for MSME Studies, Indian Institute of Foreign Trade. Concurs V. Padmanand, Partner, Grant Thornton Bharat LLP, “Encouraging financial institutions to evolve cluster-based financing instruments to make the financial sector more responsive to distinct needs of cluster MSMEs in terms of ballooning requirements would bear fruit for the sector.”

The cluster approach to support MSMEs envisages setting up a group of units manufacturing the same or similar products in a locality with adequate infrastructure in terms of roads, power, drainage, etc. Even, as per the Ganguly Committee recommendations of 2004, banks have been advised to extend banking services to recognised clusters and cater to the diverse needs of the MSME sector.

“One of the ways is to promote more consortium financing with a guarantee by the local industry associations where the finance-seeking MSME is a member. Italy, where more than 80 per cent of industrial units are from the SME sector, has successfully addressed the finance access of SME units through small equity funds and credit guarantee schemes. The NPA levels in the country were also low,” says Rangarajan.

One industry insider, on the condition of anonymity, says that the Reserve Bank of India (RBI) mandate that banks should not accept collateral security in the case of loans up to Rs 10 lakh that has been extended to units in the micro and small segments was reportedly not being adhered to in a few cases. He adds that banks are insisting on collateral security for loans as small as Rs 5 lakh. In the absence of collateral and other documents like three years’ audited balance sheets, income tax returns, etc., these entrepreneurs had to rely on moneylenders to meet their financial needs.

“Banks give loans based on the balance sheet of the industry. Micro and small industries in our country barely survive on a day-to-day basis. Banks normally discourage them as they are unable to provide the required information. For giving soft loans, a committee should be formed involving banks, industrial associations, an MSME ministry representative and two personal guarantors. The outer limit of loan could be fixed as per turnover,” says Goyal.

According to Shah of Kinara Capital, lengthy and complicated loan application processes, lack of information and service support in vernacular languages, and systemic biases based on gender or other such factors, contribute to severely disadvantaging the MSMEs, especially in Tier II and Tier III cities and rural areas. “Utilising data-driven decisions can reduce human bias and assess the MSME owner with a new lens not dependent on taking property collateral. Tech-based approaches can also speed up the loan process and offering information in the vernacular can support a wider range of business owners,” adds Shah.

Boosting Exports

“Without boosting exports especially from MSMEs, the idea of MSMEs powering India is half-hearted,” says Sahai of FIEO. The MSME sector contributes over 40 per cent to the total exports, and the target to raise it to 60 per cent has been set by the government. But the road to achieving this target is fraught with a volley of challenges.

“We are slowly losing ground to many competitors like Vietnam and Bangladesh in garments, Sri Lanka and Kenya in tea, leaving aside competition from China. Most Indian MSME exporters lack competencies to market specific products,” says Rangarajan of IIFT.

According to Sahai, the big problem plaguing the MSME sector is businesses’ inability to showcase their products in overseas markets. Thus, he believes tax deductions for the internationalisation of MSMEs should be provided. “Like Singapore where any MSME which spends $100 on overseas marketing is provided with a tax deduction of $200; so you are encouraging MSMEs to spend more on overseas marketing. Also, the government must incentivise the R&D to remain competitive,” adds Sahai.

“Most of the exportable products of MSMEs are suitable for e-commerce exports as well. The government should come out with an e-commerce export policy with accountability for its implementation,” says Rangarajan.

In addition, the importance of forging free trade agreements (FTAs) with different trading blocs in boosting exports from MSMEs can’t be negated. FTAs would facilitate competitive market entry into global markets. The export of 358 items reserved for exclusive procurement from MSMEs under the Public Procurement Policy has largely stagnated. In 2018-19, the exports stood at $27,163.75 million, in 2019-20 exports were at $27,931.41 million and in FY21, it came down to $27,601.78 million.

“I think the government is not giving adequate kind of commercial support in line with what other countries are doing. Active marketing on behalf of Indian companies is not there,” says Ashok Saigal, Co-chair, MSME Council, and Managing Director, Frontier Technologies.

Documentation, Compliance Burden

Mishra of Microtech Industries says that a lot of MSMEs prefer to remain small because of the compliance burden. “Many of the MSMEs don’t want to scale up because of the issues involved in scaling up operations such as increased compliance burden and documentation.” Also, in a special study, RBI found that complex documentation was reported as a major hurdle for entrepreneurs accessing the banking facilities.

“Making GST processes simpler to understand and follow would also help. The sheer number of HSN codes, different tax rates, and confusion prevailing among even experts in this matter slows things down. Paying GST in advance without getting setoffs locks up working capital and cash flow for small companies. Getting a GST refund remains a long-drawn process. Removing these hurdles will give small industries freedom to grow,” says Misha Gudibanda, Co-Founder of Sky Goodies.

Gudibanda says interlinkages of data and deployment of technology can make the way far easier. “If technology is employed to make the process of filing GST and taxes less complicated, then that would help a lot. The good thing is that most processes are online now, but they are still very complicated and need the help of professionals, and cannot easily be done without spending considerable funds on an accounting team and CA,” says Gudibanda.

Power Supply, Upgrading Tech

The MSME sector is also grappling with the lack of upgradation of technology and irregular and costly power supply. Rangarajan of IIFT says that power constitutes 16 per cent of the total cost of MSMEs.

“MSMEs need an uninterrupted supply of electricity. In any developed country, no industry suffers because of poor electric supply which is the prime responsibility of the state electricity board. If this is done, we save on capital costs, running costs, maintenance costs. There will be tremendous growth in output as no labour or machinery will be idle,” says Goyal of PHDCCI.

In 2021, a survey conducted by Tamil Nadu Small and Tiny Industries Association (TANSTIA) showed that the industrial production capacity of MSMEs in the state had declined by over 40 per cent in the past two years alone due to a power crisis. The survey said that if the trend continues, small industries will face a bleak future.

“The Maharashtra Chamber of Commerce in Pune and the Tirupur cluster includes all local manufacturers. The associations have come together and have installed a captive power plant which is meant only for the members. So, whether the government is giving you power or not they are not bothered. The cost has also come down substantially for them,” says Rangarajan.

Besides erratic power supply, the upgradation of technology is a big issue for the cash-strapped sector. “Technology upgradation is a no-brainer. The problem is funding. There are no good ways of funding technology purchase as of today,” says Saigal.

To bridge the gap between financing and upgradation of technology, there is a need for an MSME Technology Finance Corporation (MSME-TFC) with branches in all MSME clusters, followed by opening of branches in all district headquarters in the country. According to an industry insider who did not wish to be named, such an institution must exclusively focus on the development of new technology through R&D, commercialisation of new technologies, and upgrading of manufacturing processes of MSMEs. At least 10 per cent of their lending should be devoted to technological— product/process—innovations.

“But there is no need to have a specialised institution when the infrastructure to do that is already available in the form of Bureau of Indian Standards (BIS),” says Goyal. “Rather than opening another institution, we need to augment our existing infrastructure. BIS, which is meant to advise industries to produce high-quality products, is not doing its job properly. BIS should work closely with industries in suggesting the ways to improve and upgrade their production line and products,” he adds.

MSMEs are the backbone of the Indian economy but the government needs to remove the hurdles in their path to success.