Analysis of SMEs in India

What are SMEs?

Small and medium enterprises (also SMEs, small and medium businesses, SMBs, and variations thereof) are companies whose headcount or turnover falls below certain limits.

The lack of a universal definition for SMEs is often considered to be an obstacle for business studies and market research. Definitions in use today define thresholds in terms of employment, turnover and assets. They also incorporate a reasonable amount of flexibility around year-to-year changes in these measures so that a business qualifying as an SME in one year can have a reasonable expectation of remaining an SME in the next. The thresholds themselves, however, vary substantially between countries. As the SME thresholds dictate to some extent the provision of government support, countries in which manufacturing and labor-intensive industries are prioritized politically tend to opt for more relaxed thresholds.

Definition of SMEs in Indian context

The MSMED Act 2006, which came into force w.e.f. 02/10/2006, defines the Micro, Small, and Medium Enterprises. As per the Act, the activities are classified into Manufacturing and Service Category. Initially, the MSMED Act 2006 had not defined the ‘Services Sector’ and RBI’s guidelines were awaited. However, subsequently RBI have defined the services sector and the activities that can be covered under the SME sector.

The following chart indicates the threshold investment levels for both Manufacturing sector (INVESTMENT IN PLANT & MACHINERY) and Services sector (INVESTMENT IN EQUIPMENT) for the above three categories of Manufacturing and Services Enterprises :

While calculating the investment in plant and machinery/equipment referred to above, the original price thereof shall be taken into account,irrespective of whether the plant and machinery/equipment are new or second hand.
In case of imported machinery/equipment, the following duty/charges/costs shall be included in calculating their value:

• Import Duty (not to include miscellaneous expenses such as transportation from the port to the site of the factory, demurrage paid at the port);
• Shipping Charges;
• Customs Clearance charges; and Sales Tax or Value-added Tax. Cost of the following plant & machinery/equipments etc would be excluded:;
• equipments such as tools, jigs, dies, moulds, and spare parts for maintenance and the cost of consumable stores;
• installation of plant &machinery;
• research and development and pollution control equipments;
• power generation set and extra transformer installed by the enterprises as per the Regulations of the State Electricity Board;
• Bank charges and Service Charges paid to the National Small Industries Corporation or the State Small Industries Corporation;
• Procurement or Installation of cables, wiring bus bars, electrical control panels (not mounted on individual machines)
• Oil circuit breakers or miniature circuit breakers which are necessarily to be used for providing electrical power to the plant and machinery or for safety measures;
• Gas producer plants;
• Transportation charges (other than sales tax or value-added tax and excise duty) for indigeneous machinery from the place of their manufacture to the site of the enterprise);
• Charges paid for technical know-how for erection of plant machinery;
• Such storage tanks which store raw materials and finished products only and are not linked with the manufacturing process;
• Fire-fighting equipment; and
• Such other items as may be specified, by notification from time to time.

In case of Service Enterprises, the original cost to exclude furniture, fittings and other items not directly related to the services rendered. Land and Building would also not be included while computing the machinery/equipments cost.
SME would be meant to include Micro Small and Medium Enterprises (MSMEs). The above definitions of Micro, Small and Medium Enterprises would be in place of the existing definitions of Small & Medium Industries and SSSBEs/Tiny Enterprises.

• Micro Enterprises would include Tiny Industries also.
• Small Enterprises (Manufacturing) would mean Small Scale Industries (SSIs).
• Medium Enterprises (Manufacturing) would mean Medium Industries (MIs).
• Small Enterprises (Services) and Medium Enterprises(Services) would mean other Small & Medium Enterprises.
  Thus, SME Advances would be categorised as under:
• All advances to segments viz. Micro, Small and Medium Enterprises in the Manufacturing sector irrespective of sanctioned limits, (including advances against TDRs/Govt. Securities etc for business purposes to these categories of Borrowers), and
• Advances to Services Sectors such as Professional & Self-Employed, Small Business Enterprises, and Small Road/Water Transport Operators and other enterprises,
  – engaged in providing/rendering of services,
  – conforming to the above investment criteria and
  -enjoying borrowing/non-borrowing facilities with the Bank (including advances against TDRs/Govt. Securities etc for business purposes to these categories of Borrowers).
• Those enterprises exceeding the investment ceilings would be categorized as Large Enterprises and be outside the purview of SME.
• The sanctioned limits would no longer be the criteria determining the status as micro or small or medium enterprises in these cases.
• Reserve Bank of India has since reviewed the definition on Priority Sector and have issued revised guidelines on lending to Priority Sector vide their Master Circular dated 2nd July, 2007. As per this circular Retail Trade is excluded from the activities classified as SME.

(Source: www.bankofindia.com)

Importance of SMEs

Small and medium-sized enterprises (SMEs) are the backbone of all economies and are a key source of economic growth, dynamism and flexibility in advanced industrialized countries, as well as in emerging and developing economies. SMEs constitute the dominant form of business organization, accounting for over 95% and up to 99% of enterprises depending on the country. They are responsible for between 60-70% net job creations in Developing countries. Small businesses are particularly important for bringing innovative products or techniques to the market. Microsoft may be a software giant today, but it started off in typical SME fashion, as a dream developed by a young student with the help of family and friends. Only when Bill Gates and his colleagues had a saleable product were they able to take it to the marketplace and look for investment from more traditional sources.

SMEs are vital for economic growth and development in both industrialized and developing countries, by playing a key role in creating new jobs. Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Many small businesses start out as an idea from one or two people, who invest their own money and probably turn to family and friends for financial help in return for a share in the business. But if they are successful, there comes a time for all developing SMEs when they need new investment to expand or innovate further. That is where they often run into problems, because they find it much harder than larger businesses to obtain financing from banks, capital markets or other suppliers of credit.

Boosting industrial growth

By enhancing existing capacities, and by delivering cost-efficient goods and services as per the requirements of the local markets, SMEs have been driving industrial growth.

Inspiring Consumption and Social Change

SMEs play a defining role by offering reasonable, yet revolutionary goods and services to cater to the changing market requirements. Currently, SMEs have made its presence felt in areas like education, medical care, transportation, entertainment and local infrastructure development.

Minuscule investment

SMEs need low capital investment, in terms of per unit of output

Increased Employment Opportunities

SMEs generate both direct and indirect employment opportunities, in 2006-07, for instance, for every ten million rupees invested by the SME sector spawned employment opportunities for over 150 people. However, the same amount of investment carried out by the overall economy generated employment for just 37. 4 people. As per Government statistics in 2007-08, SMEs generated employment for 31.25 million people.

Fuelling the local economy

SMEs make use of natural resources and domestic skills to cater to the domestic market. The growth of SME sector also helps in socio-economic upliftment as it generates employment opportunities for untapped masses, living in urban and rural regions.

Discourages migration to urban areas

SMEs are synonymous for entrepreneurship. And the best part being setting up an SME doesn’t include much risk. If SMEs generate employment opportunities in rural and semi-urban areas, migration to urban areas can be stemmed to a great extent.

Transition from Agriculture Economy to Service-oriented one

SMEs can play a crucial role in achieving the transition from a dominant agricultural economy to a service oriented economy, akin to Japan. Japan’s agricultural workforce has gone done from 68 percent to 4.9 percent, in case of United States, from 44 percent to 9 percent.

Further, Indian agriculture sector can no longer generate extra employment opportunities to meet the requirements of the ever-growing population. In such a situation, only SMEs can come to the nation’s rescue.

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.

The Indian Context

The micro, small and medium enterprises (MSME) sector contributes significantly to the manufacturing output, employment and exports of the country. It is estimated that in terms of value, the sector accounts for about 45 per cent of the manufacturing output and 40 percent of the total exports of the country. The sector is estimated to employ about 42 million persons in over 13 million units throughout the country. Further, this sector has consistently registered a higher growth rate than the rest of the industrial sector. There are over 6000 products ranging from traditional to high-tech items, which are being manufactured by the MSMEs in India. It is well known that the MSMEs provide the maximum opportunities for both self employment and jobs after agriculture.

Recognizing the contribution and potential of the sector, the definitions and coverage of the MSE sector were broadened significantly under the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 which recognized the concept of “enterprise” to include both manufacturing and services sector besides, defining the medium enterprises. For collecting and compiling the data for the MSME sector (including khadi, village and coir industries), the Fourth All India Census of MSMEs with reference year 2006-07, is being conducted in the country. The Census will provide the first database on the MSME sector after the enactment of MSME Development Act, 2006.

PERFORMANCE OF MSEs

As per the quick estimates of 4th All-India Census of MSMEs, the number ofenterprises is estimated to be about 26 million and these provide employment to an estimated60 million persons. Of the 26 million MSMEs, only 1.5 million are in theregistered segment while the remaining 24.5 million (94%) are in the unregistered segment. The State-wise distribution of MSMEs show that more than 55% of these enterprises are in 6 States, namely, Uttar Pradesh, Maharashtra, Tamil Nadu, West Bengal, Andhra Pradesh and Karnataka. Further, about 7% of MSMEs are owned by women and more than 94% of the MSMEs are proprietorships or partnerships. In view of the MSME sector’s role in the economic and social development of the country, the Government has emphasized on its growth and development. It has taken various measures/initiatives from time to time which have facilitated the sector’s ubiquitous growth. No discussion on MSMEs can be complete without a full treatment of the unorganized sector in which enterprises are typically established through own funds or funds obtained through non-institutional sources, they lack managerial bandwidth, do not have established channels for marketing and are centered around a single traditional technology. More than 94 percent of MSMEs are unregistered, with a large number established in the informal or unorganized sector. The National Commission for Enterprises in the Unorganised Sector (NCEUS) defines unorganized sector as enterprise employing less than 10 workers. It has estimated such enterprises at 58 million with employment generated of 104 million persons. Of these, more than half the workers are classified as ‘self-employed’. A large segment in this universe of self-employed consists of those who are engaged in non-farm activities. This segment predominantly consists of own account enterprises, i.e., where there are no hired workers and are run by self with or without the help of unpaid family members. The own account enterprises can be distinguished into those running within households and those outside the households. The household enterprises operate on the basis of family labour – organizing production on its own, acquire its own raw material, use its own machinery and tools and market its products. Apart from own account enterprises, this segment also consists of enterprises having hired workers between 2 to 9. Very often, these enterprises are located in clusters but function independently without inter-firm linkages.

The Office of the DC (MSME) provides estimates in respect of various performance parameters relating to the Sector. The time series data in respect of the Sector on various economic parameters, is incorporated in the following Table: –

MSEs Performance: Units, Investment, Production, Employment &

Exports

• The figures in brackets show the % growth over the previous year.
• Projected

COMPARISON OF THE MSE SECTOR WITH THE OVERALL INDUSTRIAL SECTOR:

The MSE sector has maintained a higher rate of growth vis-à-vis the overall industrial sector as would be clear from the comparative growth rates of production for both the sectors during last five years as incorporated in the Table given below: –

Comparative Growth Rates

CONTRIBUTION OF MSEs IN THE GROSS DOMESTIC PRODUCT (GDP)

EMPLOYMENT IN MSE SECTOR

The total employment from the MSE sector (including SSSBEs) in the country as per the Third All India Census of MSEs with reference Year 2001-02 was 249.33 lakh numbers. The units operating with fixed premises are treated as MSEs. As per the estimates compiled for the year 2007-08, the employment was 322.28 lakh persons in the sector. The share of MSEs in the total employment among units engaged in manufacturing and services is around 34.93%.

Challenges faced by smes

Mentoring & Advocacy

Even today, most small business in India are set up by first generation entrepreneurs. They often have a product or service idea, some money, a zest to hard work but limited knowledge about markets, Government or bank procedures, cash flows or how to manage labour. This is where mentoring a hand holding support becomes crucial. At times, this comes from an individual such as friend, relative, an NGO or a parent unit. This is episodic and unable to meet the vast requirement which the country has. This is sought to be institutionalized through extension/outreach efforts of central and state Governments. Trained manpower is made available for this task, right down the district levels, to act as the friend, philosopher and guide. These resource persons guide in setting up a evit, making it commercially viable, interacting with financial institutions and understanding markets, as well as the impact of globalisation with advancements in it. There is a strong more towards linking SMEs with bigger commodity or supply chain and providing acceptable quality and delivery schedules. The Central Government’s agency for the task, the Small Industry Development Organisation, has accordingly moved away from its pre-reform regulatory to a direct promotional role of hand holding, advocacy and facilitation. This encompasses the legislative support put in place, fiscal incentives and protection from unequal competition.

Credit

Credit is the lifeline of business. Small businesses lack access to capital and money markets. Investors are unwilling to invest in proprietorships, partnerships or unlisted companies. As risk perception about small businesses is high. So is the cost of capital, institutional credit, when available, requires collateral which in turn makes the owner of the unit even more vulnerable to foreclosure. Credit guarantee funds which assist lending institution in advancing loans or mutual guarantee systems involving common guarantees from a group of people have not emerged in a significant manner. Unit finances comes under severe stress whenever an occasional event such as a large order, rejection of consignment, inordinate delay in payment occurs. The common stereotype about a banker lending an umbrella in sunshine and wanting it back as soon as it rains, gets reinforced in their dealing with small enterprises. It is, therefore, not surprising, that small enterprises prefer to first tap own resources or loans from friends and relatives and theres look for external finance.
In India, many of small manufacturing enterprises do not access bank finance and only about 16% of total bank credit finds its way to the sector. Despite being a priority sector for lending, small manufacturing enterprises get just about 8% of their annual turnover as working capital requirements, as against normative requirements of 20%. Even for this, cost of credit is high. The problem is recognized and is sought to be addressed through various ways:

• Establishment of ISO 9000 certified, specialized SSI bank branches in districts/clusters.
• Directive for working capital finance @ 20% of annual normative turnover.
• Waiver of collateral requirements upto Rs. 0.5 million.
• Setting up of a credit Guarantee Trust to cover loans upto Rs. 2.5 million.
• Composite loans from a single agency upto Rs. 2.5 million.
• A national equity fund for equity to SSI units at 5 percent service charge

Technology

As mentioned earlier, small enterprises are often regarded for their labour intensity and the capability to work with local resources. In the part, this has often led to less emphasis on technology. Run of the mill technology coupled with functional packaging and inadequate finishing have at times led to small sector products being labeled as being of poor or substandard quality. This has a cascading impact on competitiveness. As small enterprises realize the need to link up with large ones, they are having a relook at technology options which would improve productivity, effectiveness and competitiveness. While sourcing technology, small business need to concentrate on the following essential issues:

Information about Technology

For small units information about technology options is often through word of mouth or from a visit to an advanced unit. With the advent of internet, new vistas are opening up through electronic journey catalogue downloads and advanced search facilities. The technology bureau for small enterprise promoted with the assistance of the UN offers access to databases and information on technology. Technology intervention in clusters offers near by units an opportunity for a look and feel of advanced technology entrepreneurs are also assisted to participate in overseas trade fairs to update tem with latest worldwide. Tool rooms, testing centres, production-cum-process centres and workshops also assist in this task.

Actual procurement of technology

Barriers to import technology, technology transfer issues, vendor capability, after sales support, import procedures impede procurement. In India, the Asia Pacific Centre to Transfer of Technology promotes match making between buyer and seller and facilities procurement through escort services. Encouragement to import of capital goods has also helped.

Finance for Technology upgradation

Small enterprises look to external sources of funding for upgrading technology as withdrawing money from business entails its own costs. In India, a technology upgradation and modernization fund and a hire purchase scheme attempts to meet this requirement. These are however, funds at normal lending costs. A new scheme called the credit linked capital subsidy scheme, for reducing the cost of funds, has now been put into place.

Market Access

In today’s world, small enterprises can hardly match the adventising support or distribution reach of a large corporation. In India, small units sell best in limited or neighbourhood markets or when they are meeting a low volume specialized demand which no large player can effectively caterto. Increasingly, now the endeavour is to build the marketing activity of small units around their competitive advantage i.e., products which are labour intensive, items which cater to niche markets, low volume high margin products, sub assembly tasks, outsourcing jobs and ancillarisation. Sub-contracting exchanges are being established through Government and Industry associations to promote such interface. After sales service for imported products, AMCs on electronic equipment, reverse engineering (to the extent that it is WTO compatible) are the other areas being encouraged, sophisticated marketing is a task best left to large players. Small enterprises in India are realizing that the term “marketing” perhaps implies different things to different people for new SME businesses, head on competition with established giants makes little sense.

Infrastructure

Small units have traditionally operated from homes or a neighborhood work shed. Slowly, they began moving out and clustering together wherever electricity, water, raw materials, markets or labour were easier to access. Policy makers in India had anticipated the need for suitable infrastructure five decades ago and began a programme for setting up industrial estates. Non-assessment of economic viability, tardy implementation and poor maintenance due to drying up of funds affected these adversely. Later in the post reform period, the problem was sought to be addressed by setting up of such estates exclusively for small business. Almost 50 such estates have been set up. Because of their better infrastructure such as roads, telecommunication, power, effluent treatment plants, power, banks, watch & ward, and reasonable cost, they have proved to be popular with small manufacturing for factory accommodation, allotment of sheds on hire purchase as well as outright sale etc. A concerted move has also now been initiated for upgrading existing estates.

Globalisation

The globalisation of trade & commerce has been given a push by agreements in the WTO and changed the business environment. It has therefore become necessary to sensitise SMEs about these changes and prepare them for the future. In India, a number of steps have been taken in this regard. Apart from setting up a WTO cell in the nodal ministry, 28 sensitization workshops were conducted across the country. Workshops have also been held on intellectual property rights and bar coding. Monitoring of imports in specific sectors where SMEs hae a significant presence and initiation of anti-dumping action where dumping was noticed, are the other steps taken in this respect.

Procedures

Government and bank procedures coupled with inspections remain a major hurdle in growth of small units. There are over 60 central, state and local laws which regulate small businesses in the areas of labour, factory maintenance environment, municipal bye laws, taxation, power etc. These require the maintenance of as many as 116 registers and forms. To enforce these, there is an army of inspector who visit units leading to harassment, delay, obstruction and increase in cost of production. Many small units are one man shows and cannot satisfy the letter of the law. The streamlining of such rules and regulations has become necessary if the creative genius of Indian entrepreneurs is to be fully unleashed. Some state governments have exhibited initiative in this regard. The Central Government has initiated a study to enact a single law for small businesses. This enactment should ease the situation considerably.

Exit Mechanism

Like products, Industries too have life cycles. There are industry segments which have seen their best days. Similarly, there are individual units where no amount of additional funds will help. Their bank loans have become bad and non performing. A sound exit policy which also safeguards labour interests has therefore, become necessary. It is anticipated that as of 1998, over Rs. 3.8 billion were locked in sick/weak units. An exit policy would help fresh circulation of a significant amount. The first steps in this regard have been taken recently by India’s central bank where by one time settlement of dues as on 31 March, 1997 was allowed. The results have been encouraging.

Strategy Interventions for Revitalisation and Growth

Significant charges in economic environment are being heralded in by the WTO. The removal of QRS has led to increased competition with imports. Many sectors of industry are facing competition from Chinese or Taiwanese imports within the country or from Bangladesh Srilanka or Nepal in export markets. It is the belief of the Indian Government that promotion and not protection is the answer to the issues of survival and growth. Thus, while reservation of items for exclusive production continues, the focus must now be on strengthening capabilities. This implies a holistic look at the concerns of industry. As part of this, the following strategic interventions have been initiated

1. Easing access to general credit
2. Introduction of options of limited partnership and factoring
3. Subsiding cost of finance for upgrading technology
4. Industry specific technology upgradation programmes
5. Fund for developing and accessing overseas markets for export
6. Expanding reach of infrastructure programmes
7. Ushering in a regime of self certification in lien of inspections for various regulations

Interventions in the future require that hurdles to growth are removed. They must encourage a seamless movement from small to medium to large. The Indian Government, therefore, is working on a new vision for the SSI sector through a flexible approach and a motivated team. The advocacy role of Government now involves new dimensions such as building up and arguing cases before the world trade body or dispute redressal for a, articulating needs of small enterprises before decision makers and other agencies. Credit is increasingly being made available at international rates. Technology upgrades at both the cluster and the individual level are being assisted. Cluster level technologies will be at Government cost with only user charges recovered credit guarantee scheme has been put in place if our market has opened up to due to WTO, we need to enable our small units established foot holds in new markets opened up for then by globalisation. Thus, along with improving quality, they are being given the opportunity of over seas travel, conducting market surveys, test marketing etc. The existing industrial centres are being revamped by involving industry associations with some government assistance and finally a migration from sunset industries to sunrise industries is being encouraged through a comprehensive and graceful exit policy, which balances interest of labour with those of the owners.

Conclusion

The singular contribution of SMEs is on account of their unique characteristics. Their role in economic activity is manifest in both tangible and intangible ways. If this contribution is to be sustained, then their uniqueness needs to be nurtured in an overt and explicit manner. The Indian experience has shown that it is possible to design targeted interventions be they area specific like clusters or be they sector / sub-sector or product-specific. Other countries, be they Asian or OECD, also have policies which aim at similar support. The need of the hour is for us to learn from each other, drawing upon experiences and identity” “best practice policies”. These in turn have to meet local conditions and circumstances. A “one size fits all” approach will not work. Nevertheless, there can be no two opinions about the priority that SME policies deserve for achieving the socio-economic goal of employment growth and social justice, along with the individual “aspirations”.

Recent Government Policies and Measures

In addition to the growth potential of the sector and its critical role in the manufacturing and value chains, the heterogeneity and the unorganised nature of the Indian MSMEs are important aspects that need to be factored into policy making an