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The Prime Minister’s dream of a $5-trillion Indian economy by 2025 along with effective financial inclusion and sustainable economic outcomes is premised on investment from both domestic and foreign investors. Government expenditure can only provide a stimulus, but cannot alone take India to PM’s goal.

For domestic private investments to happen, the role of timely, adequate, and quality (low cost) credit cannot be overstated, particularly during the current times when Covid induced stress is maximum on almost all industries.

With the recent change in the definition, more than 95 percent of Indian companies are bought under the definition of MSMEs. So what ails the MSME sector largely reflects the credit eco-system for more or less the entire industry in this country. So it is very important to identify the issues the MSME sector face today and how we can rectify them.

But before that, let us look at various aspects of the MSME sector.

India’s MSME Sector

The Indian MSME sector is the backbone of the national economic structure and has unremittingly acted as the bulwark for the Indian economy, providing it resilience to ward off global economic shocks and adversities.
With around 63.4 million units throughout the geographical expanse of the country, MSMEs contribute around 6.11% of the manufacturing GDP and 24.63% of the GDP from service activities as well as 33.4% of India’s manufacturing output.
They have been able to provide employment to around 120 million persons and contribute around 45% of the overall exports from India.

What are MSMEs? How are they defined?

Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 which was notified on October 2, 2006, deals with the definition of MSMEs. The MSMED Act, 2006 defines the Micro, Small and Medium Enterprises based on:

the investment in plant and machinery for those engaged in manufacturing or production, processing or preservation of and
the investment in equipment for enterprises engaged in providing or rendering of services.

The significance of MSMEs:

The significance of MSMEs is attributable to their caliber for employment generation, low capital, and technology requirement.

They are also important for the promotion of industrial development in rural areas, use of traditional or inherited skill, use of local resources, mobilization of resources and exportability of products.
According to the estimates of the Ministry of MSME, Government of India, the sector generates around 100 million jobs through over 46 million units situated throughout the geographical expanse of the country.
With 38% contribution to the nation’s GDP and 40% and 45% share of the overall exports and manufacturing output, respectively, it is easy to comprehend the salience of the role they play in social and economic restructuring of India.
Besides the wide range of services provided by the sector, the sector is engaged in the manufacturing of over 6,000 products ranging from traditional to hi-tech items.

Why the MSME sector is important especially for India?

Employment: The Indian MSME sector provides maximum opportunities for both self-employment and wage-employment outside the agricultural sector.
Help building inclusive and sustainable society: It contributes to building an inclusive and sustainable society in innumerable ways through the creation of non-farm livelihood at low cost, balanced regional development, gender and social balance, environmentally sustainable development, etc.
For example: Khadi and Village industries require low per capita investment and employs a large number of women in rural areas.
Contribution to GDP: With around 36.1 million units throughout the geographical expanse of the country, MSMEs contribute around 6.11% of the manufacturing GDP and 24.63% of the GDP from service activities.
MSME ministry has set a target to up its contribution to GDP to 50% by 2025 as India becomes a $5 trillion economy.
Exports: It contributes around 45% of the overall exports from India.

How many MSMEs does India have, who owns them?

According to the latest available (2018-19) Annual Report of Department of MSMEs, there are 6.34 crore MSMEs in the country.
Around 51 per cent of these are situated in rural India.
Together, they employ a little over 11 crore people but 55 per cent of the employment happens in the urban MSMEs.

The numbers suggest that, on average, less than two people are employed per MSME.
At one level that gives a picture of how small these really are. But a breakup of all MSMEs into micro, small and medium categories is even more revealing.

What are the issues MSMEs face?

(1) Access to Credit: Most of the MSMEs are in rural and semi-urban areas where access to credit is extremely limited.

They are vulnerable to predatory moneylenders and often fall into a cycle of debt.
Lack of access to finance and timely credit support in business has been a long-standing issue for these MSMEs.

(2) Under Severe Debt: Due to difficulties faced in seeking loans and working capital from banks and delays in receiving government payments and tax refunds, most of the MSMEs are under severe debt.

(3) Under financing by formal institutions: There is an overall debt demand of ₹69.3 trillion of which 84 percent is financed by informal sources such as moneylenders, family, friends, and chit funds (IFC study).

Formal sources such as commercial banks, NBFCs and government institutions cater to a mere 16 per cent.

The failure of traditional lending mechanisms to guide credit towards these MSMEs has led to a scenario where financing is often not reliable, and steady.
This has been particularly exacerbated by the pandemic, as well as the poor state of micro financing in the country, highlighted by India’s estimated credit gap of over $330 billion.

(4) Small size of the majority of firms: More these 80 percent of these MSMEs are in the micro and small category and are depending on informal sources of credit.

The usefulness of the government’s emergency line credit stressed asset relief, equity participation and fund of funds operation make very little meaning and contribution to the sector.

(5) Insufficient financing by banks due to fear of NPAs: Banks employ various methods to limit risk by better assessment of the creditworthiness of individuals or firms, MSMEs included. To keep NPAs down, many credit-worthy individuals are denied loans by banks.

While determining creditworthiness, there are two errors that are common — False Acceptance of a bad applicant and False Rejection of a good applicant.
The former error is detrimental for banks and increases risk while the latter impacts financial inclusion and economic growth itself.
While there are number of punitive actions prescribed against commissions of irregular loan financing, there is complete absence of punitive action against omissions of genuine credit financing of businesses, particularly the MSMEs.
Thus, there is no incentive for bank managers to take risks and finance genuine credit requirements.
This kind of approach to credit adversely impacts both growth and financial inclusion.

(6) Lack of paperwork or digital footprint for small MSMEs, a factor that holds them back from being integrated into the formal economy and deprives the MSMEs to take advantage of the formal credit system.

They continue to gain access to credit against assets such as land, etc. when much of the MSME development has started to follow a digital model.

(7) Technological Disruption: India‘s MSME sector is based on obsolete technology, which hampers its production efficiency.

The emergence of new technologies like Artificial Intelligence, Data Analytics, Robotics, and related technologies (collectively called as Industry Revolution 4.0) is a bigger challenge for MSMEs than for organized large-scale manufacturing.

Other problems

Long receivables cycles make a mess of working capital management.
Limited access to trained labour, technical progress and management support limit their growth.
Other common problems faced by small enterprises are related to the availability of technology, infrastructure and managerial competence, and limitations posed by labour laws, taxation policy, market uncertainty and imperfect competition.

Opportunity areas for MSMEs in India

Telecommunications

Domestic manufacturing of low-cost mobile phones, handsets, and devices;
Manufacturing of telecom networking equipment, including routers and switches;
Manufacture of base transceiver station equipment;
Mobile customer data analytics – services oriented toward analytical solutions; and
Development of value-added services

Healthcare

Manufacturing of personal protective equipment (PPE) and face masks, as the COVID-19 pandemic has fundamentally changed social behaviour, public health and hospital needs, and created new demand;
Manufacturing of low-cost medical devices, and medical accessories such as surgical gloves, scrubs, and syringes;
Low-cost surgical procedures to reduce the cost of healthcare;
Telemedicine; and
Diagnostic labs.

Electronics

Domestic manufacturing of low-cost consumer electronics, consumer durables;
Nano-electronics and microelectronics;
Electronic Systems Design and Manufacturing including semiconductor design, electronic components design and hi-tech manufacturing under India’s ‘National Electronics Mission; and
Strategic electronics, as the government is keen on encouraging the domestic manufacturing of products needed by the security forces.

Others

Other areas that offer opportunities for MSMEs include information technology, pharmaceutical, chemical, automotive, renewable, gems and jewellery, textile, and food and agriculture.

COVID-19 and MSMEs

The MSMEs were already struggling — in terms of declining revenues and capacity utilization — in the lead-up to the Covid-19 crisis.
The total lockdown has raised a question mark on workers payment primarily because these firms mostly transact on cash. That explains the job losses.
The problem with most small Indian businesses is that they operate on thin margins and don’t have the deep financial resources to survive a significant dip in cash flows.
So, when an unexpected event like a lockdown happens and MSMEs can’t sell/produce their goods or services, it also means for many they can’t meet their monthly expenses – this includes costs like paying salaries to their employees.

Fiscal stimulus package to MSMEs under Atmanirbhar Bharat Abhiyan

Finance Minister has announced the first tranche of the Atmanirbhar Bharat Abhiyan economic package. The main thrust of the announcements was a relief to Medium, Small, and Micro Enterprises (MSMEs) in the form of a massive increase in credit guarantees to them.

What is the package about?

Instead of directly infusing money into the economy or giving it directly to MSMEs in terms of a bailout package, the government has resorted to taking over the credit risk of MSMEs.

1) 100% credit guarantee

Firstly, it will give a 100% credit guarantee for Rs 3 lakh crore worth of collateral-free loans to MSMEs that were doing fine before the pandemic hit and are now in trouble.
This deal will only apply to small businesses that already had an outstanding loan of Rs 25 crore or those with a turnover of less than Rs 100 crore.
Thus, banks don’t have to worry about potential NPAs – that headache is transferred to the government.

2) Subordinate debt scheme

The second measure is a ‘subordinate debt scheme’ worth Rs 20,000 crore and is mainly for MSMEs who are already struggling with debt and are unlikely to get fresh funding by themselves.
This scheme will allow banks and NBCs to give loans to MSMEs which are already deemed as ‘stressed’ and are thus less credit-worthy.

3) Availability of Funds

The final step involves the government creating a Rs 50,000-crore fund which will infuse equity into “viable” MSMEs, thus helping them to expand and grow.
The basic idea behind this is that MSMEs will keep their businesses afloat until they are able to operate at pre-pandemic levels.
By doing this, the government also hopes to protect the employment that MSMEs create and thus save jobs.

Government schemes to promote MSMEs

Udyami Mitra Portal: launched by SIDBI to improve accessibility of credit and handholding services to MSMEs.
MSME Sambandh: To monitor the implementation of the public procurement from MSMEs by Central Public Sector Enterprises.
MSME Samadhaan: MSME Delayed Payment Portal –– will empower Micro and Small entrepreneurs across the country to directly register their cases relating to delayed payments by Central Ministries/Departments/CPSEs/State Governments.
Digital MSME Scheme: It involves usage of Cloud Computing where MSMEs use the internet to access common as well as tailor-made IT infrastructure
Revamped Scheme of Fund for Regeneration Of Traditional Industries (SFURTI): organizes traditional industries and artisans into clusters and make them competitive by enhancing their marketability & equipping them with improved skills.
A Scheme for Promoting Innovation, Rural Industry & Entrepreneurship (ASPIRE): creates new jobs & reduce unemployment, promotes entrepreneurship culture, facilitates innovative business solution etc.
Micro & Small Enterprises Cluster Development Programme (MSE-CDP) – adopts cluster development approach for enhancing the productivity and competitiveness as well as capacity building of MSEs.
Credit Linked Capital Subsidy Scheme (CLCSS) is operational for upgradation of technology for MSMEs.

Way Forward

Focused regulatory and structural changes which will improve access, ease the transition to the formal sector and increase consumer education and protection are necessary.
In the long term, once these regulatory issues are addressed, sanctioned loans will be disbursed more easily and private investment will be boosted, creating a virtuous cycle for MSMEs in the country.
To minimize the false rejections of good applicants, routine audits of all loan applications on random sampling basis must be undertaken by RBI and administrative action taken against malafide omissions resulting in unethical denial of loans to deserving MSMEs.
The problems faced by MSMEs need to be considered in a disaggregated manner for successful policy implementation as they produce very diverse products, use different inputs and operate in distinct environments.
In general, there is a need for tax provisions and laws that are not only labor-friendly but also entrepreneur-friendly.
More importantly, there is a need for skill formation and continuous upgrade both for labor and entrepreneurs.