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Growth Imperative for the MSME Sector

MSME

Micro, Small and Medium Enterprises (MSMEs) play a major role in the Indian economy. MSMEs contribute significantly to the Indian economy in terms of Gross Domestic Product (GDP), exports, and employment generation.

Their contribution to the Indian economy is as follows:

  • MSMEs contribute 30% of India’s GDP.
  • The share of MSME-related products in total exports from India during 2018-19 is 48%
  • The estimated number of workers in unincorporated non-agriculture MSMEs in the country is 11 crore

First, let us get into numbers.

The classification of MSMEs as per Ministry of Micro, Small and Medium Enterprises, India (2020):

Classification

Micro

Small

Medium

Manufacturing Enterprises and Enterprises rendering Services

Investment in Plant and Machinery or Equipment:

Not more than INR 1 crore and Annual Turnover; not more than INR 5 crores

Investment in Plant and Machinery or Equipment:

Not more than INR 10 crore and Annual Turnover; not more than INR 50 crores

Investment in Plant and Machinery or Equipment: 

Not more than INR 50 crore and Annual Turnover; not more than INR 250 crores

MSME
Distribution of Enterprises in MSME Sector
MSME
Distribution of employment by type of Enterprises in Rural and Urban Areas

The MSME sector accounts for 95% of the industrial units and approximately 50% of exports. Besides, the sector provides employment to almost 100 million people, making it the largest source of employment after the agriculture sector. The development of this sector, thus, holds key to inclusive growth and plays a critical role in India’s future. 

Most of the Micro and Small enterprises operate in the food and agriculture sector. Medium-size firms mostly cater to the automobile, pharma, textiles, and chemicals sectors. We will focus on the 5000 medium-scale companies employing about 2 lakh persons and how these mid-size firms can grow into large-scale companies in the future. There is no clear guidance on what constitutes a large firm. But for our understanding let us assume that large-scale companies are defined as ones that have annual revenue exceeding $500 mn and provide employment to more than 1000 people. As per Capital IQ data, India has about 800 such firms which include both public and private companies. Not only are these firms more productive (about 11 times than a usual firm) but they also are the bulwark of our economy as they generate almost 40 percent of all exports and contribute revenues equivalent to 48% of nominal GDP.

The transition!

MSMEs are the backbone of India’s economy. However, for India to grow exponentially we need these MSMEs to mature into large firms in the decade to come. Advanced economies tend to have a larger share of employment in large firms than other countries. Such firms are usually more productive and have better market linkages. They can lower production costs while making high-quality investments and reaching the markets they need to succeed. They are more likely to innovate, more likely to export, and more likely to adopt international standards of quality. They typically pay higher wages and provide more secure employment than small firms.

The upward movement of mid-size firms will not be easy, but this transition is necessary for the overall growth of the economy. As production is reorganized from medium-scale firms to larger firms, resources are better used, firms take advantage of economies of scale and scope, and they invest in innovation, standards, and human capital. Scale is ultimately associated with productivity, which is a driving force of growth.

The following steps are needed to unlock the MSME sector in India and help the mid-size firms take the leap to large scale firms:

Support of MSME firms through Industrial policies (Ease of Doing Business)

Ease of doing business is predominantly crucial for the MSME sector that can lead India’s economic growth, and this can be done by state and central level policies in the form of incentives, regulatory clearances, and labor laws. The government could continue to work toward the ease of doing business in India by streamlining regulations and processes and by issuing clear directives on future regulatory requirements. MSME firms often benefit heavily from industrial policies aimed at supporting scale per se or supporting the buildup of specific sectors and activities. These policies rebalance economic growth toward manufacturing with the aim of reaping productivity improvements and entry into global value chains. A central feature of large firms—economies of scale and scope—are particularly important in manufacturing.

Promotion of Foreign direct investment (FDI)

India has one of the most liberalized FDI policy worldwide, wherein 100% FDI under automatic route is permitted in many sectors. The FDI policy equally applies to the MSME sector. Liberalized FDI Policy should be pursued to ensure that along with attracting investment, modern and cutting-edge technology is brought in the country to improve overall productivity and competitiveness of the MSME sector. 

FDI can attract multinational enterprises which help in accelerating job creation, increase in tax revenue, and aggregate productivity. Almost all economies have policies and investment strategies aimed in part at recruiting large multinational enterprises to operate in their country. These strategies can result in significant increases in the share of large firms in a short period of time.

Development of MSME clusters

A cluster is a group of enterprises located within an identifiable and as far as practicable, contiguous area and producing same/similar products/services. We should have policies to promote MSME clusters in sectors such as automobiles, food processing, textiles, and pharma. Keeping this in mind, the Government has adopted the Cluster Development approach as a key strategy for enhancing the productivity and competitiveness as well as capacity building of MSMEs and their collectives in the country. Collectively these clusters can act as a large firm and utilize the advantage of scale and scope to increase productivity and employment in their clusters.

Use of Technology

Technology is increasingly seen as a business enabler and a vital tool for bringing in process efficiencies and a higher degree of standardization. In order for MSMEs to develop a competitive advantage to operate in the global market, a strong focus on implementing new-age technology, developing indigenous technology as well as technology collaboration with global partners is likely to play a crucial role. Technology plays a pivotal role for MSME to scale up their operations and become part of global value chains.

Access to Capital 

The ability of MSMEs to spur growth and foster job creation is limited by their ability to find adequate finance. A 2018 study on the MSME finance gap in India by the International Finance Corporation (IFC) estimates the overall demand for both debt and equity finance by MSMEs at $1.4 tn, which comprises $1.1 tn of debt demand and $283 bn of equity demand.

With appropriate policy interventions and support to the MSME sector, Government can provide the required support to the mid-size firms to compete on a global scale and grow in the process. Access to institutional capital should not be a hurdle for a mid-size firm to grow in a large-scale firm.

Schemes such as Credit Guarantee Trust Fund for Micro & Small Enterprises (CGTMSE), Credit Linked Capital Subsidy for Technology Upgradation (CLCSS), Micro & Small Enterprises Cluster Development (MSE-CDP), Scheme of Fund for Regeneration of Traditional Industries (SFURTI), and Scheme for Promotion of Innovation, Rural Industries and Entrepreneurship (ASPIRE) provide institutional finance and have been specifically targeted towards MSME sector.

Growth Imperative

To capture frontier manufacturing opportunities in the coming decade, India needs to triple its number of large-scale firms, with more than 1,000 midsize companies scaling up from the current state. Addressing a 'missing middle' of midsize firms can enable the emergence of 1,000 more large firms by 2030. Improving access to capital and easing other barriers to business would help the best-performing firms of all sizes climb the ladder of scale and global competitiveness. 

Government has also put its focus on ensuring the growth of domestic firms in India. The government launched the 'AatmaNirbhar Bharat' scheme which has witnessed a significant push towards enhancing domestic industries through a slew of measures like incentives, subsidies, and funding support. The underlying goal is to strengthen the manufacturing and export capacities of domestic firms and industries so as to put them at the heart of global supply chains. If India has to become a $5 tn economy, then it has to ensure that the MSME sector gets the maximum attention in the growth story of India. The recently launched Production Linked Incentive (PLI) scheme is meant to ensure that India has global champions in each sector. The scheme will also support the mid-size firms to grow and compete with global firms. This not only helps the MSMEs to grow but also helps the nation to become a manufacturing hub of the world. The PLI scheme will also lead to investments in innovation, research and development, and upgradation of technologies developed and deployed by the MSME sector.

India is at an inflection point and has an opportunity to raise its manufacturing prowess to cater to its domestic demand and also to global markets. Both central and state governments along with businesses have the power and the tools to catapult India into a high-growth manufacturing-based economy. An ambitious vision backed by a concrete action plan is needed to fulfill the demand for sustainable economic growth, gainful employment opportunities, and higher productivity.