Going ahead, the government could design specific schemes to help MSMEs modernise technology and obtain quality certification
On May 13, when the finance minister unveiled the first tranche of a Rs 20 trillion stimulus package, it felt like the trailer to a long-awaited movie. The announced measures touched upon key segments of the economy — micro, small and medium enterprises (MSMEs), real estate, construction, shadow banking, which were already in bad shape and are now in dire straits. The thrust was to get credit flowing, revive confidence, and to retain and create jobs in sectors with large multiplier effects.
While the devil is always in the detail and many concerns can be raised, such as how much additional budgetary spending is entailed, the fiscal impact, implementing capacity, and so on, what stands out is the focus on MSMEs. The government’s recognition of the challenges faced by Indian MSMEs rings loud and clear. The slew of measures for MSMEs seems like a bonanza package that covers critical areas of financing, marketing, capacity, and modernisation, all long-standing concerns for Indian MSMEs.
The point of this article is not to question how well these measures will be implemented or how much the government will actually shell out in support to MSMEs. The aim is to highlight the importance of two aspects — access to affordable credit and capacity expansion that are addressed by the proposed measures and which are validated by recent empirical studies on MSMEs by Mukherjee and Chanda.
Let us first turn to the financial aspect of the MSME package. The government announced Rs 3 trillion worth of collateral-free automatic loans of four-year tenure for eligible firms, along with moratorium of 10 months and 100 per cent credit guarantee for banks and non-banking financial companies (NBFCs) on principal and interest until October end. This is expected to help some 4.5 million units resume activity. Another credit-related measure is the provision of Rs 20,000 crore as subordinate debt to help around 200,000 stressed MSMEs, with provision of Rs 4,000 crore by the government to Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).
Why are these proposals significant? Leaving aside issues of implementation and transmission of credit for the time being, these proposals are important as they go to the heart of the main challenge facing Indian MSMEs today, which is lack of access to credit at affordable rates due to risk aversion on the part of lenders and lack of collateral. This well-recognised fact finds strong validation in Mukherjee and Chanda (EJDR, 2019) study. Analysis based on a merged 3rd and 4th Economic Census dataset comprising of over 10,000 MSME manufacturing firms shows that post liberalisation, most MSMEs have been adversely affected by increased competition in the product markets and have also not been able to realise gains from increased access to better quality, larger scale, and greater variety of intermediate inputs. A key reason is their poor financial health and credit constraints. Interestingly, those MSMEs which had better financial health, were able to realise productivity gains following liberalisation. Thus, the steps announced to facilitate the flow of credit, provide guarantees, and help stressed MSMEs are strongly validated by the empirical reality.
Let us next turn to the issue of capacity expansion, and formalisation of MSMEs which tranche 1 also seeks to address. There are two important proposals in this regard. First is the announcement of Rs 50,000 crore equity infusion into viable and eligible MSMEs through an MSME fund of funds, along with a corpus of Rs 10,000 crore. The aim is to help MSMEs expand capacity and eventually get listed. Second is the increased investment limit on plant and machinery or equipment to qualify as MSMEs and inclusion of turnover as a criterion.
Both proposals are significant as they address another core issue plaguing Indian MSMEs, that is, their inability to realise economies of scale, invest in technology, modernise, and procure inputs in large scale, due to size limits. Indian MSMEs choose to stay below the defined ceilings to avail of various benefits and schemes. This prevents them from improving their efficiency, upgrading technology, and moving up the value chain. In a recent study (Mukherjee and Chanda, 2020) based on CMIE Prowess data, we find strong evidence backing these effects of definitional limits on the performance of MSMEs. The results show that the previous upward revision in the investment ceiling under the MSMED Act, 2006, resulted in increased productivity and markups of Indian manufacturing MSMEs, by enabling scale economies, investment in technology, and access to imported intermediates. Thus, the definitional changes proposed for MSMEs, along with the modernisation and expansion fund for eligible MSMEs, is a welcome step and is validated by empirical evidence. The new definitions will provide more flexibility to MSMEs to grow, modernise, and access inputs. Further, a single definition for manufacturing and services MSMEs is significant at a time when boundaries between services and manufacturing are getting blurred, servicification of manufacturing is on the rise, and there are growing opportunities for services businesses.
However, not all the proposed measures affecting MSMEs are welcome. One such concern is the ceiling on government procurement tenders, which has been raised to Rs 200 crore, basically to reserve demand for local MSMEs. It may be wiser to focus on making MSMEs competitive and to link them to lead firms so that they can participate effectively in global value chains than to protect them with such restrictions.
Overall, the initial measures that have been taken for MSMEs are in the right direction. Going ahead, our studies suggest the need to help MSMEs modernise their technology and to obtain quality certification. The government could design specific schemes in these regards.
Chanda is RBI Chair Professor in Economics, IIM Bangalore; Mukherjee is Assistant Professor in Economics, School of Business Management, Narsee Monjee Institute of Management Studies University, Mumbai