Surviving the pandemic: Time to boost MSME sector for the sake of inclusive growth

Operations At A Suhana Spice Factory Ahead of GDP Figures

By Prof Balwant Singh Mehta, Prof IC Awasthi, Dr Simi Mehta, Prof Bharat Singh, Prof Soumyadip Chattopadhyay, Prof Nitin Tagade, Rahul Ranjan, Dr Arjun Kumar*

MSME sector is the second largest employment creator after agriculture in the country, and provides employment to 120 million people through 36 million enterprises. It contributes around 31% to the GDP and 45% of the overall export. MSMEs promote inclusive growth by providing employment opportunities in rural areas especially to people belonging to weaker sections of the society. In the pandemic situation, the need for boosting this sector is critical. Government has supported this sector through relief packages and redefining this sector. In spite of potentials, this sector has challenges and concerns that needs to be addressed from the long terms perspective.

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The unprecedented pandemic brought about by Covid-19 has entailed an enormous loss of human lives and virtually crippled economies worldwide. Economic activities have been virtually halted for over two months and the disastrous pandemic has resulted in a massive erosion of jobs and livelihoods. Economies worldwide are facing a serious crisis of recession, probably of the worst kind, after the great depression of the 1930s. Growth rates are likely to tumble down and post very low growth rates or even likely to turn into negative territory. The growth rate is likely to register less than 1% in 2020 and turn into negative growth in the first few quarters. This pandemic has adversely impacted enterprises and workers both in the organized and unorganized sectors of the economy. In particular, the Covid-19 lockdown has enormous adverse impact on Micro, Small & Medium Enterprises (MSMEs) sector in terms of closure, job losses, revenue losses and many units have reached in the brink of extinction. International Trade Centre (2020) report shows that nearly two-thirds of micro and small firms have reported that the crisis adversely affected their business operations, compared with about 40% of large companies. One-fifth of MSMEs stated that they risked shutting down permanently within three months1. The situation is more serious in the case of emerging countries like India with a poor resource base, which is battling the serious economic crisis due to pandemic.

Importance of MSMEs

The MSMEs have been recognized as the growth engine for most of the economies across the world. This sector has the capacity to develop indigenous technologies and employment generation at comparatively lower investment and capital cost, next only to agriculture in emerging market. It is estimated that around 600 million additional jobs would be required in the next 15 years to absorb the growing labour-force, particularly in Asia and Sub-Saharan Africa. This sector has the potential to create 4 out of 5 new positions in emerging economies. Every year, on June 27th, is observed as MSMEs days, which are the backbone of most of the emerging economies. According to the International Council for Small Business (ICSB), formal and informal MSMEs make up over 90% of all enterprises and account on an average 60-70% of the total employment and 50% of GDP. As per the World Bank, MSMEs contribute up to 90% of total enterprises, 60% of total employment and up to 40% of national income (GDP) in emerging economies. The labor-intensive and inherent nature of large-scale employment creation in the shortest possible time, makes MSMEs, the most important sector of the economy for these countries.

This sector is the second largest employment creator after agriculture in the country, and provides employment to 120 million2 people through 36 million enterprises, contributes around 31% to the GDP and 45% of the overall export. MSMEs promote inclusive growth by providing employment opportunities in rural areas especially to people belonging to weaker sections of the society. It provides opportunity for budding entrepreneurs to build creative products boosting business competition and fuels growth. It acts as a bulwark for Indian economy, providing resilience to ward off global economic shocks and adversities. The MSME ministry has set a target to up its contribution to GDP to 50% by 2025 as India becomes a $5 trillion economy.

In this context, we have explored four key issues to understand the MSMEs sector of India in the present crisis: (i) what is the impact of covid-19 lockdown on MSMEs, (ii) what are the relief measures taken by the government for the survival of on-going crisis for the sector, (iii) what are the challenges the sector is facing, and (iv) what measures needs to be taken by the government and other stakeholder to boost the MSME sector post-covid-19 in the country.

Covid-19 and MSMEs

The MSMEs is one sector, which has been hardest hit by covid-19 lockdown in the country. Most of the business and economic activities have almost come at halt or disrupted across the country. As close to half of the India’s export comes from products and services within this sector. Severe disruptions of supply-chain especially for those businesses that do not manufacture or provide essential services have badly affected during the lockdown. This sector was already reeling under huge distress firstly because of ripple effect of demonetization, and poorly implemented GST followed by the prolonged economic slowdown and finally, the biggest of all — the COVID-19 which is going to aggravate the crisis in this specific sector further. The shortage of workers, lack of capital and maintaining physical distance norms would delay the business to operate at its full capacity and may also reduce their returns significantly.

The study conducted by the All India Manufacturers’ Organization (AIMO), with large membership of 46,525 MSMEs, self-employed and corporate CEOs, raised concerns on how more than one-third of the (35%) of the respondents revealed that their enterprises were beyond recovery. Another study conducted by Magma Fincorp, and business school Bhavan’s SPJIMR showed that most of the 14,444 MSMEs surveyed unable to meet immediate capital requirements. Nearly half of the respondents revealed adverse impact in the range of 20-50% on their earnings due to the disruptions caused by the COVID-19 pandemic. The survey indicated that the smaller size firms–micro and small were more affected by the pandemic.

Government Efforts

Government has taken many measures for the survival of on-going crisis for the sector. The measures are following:

(a)New Classification

MSME Act, 2006 was first introduced in 2006, which classified MSMEs separately for manufacturing and service sector in terms of investment in plant & machinery. However, this classification mainly benefited to manufacturing enterprises only. To allay these concerns, on 13th May 2020, government of India introduced a composite criterion in terms of investment and annual turnover to classify enterprises in the manufacturing and services in a single definition. The government has retained both investment in plant, machinery and equipment as a criterion on one hand. On the other hand, it has sought to plug the bill-envisaged turnover criterion. Thus, a composite criterion has emerged in determining whether an entity is classifiable as a micro, small or medium enterprise (Table-1).

msme1

It is envisaged that this arrangement would incentivize enterprises to modernize without worrying about losing their MSMEs status, while also easing the process of verification. The new classification would eliminate the need for frequent inspections which was earlier required to check the investment in plant and machinery. This definitional also eliminated the distinction between manufacturing and service sectors. Some other benefits of reclassification of MSMEs are; (a) it helps to get government tenders, (b) MSMEs get 15% import subsidy from the government on fully automatic machinery, (c) easy to avail loan at low rate of interest and in some cases government wave off their loans partially/fully, (d) becomes easy to get International Organization for Standardization (ISO) certificate with low expenditure and easy to take license from different government departments. The intention behind the definitional changes of MSMEs is inclusion of maximum enterprises in MSMEs. However, a key concern in estimating the turnover of entities remains as the Goods and Services Tax Network (GSTN) captures turnover data of enterprises but does not capture data pertaining to investment in plant and machinery without which it is difficult to identify MSMEs entities registered on the GSTN. This issue remains unresolved since the revision now is based on composite criteria of both investment and turnover. Other concern is the value addition of trader, which is not only lesser than that the manufacturer, but also the margins enjoyed by the former is greater since manufacturers would typically have costs such as loans incurred in setting up equipment and machinery.

According to the MSMEs new classification, almost 88% of the MSMEs in the country are micro, around 12% are small and only 1% are medium enterprises. In particular, the micro-enterprises are mostly informal/unorganized while only few small and most of the medium enterprises are registered or organized. The available estimate shows that approximately 90 % (Malhotra et al, 2019) of the MSMEs are unorganized enterprises and with around 95% of the workers are informal. The fourth census of MSMEs, though dated, could provide a sense of proportion of the MSMEs in the organized (or registered) and the unorganized (or un-registered) sectors, showing that the bulk of the MSMEs (over 94 percent) would be in the unorganized sector providing informal employment. This indicates that predominance of informality in the MSMEs sector needs inclusion in the formal system. Hence, the aim of new classification of MSMEs is a welcome step to include maximum enterprises and workers in the system to get the optimum benefits of government welfare measures.

(b)Relief Package

Government has announced a slew of measures to rescue MSMEs under the Atma-Nirbhar Bharat Abhiyaan, which included collateral-free, automatic loans of up to Rs 3 trillion, backed by government guarantee, and updated definition of MSMEs, besides expediting payment of pending dues. The government also announced extension of registration and completion date of real estate projects under RERA; immediate pending refunds issuance to all non-charitable trusts; extension of the due date for Income Tax Return (ITR) for FY’19-20 to November 30, 2020 and deferring GST (goods and services tax) payments until June 2020. In this context, the governments is projecting MSMEs as an employment generator, which could resolve the problem of rising unemployment and provide jobs to millions of skilled and unskilled people, who have lost their jobs in the on-going crisis.

However, the package misses the opportunity to address structural issues related to MSMEs credit. Up to 100% of loans given to MSMEs would be sovereign-backed under the new scheme. However, this would encourage both banks and borrowers to never return the money and to become defaulters. It will discourage banks from willingly lending to these MSMEs in the future. Rs 3 trillion credit will be provided to MSMEs as automatic collateral-free loans. These loans will be for four years and do not have to be repaid in the first 12 months. In other words, defaults will happen in future fiscal years, by when the economy and taxes would have recovered allowing the government fiscal space to spend money for its guarantee. With a 100% government guarantee, the bank will not bother to chase the borrower. As such, this amounts to the government paying the banks after the borrower has defaulted. As the government does not have the fiscal space to pay MSMEs Rs 3 trillion today, it is giving money through banks, and will pay back these banks in the future. Banks are not lending much today, so they have the ability to implement this package. This poses no risks to them. Alternatively, the government could have borrowed money and then directly given money to MSMEs through government departments. This would have meant a higher fiscal deficit and more government borrowing, and would have had administrative issues.

On the other hand, National Sample Survey 73rd round data shows that only 11 and 16% MSMEs of manufacturing and services respectively reported they had credit problem in the last year. While 42% manufacturing enterprises reported the demand problem they had in the last year. So far, more than Rs. 2 trillion and Rs. 1 trillion loans have been taken by MSMEs in manufacturing and services respectively. They paid around Rs. 30 billion per month as an interest by MSMEs in manufacturing and that figures of MSMEs in services are Rs. 15 billion per month as an interest. The additional loans amount will definitely put extra burden on MSMEs. All India Manufacturing Organization (AIMO), a federation of MSMEs survey also revealed that at least 78% of the MSMEs are not satisfied with the financial package execution and are expecting that the government should provide an alternative financial mechanism than just loans, and provide them a wage stimulus for their workers. On the whole, these are good steps to be taken to ease short-term liquidity concerns, the stimulus package focused on the MSMEs sector will have to be more far-reaching.

Challenges of MSMEs Sector

Following are some of the key challenges of MSMEs sector:

(a) Cash Flow and Capital

The delayed payment and thin margin due to current disruption in supply-chains, businesses and competition is leading to poor cash flow and lack of capital for the investment in the MSMEs sector. Only 16% of total debt supply is provided by formal financial institutions, the rest is either self-financed or financed from the informal sector. Therefore, bank and formal financial institution are reluctant to offer MSMEs financing because of poor balance sheets and non-performing assets. Even most of the MSMEs are non-interested in taking loan due to their low capacity to return the loan and payment of installment. On the other hand, most banks are also reluctant to lend to MSMEs because, from the perspective of bankers, they lack experience of running enterprises and poor financial status.

(b) Technological Up-gradation and Skilled Manpower

The poor cash flow and low returns results in difficulty in investment for up-gradation of machine and technology and they are forced to operate with old technologies and machinery. Additionally, the low supply of skilled manpower is a constraint for the MSMEs. The skilled workers usually have high wage premium in the market and MSMEs cannot afford to pay high wages/salary. Therefore, they are forced to work with less skilled and unskilled workforce. This forces them to operate in a low endowment base.

(c) Market, Raw Material and Infrastructure

It is becoming difficult for most of the MSMEs to cater the market needs because of new technologies, and competition to provide the quality products and services to the customers. Procurement of raw material at a competitive price is a common problem. The smaller units that use imported raw material face difficulty in obtaining raw material either on account of the foreign exchange crisis or regulator delays. Non-exposure to best management practices in manufacturing, marketing, distribution and branding and lack of adequate information further hinders their productivity. MSMEs still do not have access to an un-interrupted power supply, affordable logistics, internet and data connectively. These challenges also lead to pose many operational problems that leads to reduce productivity, failure in on-time delivery, and lack of flexibility to meet demand.

(d) Automation

Automation is playing a key role in improving the efficacy and productivity of enterprises. Despite financial limitations, many MSMEs are eager to upgrade to new technologies. But finding the right technological solution at an affordable cost is difficult. Though there are many low-cost automation products available, integrating them into a meaningful solution is a challenge. Besides, implementation partners are not actively participating in developing MSME-specific automation solutions. Although MSMEs realize the benefits of industrial automation, their core problems prevent them from moving ahead. Any automation demands investment for implementation. SMEs’ thin profit margins and ROI (return on investments), coupled with a general lack of cooperation from banks, make it difficult for SMEs to participate in the automation race.

(e) Government Policy/Labour Regulation

The MSMEs faces many bureaucratic hurdles such as delay in getting power connection, water connection, and permission of concerned authorities to discharge effluents, etc. Further, multiplicity of labour laws and complicated procedures associated with compliance of such laws adversely impact MSMEs to grow. The complexities of labour laws and regulations have been responsible for the creation of dwarf entities in India. It is estimated that there exist as many as 165 labour laws including 50 central laws. A plethora of legislations kicks into effect on the basis of the number of employees an entity employs with differing compliance requirements. For instance, the Trade Unions Act, 1926 can be implemented when an entity employs seven or more workers, while the Factories Act, 1948 finds applicability when the number of employed rises to 10, and Employees Provident Fund and Miscellaneous Provisions Act, 1952 is attracted when the number of workers employed rises to 20. Further, retrenchment of workers is extremely tricky as the dismissal of a worker in a factory and certain other specified establishments with more than 100 or more workers requires the approval of the concerned labour department. The costs of statutory compliance have been noted to be among a significant constraint in Indian MSMEs remaining small in scale and largely informal with some estimating that formal sector entities require to meet 3,000 plus annual filings alongside 60,000 plus items of compliance. The costs for an establishment, per worker, is estimated to increase by 35% due to the range of regulations that find applicability once an establishment has 10 or more workers.

(f) Data on MSMEs Unit

There is lack of comprehensive dataset on MSMEs units. There has been no census for this sector during the last 13 years – the fourth and last census on Indian MSMEs was conducted as far back as 2006-07.The information regarding these enterprises is presently known to be scattered across different datasets such as the Udyog Aadhaar Memorandum (UAM), MSME Databank, ESIC, EPFO and the Goods and Services Tax Network (GSTN). The first two datasets contain self-certified, voluntary information provided by businesses that wish to register on these portals, while the GSTN has a statutory requirement that only businesses with a turnover of more than Rs. 4 million need to be registered on it. The absence of reliable (and updated) information on this key sector of the economy is also noted by an RBI Expert Committee on MSMEs, in June 2019.

Way Forward

Following are some of the important steps needs to be taken to by the government and other stakeholders to boost the MSME sector post-covid-19 in the country.

  • The MSME sector is characterized by limited accessibility to formal credit and dominated by massive informality, especially with the presence of large micro–units (98 per cent of the total) comprising one–person business units and those that employ up to 10 persons. It is a highly heterogeneous set of business units, engaged in manufacturing, trade and service activities. It is the time that MSMEs are accurately profiled through updated, comprehensive information about these unincorporated business units and workers within. The lack of a comprehensive dataset on MSMEs units and their employment profiles will exacerbate issues of targeted relief delivery in this crisis situation.
  • The real challenge today lies in identifying unincorporated MSMEs, of which 99% are micro-enterprises that remain largely informal. If wage support is rolled out for labour/workforce in MSMEs, the Jan Dhan-Aadhaar-Mobile (JAM) would be ideal to use as a transfer mechanism. The importance of a wage (and incentives) support programme also comes highly advocated by the ILO – a recent report mentions that countries such as India, Brazil, and Nigeria, with a ‘lion’s share of the workforce in the informal sector’, will need to introduce such wage support to prevent increase in poverty in working classes. The current provisions have more exclusions rather than inclusion, this needs urgent interventions.
  • The government has announced that a stimulus package focused on the MSMEs sector is in the offing. It is important, however, that such a package focus not just on providing temporary relief through short-term liquidity infusions, but also go beyond, to address medium- and long-term issues that will test their resilience.
  • There is need to campaign like Skill India, Startup India, Digital India and Make in India aim to provide MSMEs players with a level playing field and a definitive push towards enhanced productivity by increasing internet penetration, customer’s familiarization with digital payments fuelled by Business-to-Consumer(B2C) ecommerce players facilitate MSMEs sector growth.
  • There is an urgent need to upgrade infrastructure utilities (like water, power supply, road/rail) for any enterprise to run its operations successfully. Entrepreneurs need to develop quality conscious mindsets embedded in the organisational culture. Sensitisation and handholding of MSMEs at different and upgraded level of certification is the need of the hour. Government should provide enhanced development and upgrade existing rail & road network and other infrastructure facilities in less developed and rural areas to boost growth and development of MSMEs. There should be proper research and development in respect of innovative methods of production and service rendering. Further, the government should promote and subsidise the technical know-how to micro and small enterprises.
  • The revised definition is a forward step in this direction. However, more measures may be required in order for MSMEs to scale up and be competitive. Long-standing factors that have inhibited growth need to be acknowledged and addressed through labour law reform and the organized structures of databases. Supplementing the definitional change with these reforms will help these vast number of informal units’ transition to a formal structure, achieve economies of scale and reap productivity gains without being held back. Coherent regulatory frameworks can provide an enabling environment to foster MSMEs development. Barriers to entry, including technical regulations, compliance with Environment, Health and Safety (EHS) standards, labour laws and regulations need to be addressed.
  • The crucial role of MSMEs will be in exploring the potentials of creating decent employment. This would require not only formulating policies at enterprise level for improving human capital, efficiency and productivity of MSMEs, but also launching structural transformation that provide a regulatory framework conducive to their growth.
  • The impact of covid-19 is long-term in nature and for quick revival of the MSMEs sector would require special focus towards boosting exports. Necessary practices will be adopted by enterprises to reduce power and logistics costs, as well as cost of production to become competitive in the overseas market. Further, there is a need to focus on import substitution to replace foreign imports with domestic production. To boost the MSMEs market promote e-commerce platform similar to Amazon and Alibaba where Indian MSMEs can showcase and sell their products to any buyer in any part of the world is need of the hour.
  • Government has initiated skill mapping across states where migrant population is huge with a view to rehabilitating them in the local labour market with upgrading their skills, if required. The initiative is laudable in the situation where migrant labour have moved from the work places from urban centres to their villages in the wake of Covid-19 lockdown. It is likely that they will not come back soon to these urban locations. This provides opportunity to governments to convert the crises in the opportunity by rehabilitation programme by increasing wage and self-employment opportunities in MSMEs in rural areas or semi urban areas.
  • The workers’ productivity (GVA/Workers) in micro enterprises are lower than small, medium and larger enterprises which means per additional workers in micro enterprise GVA would be increased lesser than the other enterprises. The workers’ productivity is low and by four times lower compared to China’s MSMEs sector. The productivity of MSMEs sector in China is four times higher compared to India. China’s policy focus on MSMEs and small business sector is immense including ease in financial support and preferential income tax policy. High quality of infrastructure with uninterrupted power supply helps to boost this sector. The supportive bureaucracy makes the MSMEs regime hassle free and conducive to business environment. However, such conducive business environment is lacking the productivity of this sector. Clearly, much to learn from the Chinese experience for promoting MSMEs sector as an efficient and employment generating sector.
  • To take an advantage of recent trade war between China and other developing countries, the large enterprises need to make structural changes with their focus on generating employment at larger scale. Recently, German Von Wellx Footwear Company agreed to shift their production units from China to India. India has an advantage of demographic dividend and huge number of workers with low wage rate. There is simultaneous scope to promote the larger enterprises with MSMEs. Industrial growth cannot happen in a vacuum unless there is way to promote the larger enterprises within the policy reform is not likely to happen on a big scale to achieve the vision of ‘AtmaNirbhar Bharat’.

*The authors are affiliated with Impact and Policy Research Institute (IMPRI), New Delhi; University of Delhi, Delhi; Institute for Human Development, Delhi; Visva Bharati University, Shanti Niketan; Savitribai Phule University, Pune

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