MSME Funding: A Different Standpoint for Banks in India
Introduction:
The Micro, Small and Medium Enterprises (MSME) sector has emerged as a highly vibrant and dynamic sector of the Indian economy over the last five decades and have been a primary focus of policymakers at the central and state levels as it is a valuable contributor to the overall economic growth and development in terms of employment, value chain creation, foreign exchange earnings, critical supplier of large industries, promotion of regional balance and inclusive development, and so on.The Micro, Small and Medium Enterprises Development Act was notified in 2006 to address different issues affecting MSMEs, inter alia, the coverage and investment ceiling of the sector.The earlier criterion of classification of MSMEs under MSMED Act, 2006 was based on investment in plant and machinery / equipment.A revision in MSME criteria of classification was announced in the Aatmnirbhar Bharat package on 13th May, 2020. This has been done in order to be realistic with time, to establish an objective system of classification, and to provide ease of doing business.
Micro enterprise: Investment in plant and machinery or equipment does not exceed one crore rupees and turnover does not exceed five crore rupees.
Small Enterprise: Investment in plant and machinery or equipment does not exceed ten crore rupees and turnover does not exceed fifty crore rupees.
Medium enterprise: Investment in plant and machinery or equipment does not exceed fifty crore rupees and turnover does not exceed two hundred and fifty crore rupees.
According to the National Sample Survey (NSS) 73rd round, carried out by the National Sample Survey Office, Ministry of Statistics & Program Implementation, there were 633.88 lakh unincorporated non-agricultural MSMEs in the country, Out of which:
- 65 lakhs are in manufacturing
- 03 lakh in non-captive electricity generation and transmission
- 35 lakh in trade
- 85 lakh in other services
- 88 lakh (51.25%) are in rural areas, while 309 lakh (48.75%) are in urban areas
- Approx 1.5 crore MSMEs are under GST
Why MSMEs are focus area of lending:
MSME sector in India is one of the largest in the world. The sector is diverse, ranging from small-scale industries to high-tech start-ups, and encompasses a wide range of industries such as textiles, agro-processing, and electronics.Following are the reason, MSMEs are focus area of lending:
Diversification of Risk: MSMEs loans are smaller in ticket size compared to corporate loan. This helps the banks to diversify their concentration risk.
Higher Margin:Corporate bargain hard with Banks for lower rate of Interest, whereas MSMEs comply the condition put by Banks. Hence Banks have higher margin on MSMEs loan.
Employment Generation: MSMEs are the largest employer in India, providing employment to over 11.10 crores people. They are also a source of livelihood for many people in rural areas. This makes the MSME sector the second largest job provider after the agriculture sector.
Contribution to GDP: MSMEs contribute to around 30% of India’s GDP. They play a crucial role in the growth of the manufacturing sector, as well as in the service sector. It contributes around 6.11% of the manufacturing GDP and 24.63% of the GDP from service activities. MSME ministry has set a target to up its contribution to GDP to 50% by 2025 as India becomes a $5 trillion economy.
Innovation: MSMEs are often more innovative than larger companies. They are more nimble and can adapt to changes in the market more quickly. This has resulted in the development of many new products and services in India. MSME provides opportunity for budding entrepreneurs to build creative products boosting business competition and fuels growth.
Regional Development: MSMEs are spread across the country, including in rural areas. They help in the development of these regions by providing employment and contributing to the local economy.
Export: MSMEs account for a significant share of India’s exports. They play an important role in promoting India’s brand image globally. As per an estimate, MSMEs contribute around 45% of the overall exports from India.
Strong Linkage between MSMEs and MNCs:At present, MSMEs create more than 8,000 intermediary and value-added goods. Multinational companies, in turn, get these auxiliary goods for producing final products. As a result, a robust supply chain has been established over the years fuelling reliable supply of goods to various sectors. Building and leveraging upon these linkages can help India to truly become a self-sufficient nation.
Commendable Outcomes:The MSME sector has time and again proved its ability to bring efficient outcomes. At present, India has around 6 crore MSMEs employing a gigantic 40% workforce. By furnishing jobs in rural and urban areas; the sector promotes literacy, regional development, better living conditions, and eliminates income inequality.
Labour Intensive Industries:Due to the higher capital-output ratio, growth scope in small scale industries is usually high even with a small investment. This results in the flourishing of small scale businesses in remote and rural parts, driving fair growth opportunities.
Import Substitution and Bridge Trade Deficit:As the Government focuses on Atamnirbhar Bharat and Make in India, MSMEs are the ground players to achieve self-dependency. Under such programmes, MSMEs’ production capacities have increased greatly. Not only do they provide an alternative for India’s soaring import bills, but also bring down a huge trade deficit. Further, the Indian Government now plans to bring out a roadmap to establish a semiconductor ecosystem to boost designing, manufacturing and packaging of semiconductor chips majorly by MSMEs. Also, the Indian Government is planning to enhance the export contribution of MSMEs in the Indian economy to 60% in upcoming years.
Creates New Avenues of Growth:As the Indian Government and private sector come together to provide a conducive environment for MSMEs, the entrepreneurs are now exploring the new domains. Lately, there has been a massive growth in MSMEs engaged in tea, coffee, fishery, bamboo, food-processing, and organic farming domains. Not only do they produce diverse products for domestic and global market demands, but also offer huge unexplored areas with high outputs.
Ensures Inclusive and Sustainable Growth: As a huge chunk of India’s rural population is still engaged in agriculture and that to mostly disguised employment, MSMEs offer a new wave of solutions. According to Government data, 50% of MSMEs in India operate in rural parts employing rural populations. Moreover, as MSMEs offer jobs for unskilled labourers, their importance can’t be emphasized enough in an economy like India. Besides providing jobs to rural and unskilled individuals, 97% of workers in MSME sectors come from the micro-strata of the society. Hence MSMEs promote inclusive growth by providing employment opportunities in rural areas especially to people belonging to weaker sections of the society. For example: Khadi and Village industries require low per capita investment and employs a large number of women in rural areas.
Financial inclusion: Small industries and retail businesses in tier-II and tier-III cities create opportunities for people to use banking services and products.
Protection from global economic Shock:Indian MSME sector is the backbone of the national economic structure and acts as a bulwark for Indian economy, providing resilience to ward off global economic shocks and adversities.
Issues Hindering MSMEs Potential:
The Micro, Small and Medium Enterprises of India have shown better growth trajectories as compared to the other sector. Thus, the proactive role of MSMEs in the Indian economy is crucial for making India a $5 trillion economic giant. Despite recording a huge contribution of MSMEs in the Indian economy, there are grave challenges faced by small scale industries that require timely addressal. A regional imbalance in MSME distribution is quite evident as states like Uttar Pradesh and Madhya Pradesh tops the list while poor states such as Bihar lie at the bottom. The major reasons behind the regional disparity are the unavailability of resources; be it raw material, financial aid, technical knowledge, or entrepreneurial assistance.
The Financial Stability Report by the Reserve Bank of India highlighted the liquidity crunch and rising bad loans in the MSME sector. Even after numerous credit guarantee plans and MSME loan schemes, the NPA load in the sector is still on a rise indicating challenges of MSMEs. Moreover, high credit cost, almost zero R & D, lack of skill development, complicated labour codes, etc. are still the biggest challenges that MSMEs face. Below are the main challenges associated with MSMEs:
Access to Finance: Access to finance is one of the biggest challenges faced by MSMEs. These businesses often struggle to secure loans from formal financial institutions due to a lack of collateral, limited financial history, and high interest rates.
Infrastructure: MSMEs often operate in areas with poor infrastructure, such as inadequate transportation, power, and water supply. This can make it difficult for them to operate efficiently and meet customer demand.
Skilled Workforce: MSMEs require skilled workers to operate their businesses effectively. However, they often struggle to attract and retain skilled workers due to a lack of competitive compensation and benefits.
Technology Adoption: Many MSMEs are slow to adopt new technologies, which can put them at a disadvantage compared to larger companies. This can make it difficult for them to compete in the market and keep up with changing customer demands.
Regulatory Compliance: MSMEs are subject to a wide range of regulations, which can be difficult and costly to comply with. This can be especially challenging for smaller businesses, which may not have the resources to hire dedicated staff to handle compliance.
Addressing these challenges can help support the growth and success of the MSME sector.Developing innovative financial instruments can help cater to the unique needs of MSMEs in India. By addressing the challenges of collateral, supply chain financing, access to digital financial services, invoice financing, and credit guarantees, financial institutions can better serve the needs of MSMEs and support their growth and success. In order to increase formal credit flow to MSMEs, the sector must be swiftly formalised. To address these challenges, several programmes have been implemented like Udyam, the Open Credit Enablement Network (OCEN), and the Trade Receivable Discounting System (TReDs).The development of open-source digital platforms and ground-breaking initiatives like PM GatiShakti, the National Logistics Policy, and the Production-Linked Incentive (PLI) programmes are expected to boost the manufacturing output and shall further support economic growth.
Conclusion:
With a second-largest MSME base after China, the scope of small scale industries’ expansion and proactive collaboration is quite high.With low investment requirements, operational flexibility and the capacity to develop appropriate indigenous technology, MSMEs have the power to propel India to new heights. The importance of MSME in the Indian economy stands unparalleled compared to any other sector.The ambitious target of $5 billion economy with a 25% contribution from the manufacturing sector will require the MSME sector to play a pivotal role. In addition to the various facilitating schemes announced by the government to support the sector, ramping up investment into the sector will be crucial.In conclusion, MSMEs are a key driver of the Indian economy, and they produce excellent opportunity to Banks for their lending activity.