In India, over 81 million economic entities, excluding those involved in crop production, public administration and defense, are estimated to be operational. But majority of them are survivalist entities: they do not employ any permanent labour and operate out of non-permanent structures.
Excluding such entities, there are over 27 million entities. We call them “commercially visible” entities as they employ at least one labor and operate out of a permanent structure. Of these commercially visible entities, over 99% are Micro, Small and Medium Enterprises (MSMEs) which contribute 35% to GDP and employ 25% of non-farm workforce. Large entities, which constitute around 1% all entities in the country, also contribute around 30% to GDP. This shows that the contribution of MSMEs to overall growth is low.
To realize their potential, MSMEs should be provided with an enabling eco-system to accelerate their growth. We have been engaged with MSMEs over the years, and our studies repeatedly indicate that MSMEs need three crucial growth enablers. Access to finance has emerged as the single largest enabler for growth followed by the cluster development and access to markets.
The core challenges that MSMEs requiring external finance face include high collateral requirements, high interest rates and complex application procedures. On the other hand, banks and other formal lending institutions operate within an ecosystem of credit guarantee, adherence to the various guidelines, regulatory compliance, monitoring end use of funds, financial information dissemination and reporting financial data and frauds. Various studies reveal that the banking sector faces several limitations in sanctioning loans to the MSMEs. Very often, banks have raised concerns over compliance towards documentation, regulatory adherence and financial discipline followed by MSMEs.
It is in this context, the proposals made in the Union Budget 2020-2021 to amend ‘Factor Regulation Act, 2011’ to extend invoice financing to MSMEs via NBFCs and recommendations for app-based invoice financing loan products assume significant importance.
These initiatives are well-intended and will boost ‘Supply Chain Finance’ penetration in India which stands at significantly less than 1% of GDP compared to around 12% of GDP in countries that are similar in size to our economy. Supply chain finance circumvents the problems faced in traditional lending by leveraging on the credit history of large firms.
Hence, even MSMEs which have thin credit history files can now have access to funds at competitive rates. Proposal to introduce a scheme to provide subordinate debt, which will be considered as quasi-equity, for entrepreneurs of MSMEs is also expected to fill up the white space in MSME lending.
The proposal to launch ‘Niryat Rin Vikas Yojana (NIRVIK)’ scheme to provide higher export credit disbursement, enhanced insurance cover and reduced premium for small exporters aims at activating an important lever of the MSME growth wheel i.e. participation in Global Value Chains (GVCs). Participation in GVCs offers MSMEs considerable opportunities for growth by knowledge spillovers and by enabling them to specialise in specific processes.
Along with the NIRVIK scheme, the proposed extension of handholding support to MSMEs for technology upgradation, R&D, business strategy, etc. will increase the likelihood of MSMEs exporting more, increase their competitiveness and improve their long-term financial prospects. Proposed measures such as setting up of an Investment Clearance Cell, Knowledge Translation Clusters, revising the turnover limit of startups for availing tax deduction, etc. is expected to fuel the dynamism in the sector by encouraging more entry of firms.
Apart from these benefits, the sector would further gain from the other measures which are targeted at improving the overall business environment and through increased allocation towards farm, infrastructure and social sector. While all these measures offer promising outlook for the sector, what needs to be ensured is that these schemes are followed through till successful execution and deliver the intended benefits.
(Author is Chief Economist, Dun & Bradstreet)
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