Role of MSMEs in Indian Economy
- 15 May 2020
- 8 min read
This article is based on “Liquidity lifeline: On Nirmala’s MSME package” which was published in The Hindu on 14/05/2020. It talks about the challenges of and steps to be taken to revive the MSMEs sector.
In order to revive the Indian economy amid Covid-19 pandemic, the government has announced an economic package under Atmanirbhar Bharat Abhiyan. The main thrust of the announcements has been the massive ₹3-lakh crore collateral-free assistance or sovereign credit guarantee to the Micro, small and medium enterprises (MSMEs).
Like other sectors of the Indian economy, MSMEs have been hit badly due to lockdown imposed by the government to tackle Covid-19 pandemic. However, even before the current crisis, MSMEs growth has been marred by several challenges.
In such a situation, providing merely a stimulus package may not be effective, until adequate reforms are carried out to solve its pressing problems and to utilize its potential.
Reason for Giving Credit Guarantees
- A credit guarantee by the government helps as it assures the bank that its loan will be repaid by the government in case the MSME falters.
- Efforts to pump liquidity via the bank have not been successful in the past, because banks simply do not want to lend any new money.
- Banks, quite justifiably, suspect that any new loans will only add to their growing mountain of non-performing assets.
- So the issue was banks had the money but were not willing to lend to the credit-starved sections of the economy.
- Thus, as part of the solution, credit guarantees are chosen by the government.
Significance of MSMEs
- The significance of the MSMEs sector can be noted from the fact that it is the second-largest employment provider, after agriculture in India.
- In India, at present, there are nearly 56 million such enterprises in various industries, employing close to 124 million people.
- Of these, nearly 14% are women-led enterprises, and close to 60% are based in rural areas.
- In all, the MSME sector accounts for 8% of India’s GDP and 45% of merchandise exports.
- Due to this, the MSME sector is called the growth engine of the nation.
Challenges Pertaining to MSMEs
Lack of Adequate and Timely Access to Finance
- Access to finance continues to remain the biggest challenge for MSMEs and has constrained their growth.
- MSME funding from banks has been stalled, as decision-making managers are reluctant of loans going bad.
- After the IL&FS crisis and its effect on the other NBFCs (Non-Banking Finance Companies), MSMEs ran into deep trouble because of the liquidity crunch that followed.
- Due to this, MSMEs are not able to invest in manufacturing, purchase raw materials on time, access new technologies or acquire new skills due to lack of funds which is a big handicap especially in its fight with global competitors.
- India‘s MSME sector is based on obsolete technology, which hampers its production efficiency
- With the emergence of new technologies like Artificial Intelligence, Data Analytics, Robotics and related technologies (collectively called as Industry Revolution 4.0) is a bigger challenge for MSMEs than for organized large-scale manufacturing.
- MSMEs require a lot of government services and approvals, for which the entrepreneur has to run around various government departments.
- Getting construction permits, enforcing contracts, paying taxes, starting a business and trading across borders continue to constrain doing business.
- Regulatory risks and policy uncertainty in the past have dented investor confidence.
Problem of Scale
- Majority of the firms in MSMEs are micro-enterprises.
- The MSME space is virtually a micro space formed by a plethora of small and local shops and hence, scaling them up is a problem, especially when fund access is challenging.
Steps To Be Taken
- Increasing Domestic Manufacturing Capabilities: The government can play a crucial role in creating domestic manufacturing capabilities by leveraging proposed public procurement and projects.
- For example, Mega public projects such as Sagarmala, Bharatmala, industrial corridors, and the Pradhan Mantri Awas Yojana (PMAY) can stimulate domestic manufacturing activities.
- This should be accompanied by a simplification of the regulatory process.
- Cluster Manufacturing: Efforts should be made to develop self-sufficient clusters of manufacturing competence, with Cluster Administrative Authorities, empowered to provide single window clearances to entrepreneurs and investors.
- Leveraging Industrial Revolution 4.0: Disruptive technology, while leading to job losses in traditional areas, also presents new job opportunities.
- A greater connect between government-industry-academia is required to identify the changing requirements in manufacturing and prepare an employable workforce.
- Also, the Industrial Revolution 4.0 will boost the Industrial supply chains in India.
- Need to improve Ease of Doing business: Reforms: India has already taken several steps, due to which ease of doing business in India has improved significantly (India’s ranking in ease of doing business report has improved from 142 in 2014 to 63 in 2020).
- However, still some reforms are needed in regard, especially in the field of land, labour reforms and in enforcing contracts.
- Making Indian Products to Match Global Standards: There is a need for harmonizing Indian quality standards with global standards in many sectors.
- Lack of harmonization has affected Indian exports and prevented the leveraging of trade agreements adequately.
- There is a need to promote ZED manufacturing (Zero effect- Zero Defect) as envisaged by Make in India.
Collateral-free assistance or sovereign credit guarantees to the Micro, small and medium enterprises (MSMEs) will ease the financial crunch. However, the government should devise this scheme in such a way that the issue of moral hazard can be averted.
Issue of Moral Hazard
- Collateral-free assistance and credit guarantees leave no incentive for the borrower to pay back, as he has nothing to lose.
- Also, as the banker is assured of payback from the government so why should he bother to check if the borrower is deserving or not.
Drishti Mains Question
Discuss the role of MSMEs sector in India’s growth and how far sovereign credit guarantee will help in reviving it.
This editorial is based on “Liquidity lifeline: On Nirmala’s MSME package” which was published The Hindu on May 14th, 2020. Now watch this on our Youtube channel.