MSME- An Indian Perspective

Micro, Small and Medium Enterprises or MSME sector has been a popular topic
of discussions in media, among academicians, national and international forums
and among policy makers in recent times. What is it that makes it so important a
sector to attract such a wide attention? The answer lie in the fact that it has
played a very important role in socio-economic development of the country by
contributing significantly to the overall growth in terms of the GDP, employment
generation and exports. It is the back bone of Indian economy. It contributes
to about 8%-9% of India’s GDP by providing employment to more than 40 million
people in course of producing about 8,000 products. It comprises 45% of the
industrial output in the country and contributes to about 40% of India’s
exports.

Definition of MSME

Enterprises are broadly classified into two categories:

a) Enterprises engaged in production/Manufacturing of goods for any

industry
b) Enterprises engaged in rendering/providing of services

Both categories of enterprises have been further classified into micro, small,
medium and large enterprises based on their investment in plant and machinery
(for manufacturing enterprises) or on equipments (in case of enterprises
providing or rendering services). The present ceiling on investment to be
classified as micro, small or medium enterprises is as under:

* Fixed costs are obviously higher

SME in the global scenario

Even in the global scenario SMEs have always played a crucial role in their
respective country's economy. International comparisons reveal that SMEs
create the majority of jobs.

In the USA, nearly half of the private workforce is employed in small firms, of
which three-fifth have less than five employees. In Japan, 78 percent of jobs
are generated by SMEs.

The same sector in Korea accounts for 99 percent of all manufacturing

enterprises and 69 percent of employment in this sector. Therefore, SMEs
must play a central role in the country’s employment strategy. This will require
modification of policies and programmes to level the playing field, improve
availability of credit, increase productivity, raise quality consciousness and
competitiveness, and enhance job quality.

Recent experiences of different countries in the context of globalisation also

demonstrate that SMEs are better insulated from the pressures generated by
the volatility of world trade and capital markets. They are more resistant to the
stresses, and more responsive to the demands of the fast-changing technologies
and entrepreneurial responses. Indeed, they are observed to be a very
important vehicle for new technology adoption and entrepreneurial development.
Ensuring the competitiveness of the SMEs is important as it would help in
overall growth of manufacturing sector as also the national economy.

Impediments to growth

Much has been said and done for the development of MSME in India through
policy initiatives, regulatory intervention and industry forums. However given
the sheer size and the key role played by MSME much more needs to be done.
Before proceeding towards the solutions it is very important to understand the
problems at the most basic level. The problems faced by most of the players in
this sector are:

Access to funds: Funds are required for starting a new business, to grow the
existing business, research and development, marketing and working capital.
Banks are not very comfortable in lending to MSMEs due to a variety of reasons
including small size, lack of information, lack of understanding of the business,
lack of effective internal mechanisms to understand and evaluate the credit
risk involved with this sector. In addition to this time taken for raising funds,
complex procedures, high collaterals etc make it difficult for MSME to get
bank finance at low cost.

Archaic and outdated labour laws: Regulations and legislations are formulated to
support businesses and to protect the rights of different stakeholders.
However multiple and at times contradictory laws defeat the whole objective of
regulations and instead become impediments to growth of the businesses. There
are currently number laws like Minimum Wages Act, 1948; Trade Unions Act,
1926; Contract Labour Act, 1970; Weekly Holidays Act, 1942; Beedi and Cigar
Workers Act, 1966 and many more. Compliance with them creates cost in terms
of time and money for MSMEs and hampers their growth.

Research and development: This is one very crucial area where Indian MSMEs
are way behind their global counterparts. This not only affects the quality of
products and services but also reduces the competitiveness in the international
market.

Government policies: Government of India have been taking various initiatives

towards promoting and developing MSME sector in India since independence. A
number of high level committees have been formed to address various concerns
pertaining to MSME. However poor implementation restricts the effectiveness
of the policies leading to persistence of issues.

Lack of awareness of global trade: The dynamics of business has gone a sea
change during the last decade. Integration with the international markets has
become a crucial factor for success of all type of enterprises including MSMEs
which seeks a market oriented approach. Most of the players in this sector are
product and technology oriented. In addition to this there is a lack of
information, capability to build up an international market position and
insufficient management skills. A high cost of acquiring information on foreign
buyers, distribution channels, quality standards etc creates serious competitive
disadvantage for this sector for competing effectively in the international
market.
Management: Majority of companies in this sector are people run companies
rather than system run companies. Over dependence on a few key personnel
creates challenges to grow up in scale and operations and also the exit of such
personnel may create serious limitations for continuation of the business.

Impact of current meltdown on MSME

The current meltdown of global financial and commodity markets begun with the
fall of housing markets in USA leading to collapse of the sub-prime market in
August 2007. The problems later on engulfed the entire financial and
commodity markets throughout the world leading to a serious liquidity crisis and
most of the developed economies going into recession including USA, UK, and
Japan. It also led to slowdown in emerging economies like India and China as
most of their growth was either due to exports to developed markets like USA
or due to foreign investments. Fall of credit markets in US and Europe resulted
in foreign investors pulling back their investments leading to a sharp fall in
equity indexes around the world.

Coupled with this the RBI followed a tight monetary policy by increasing the key
rates like Repo, reverse repo and CRR resulting into a serious liquidity crunch in
the domestic markets.

The impact on MSME sector of the above can be understood as under:

• Slowdown in key markets like USA, Europe and Japan resulted in decline
in demand for goods produced by export oriented enterprises hence
directly affecting their revenues and profitability.
• Due to overall increase in risk perception and liquidity crunch in the
domestic markets the cost of funds has increased considerably for the
MSMEs to more than 15% now.
• Many MSMEs did a lot of capacity building during the boom time, a
significant amount of which was financed by debt increasing the interest
cost significantly. Such companies are facing liquidity pressures due to
decrease in demand for their products and unavailability of alternative
sources of finance.
• The big financial firms in US and Europe were the key clients of Indian
BPO and KPO industry. The collapse of big banks like Lehman Brothers,
 Bear Sterns etc. led to immediate cut down of their business seriously
affecting the outsourcing industry.
• Export oriented auto ancillary manufacturers have been the worst
affected due to fall in demand of vehicles resulting as a result of high oil
prices during the first 9 months of the year and a general economic
slowdown.

Steps taken by GOI in wake of the current crises

• A four per cent cut in ad-valoram duty across the board, to boost
additional spending
• Government to seek authorisation for additional plan expenditure of up to
Rs 20,000 crore in the current year
• to provide an interest subvention of two per cent up to March 2009 for
pre and post-shipment export credit for labour-intensive exports like
textiles, leather, marine products and SME sector
• To provide an additional Rs 1,100 crore for full refund of terminal excise
duty/CST and another Rs 350 crore for export incentive schemes and a
back-up guarantee of Rs 350 crore to ECGC (Export Credit Guarantee
Corporation) for providing guarantee for exports to difficult markets and
products
• The government doubled the current guarantee cover for loans to up to
Rs one crore from the existing limit of Rs 50 lakh.
• Lock in period for loans covered under the existing credit guarantee
scheme will be reduced from 24 to 18 months, to encourage banks to
cover more loans under the guarantee scheme.
• RBI announced a refinance facility of Rs 7,000 crore for Small Industries
Development Bank of India to facilitate the flow of credit to such
industries.
• Textile sector to get an additional Rs 1,400 crore towards the entire
backlog of Technology Upgradation Fund.

Current funding scenario

Banks have been the most important funding option available to MSME. At the
end of March 2007, the loans outstanding against the MSME sector from the
scheduled commercial banks is estimated at $54 billion. Apart from banks
MSMEs can also access funding through various schemes run by Ministry of
MSME and SIDBI. Recently funding through PE, venture capital, ECB and
factoring have also increased and was to the tune of $3 billion during 2007.

Alternative Sources of finance- the way forward…..

Factoring: A challenge for many small businesses is access to financing. In

particular, many firms find it difficult to finance their production cycle, since
after goods are delivered most buyers demand 30 to 90 days to pay. For this
duration, sellers issue an invoice, recorded for the buyer as an account payable
and for the seller as an account receivable, which is an illiquid asset for the
seller until payment is received. Factoring is a type of supplier financing in which
firms sell their credit-worthy accounts receivable at a discount (equal to
interest plus service fees) and receive immediate cash. Factoring is not a loan
and there are no additional liabilities on the firm’s balance sheet, although it
provides working capital financing. In addition, the supplier can mitigate the
credit risk if the factoring is done “without recourse” meaning that the factor
that purchases the receivables assumes the credit risk for the buyer’s ability to
pay.

Factoring is a comprehensive financial service that includes credit protection,

accounts receivable bookkeeping, collection services and financing.

The benefit of factoring is that the credit provided by a lender is explicitly

linked to the value of a supplier’s accounts receivable and not the supplier’s
overall creditworthiness. Therefore, factoring allows high-risk suppliers to
transfer their credit risk to their high-quality buyers. Factoring may also be
particularly well suited for financing receivables from large or foreign firms
when those receivables are obligations of companies who are more creditworthy
than the factoring client itself.

Venture capital/Private equity: This is yet another attractive source of finance

especially for new firms in this sector and firms which might not be suitable for
borrowing from banks. Apart from providing risk capital to the enterprises, VC
firms may also work at an operational and managerial level by offering their
skills and expertise hence contributing toward success of such enterprises. The
total equity investments in MSMEs including VC amounted to Rs 4000 cr in
2007-08.

Road to be taken going further.....

 A Market oriented approach: About 66% of the MSME fail because of

lack of demand. A market oriented approach can help MSMEs to design,
develop and produce goods as desired by the customers and hence
ensuring a good demand for them.
 Exploring and utilizing alternative sources of finance: Banks loans and
working capital limits from banks are the finance is the most preferred
financing option for the MSMEs. However it is not easy to get bank
finance at a lower cost. The enterprises should explore other sources of
finance like factoring, PE, Venture capital, ECB etc
 The MSMEs need to enhance managerial skills and knowledge on
prospective markets by employing professionals and/or through advisors
specializing in these areas.
 The Credit Guarantee Scheme offered to the MSMEs by the government
should cover a guarantee of 100 percent rather than 75 percent.
 The cluster approach has been quite successful. More than 350 clusters
exist in India, at present in totality they contribute about 60% of India’s
export. Some of them are so big that they produce up to 70% to 80% of
the total volume of that particular product produced in India. This
approach needs to be encouraged further through public private
partnership (PPP), geographically concentrated in few areas which have
immense opportunities for expanding employment and also has
opportunities for exports.
 Reforming of the existing multiple and contradicting regulations and laws
to make way for more industry friendly and supportive regulations.
 The coverage of the Technology Upgradation Fund (TUF) Scheme needs
to be broadened to the entire SME sector irrespective of the product
line. At present it is available for cotton, textiles and jute industry.
 Ensuring access to infrastructure, in respect of power, water, roads, etc.