Why MSMEs don’t grow in size? – UPSC GS3

What is issue with MSMEs

• Despite MSME contributing 20% of the GDP and employing about 110 million workers,  we have failed to make bold policy-moves to make it more productive and competitive.
•  MSMEs are not becoming ‘larger’ and more dynamic, with 99% of the estimated 60 million being micro-enterprises with limited aspirations.
• At the core of this lack of competitiveness is a structural issue.

Addressing the structural challenges

Size

• Consider  India’s largest textile cluster vs Bangladesh’s largest.
• More than 70% of the units in Tirupur are micro-enterprises with less than 10 employees while only 20% of the units in Narayanganj in Bangladesh have less than 10 employees.
• This factor makes the cluster in Bangladesh more competitive and helping Bangladesh’s exports grow faster than India’s.
• Though  Bangladesh has other advantages also, but this structural difference is critical.

Relation between size and productivity

• Productivity data from manufacturing MSMEs in OECD show that the productivity of medium firms (50-250 people) could be as much as 80-100% higher than that of micro firms (<9 employees).
• Growth in scale allows them to invest in people to improve skills, in better technology & processes, and in innovation.
• The most-competitive of them grow from their small beginnings to become world-beaters.
• This push to grow and improve capabilities and productivity is central to dynamism of any country’s industrial structure.
• This dynamism of micro-enterprises has been one of the less-reported policy levers behind China’s rise as an industrial powerhouse.

What stops MSMEs in India from growing?

• Our policy-legacy of highly restrictive asset-based definition which has only recently been relaxed, coupled with a mindset, and, policies, to support the ‘small is beautiful’ narrative.
• Overly complex regulatory regime doesn’t differentiate enterprises on their scale, other than the really tiny ones, in terms of compliance needs.
• For example, if a unit has more than six employees, the trade union law becomes applicable, If a unit has more than 10 employees, the Factories Act is applicable.
• Small enterprises thus face the same multitude of regulatory requirements as larger ones, and end up having compliance costs account for a higher percentage of revenue.
• For the tiny/micro units, there is simply no incentive to grow and enter the formal economy.

Policy intervention needed

1) Getting MSMEs into formal credit system

• To do this, we need to adopt an approaches that can help banks and NBFCs move away from asset-backed lending, towards some form of cash-flow-based lending.
• Small retailers are outside the formal credit system, unable to invest, modernise and grow, given they lack fixed ‘assets’.
• But, all of them are linked to, and sell, brands of well-known, large companies.
• If banks and NBFCs work with these companies and use anonymised data on sales and credit-performance to develop credit-scores for lending to them?
• Similar innovative ways could help cover other micro-unit segments.

2) Simplified tax and regulatory regime

• The second policy intervention needed is to de-average and implement a simplified tax and regulatory regime for MSMEs.
• This would also reduce the cost of compliance.

3) Development of digital platform

• The third intervention, appropriate for digital era, is to develop a comprehensive ‘digital platform’ for the sector.
• This will call for a mandatory, unique identifier for all.
• The platform will have to be linked to different relevant databases.

Conclusion