The definitional changes made for MSMEs would address the problem of “dwarfism”
The growth of the micro, small and medium enterprises (MSMEs) has been an integral part of our growth story. The Indian economy grew at an average rate of over 6.5 per cent during the period 1980-2010. The growth story has spluttered in recent times with two important engines of growth — private investments and exports — not firing.
The MSME sector plays a critical role in boosting both these engines and MSMEs’ relatively poor performance has contributed to tepid private investments. Outstanding bank credit to MSMEs remained constant for three fiscal years from 2015-16 to 2018-19. Consequently, lending from NBFCs has become an important source for credit to MSMEs. NBFC credit to MSMEs grew from 8 per cent to 13 per cent of their lending to MSMEs between 2015 and 2018. The MSME sector contribution to exports declined from nearly 50 per cent in 2015-16 to 48.6 per cent in 2017-18. The collapse of the Infrastructure Leasing & Financial Services or IL&FS led to a subsequent fall in the flow of credit from NBFCs to MSMEs.
The GST reform implemented in July 2017, while being hugely beneficial, impacted MSMEs adversely by disrupting their supply chain with the large industry for whom they were ancillary suppliers. This was because the small units opted out of the GST duty regime on compliance concerns and the large units could not therefore avail of the input credit on purchases from the smaller units. This situation could have been avoided if the original provision of the GST law — of providing the unregistered unit the option of GST payment on a reverse charge mechanism (RCM) — had been retained. This facility was only confined to a few specified commodities.
Therefore, it is suggested that the original provision of RCM for purchases from smaller units including units opting for compounding should be fully restored. This would ensure that the large units pay GST duty on behalf of unregistered small units by raising input invoices and then availing of the credit. Here, the larger units may face some higher working capital issues but this would be compensated by negotiating a better price with the smaller units.
The other change which needs to be made is to persuade the larger units to both accept and raise GST invoices on the Trades Receivables Discounting System (TReDS) platform so that payment to MSMEs are made in a time-bound manner. To prod the large units in this direction, the Securities and Exchange Board of India (Sebi) could issue guidelines that will incentivise these units to participate in the TReDS platform by factoring this in for higher credit ratings.
In the post Covid-19 scenario, as MSMEs fight for survival, the GST amendment together with ensuring quick payments for supplies made would be useful. The MSMEs package announced by the government will definitely help the sector tide over difficult times. The definitional changes made for MSMEs would address the problem of “dwarfism” which was basically the disincentive for small units to grow because of the fear of losing many of the fiscal and monetary benefits.
This has led to a situation where the micro units employing less than 10 persons constitutes more than 90 per cent of the MSME universe. The small scale of operations makes them vulnerable to any economic crisis. Therefore, the changes announced by the government would help the process of micro units to become small and small units to become medium sized. This requires the units to have better access to markets capital and technology.
To sum up, the growth of the MSMEs depends on larger units embracing them in the supply chain. The suggested GST changes in the law together with the Sebi guidelines will help in achieving this.
Krishnan is retired member, CBIC, and currently national leader, Tax and Economic Policy Group, EY India; Deepraj is senior tax professional, Tax and Economic Policy Group, EY India
Views expressed are personal