MSME Sector- Growth,

Challenges & Opportunities

Analysis and Report by Resurgent India

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CHALLENGES

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Lack of adequate and timely finance for SMEs

High cost of credit

Contents

Message from the desk of Sh. Jyoti Gadia, Resurgent India

MSME Sector Overview

MSME Sector Opportunities

ESDM, IT& ITeS, Pharmaceuticals, Automotive

Auto Components, Railways, Defense, Textile, Other Sectors

MSME Sector Challenges

Government Support and Policies

Key Considerations/ imperatives for MSME growth

Conclusion

Message

The MSME sector contributes in a significant way to the growth of the Indian economy across the realms of production system, employment generation, national output, exports etc. The MSME Sector comprises of approximately 48 million units that produce more than 6,000 products ranging from traditional to high-tech items. The sector is driving sustainable growth in Indian economy by providing employment to around 111 million people, accounts for 45% of the manufacturing output, 40% of the country's exports and contributes 8-9% to the country's GDP. ‘Make in India’ campaign is driving various initiatives at national, state and district level that are enabling growth and development of the MSME sector. Further, MSMEs are on course to make significant impact in the area of indigenization, with both domestic and foreign companies investing in the ‘Make in India’ initiative. MSMEs are increasingly focusing on securing investment and technical know-how from foreign firms, which on the other hand, would be willing to leverage existing networks / resources of the MSMEs to get higher returns on investment. The Indian MSME segment has the potential to emerge as a backbone for this economy and act as an engine for growth, given the right set of support and enabling framework. To flourish, MSMEs need a conducive business environment, adequate basic infrastructure, access to funding at reasonable rates, equity and venture capital, advisory assistance, knowledge about market opportunities and market linkage avenues. To achieve this, Government and Industry must make collaborative efforts to create a supportive ecosystem for MSMEs. We hope the report manages to touch upon all pertinent topics for the industry, to be taken forward for larger deliberation and action. Jyoti Prakash Gadia Managing Director Resurgent India Limited

MSME Sector Overview

Introduction

Micro, Small and Medium Enterprises (MSME) sector is a significant contributor to the

economic growth of the country. It not only acts as the backbone of manufacturing,

agriculture & engineering and services, but also is among the top employment

generating sectors. Being complementary to large industries, it contributes enormously

to the country’s GDP besides fostering the entrepreneurial spirit. Today, the sector

produces a wide range of products, from simple consumer goods to high-precision,

sophisticated finished products; demonstrating high growth potential and stake in

manufacturing and value supply chain.

The sector is characterized by low investment requirement, operational flexibility and

location wise mobility. This enables providing employment at lower capital cost and

also helps in correcting regional imbalances through industrialization of rural and

backward areas, towards an efficient and inclusive growth model.

MSME Characteristics

1. Number of Units: As per the last MSME Census, the latest projected estimate for

2013-14 is 488.5 lakhs. Majority of the units are categorized as Micro

enterprises. In terms of manufacturing and Service based MSME, the split is 32

and 68 percent respectively.

2. Registered Units: As per the last MSME Census estimates, only about 6 percent

of all units represent registered.

3. Leading MSME Industries: Retail followed by Professional Services constitute

about 40% of the MSME sector. Manufacturing comes next at about 12%.

361.8 377.4 393.7 410.8 428.7 447.7 467.6 488.5

0.0

100.0

200.0

300.0

400.0

500.0

600.0

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14

Working Enterprises

Source : Zinnov Research

Role and Importance to Economy:

1. MSME Share of GDP: MSME Annual Report 2014-15 pegs the estimated

contribution of MSME sector to GDP at around 8 per cent. Details below:

MSME Share in

total GDP (%)

2006-

07

2007-

08

2008-

09

2009-

10

2010-

11

2011-

12

2012-

13

Manufacturing 7.73 7.81 7.52 7.45 7.39 7.27 7.04

Services 27.40 27.60 28.60 28.60 29.30 30.70 30.50

TOTAL 35.13 35.41 36.12 36.05 36.69 37.97 37.54

Source : Annual MSME Report, 2014-15

2. Employment Contribution: Similarly for the Employment figures, the latest

Annual Report for MSMEs puts the projected estimate of employment at 1114.29

lakh, having grown at a CAGR of 4.7% over a period of 7 years ending 2013-14.

This is projected data for upwards of 2007-08.

20.0

12.0

19.010.0

9.0

8.0

8.0

6.08.0

Market by Vertical

Retail

Manufacturing

Professional Services

Hospitality

Education

Travel

Real Estate

Logistics

Others

805.2 842.0 880.8 921.8 965.2 1011.8 1061.5 1114.3

0.0

200.0

400.0

600.0

800.0

1000.0

1200.0

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14

Employment (in lakhs)

35.0

8.011.06.0

40.0

Product level share of exports for MSME

Pearls, Gems, Jewellery,Metals, Coins

Electrical & ElectronicsEquipment

Articles of Apparel

Pharmaceuticals

Others

Corresponding to increase in GDP contribution, there is a potential to

employment contribution to over 50 percent over the next decade as per KPMG

estimates. It will be critical for more units to come under the registered umbrella

of MSMEs, wherein growth incentives like direct benefits could be helpful.

Globally, employment generated by MSME as a percentage of overall

employment ranges from 15% (Argentina) to about 90% (Canada). Current

MSME employment is under 30 per cent of the overall employment for India.

3. Share of Exports: Exports are critical for the health of any economy by

influencing the level of economic growth and balance of payments. Exports help

earn prized foreign exchange, correct fiscal deficit, create self-sufficiency and

strengthen global branding and competitiveness. The government is focusing on

improving ease of doing business for MSMEs to increase exports from the

country.

The share of MSMEs in India’s total exports was estimated to be over 40 percent

in the last 3 years as per MSME Annual Survey 2013-14. As per Directorate

General of Commercial Intelligence and Statistics (DGCI&S) data, the total

exports from Micro, Small and Medium Enterprises (MSME) sector have been

provisionally estimated as:

Year MSME Exports (USD Mn)

2010-11 1,11,403

2011-12 1,31,483

2012-13 1,28,162

Details on sector split provided below:

Source: Share of MSME Exports – Ministry of MSME, Annual Report 2013-14

The current contribution reiterates the role of MSMEs in shaping economic

development of the country. While globalization has increased the competition

levels for MSMEs, it has also opened multiple avenues to shore up the growth of

the manufacturing sector. There is huge potential to diversify the export basket

and regional coverage.

Building competitive export quality also helps build self-reliance. Currently, the

country is heavily dependent on imports. While imports of crude are inevitable,

the government schemes are helping build self-sufficiency via incentivizing

investments across consumer goods and electronics, high engineering,

healthcare, automotive, defense, electronics and telecom industries. Further,

with the on-going government thrust on awareness and marketing of ‘Make in

India’ brand, schemes for MSMEs are in place to be benefited from.

MSME Sector Opportunities

MSMEs can target to increase their share in the top industry sectors by leveraging the

growth trends in these sectors. Some of them have been mentioned below -

The Electronics Systems Design and Manufacturing industry (ESDM)

The Electronics Systems Design and Manufacturing industry (ESDM) consists of four

key components- electronics products, electronics components, semiconductor design

and electronics manufacturing services. The market size of the Indian ESDM industry is

estimated at USD 80 Bn in 2014 and is expected to reach a size of USD 220 Bn by 2020.

MSMEs form the backbone of the ESDM sector not just in India but also in countries like

Taiwan, Japan, South Korea, China and Germany. Providing a favorable environment to

develop MSMEs can greatly contribute to high value-added indigenous ESDM sector.

Over the years, the government through its policies has aimed at promoting the growth

of MSMEs in the ESDM sector. The launch of National Policy on Electronics (NPE) is a

notable step towards this objective. Further, it has been proposed to establish a

‘National Electronics Mission’, a nodal agency for the electronics industry, to enable

MSMEs to play a role.

The Union Budget 2016 has introduced several changes to benefit the MSMEs in the

ESDM sector. Most of the changes are in the indirect tax structure aimed to strengthen

local manufacturing of electronics especially in the IT Hardware and mobile phones. A

number of duties have been rationalized to promote local manufacturing of a wide

range of products such as charger /adapters, battery, wired headsets/speaker, routers,

modems, set top boxes, digital video recorder (DVR), NVR, CCTV cameras, Microwave

Ovens and other electronic products. For instance, the government has imposed duty on

electronic products like charger /adapters, battery, wired headsets/speakers for

manufacture of mobile phone and waived duty on inputs / components / parts used to

manufacture them. This brings opportunities for existing MSMEs and encourages new

players to engage in local production of such products. Further, the MSMEs can also

explore opportunities in manufacturing of electronic devices needed by armed forces,

low-cost consumer electronics, consumer durables, Nano electronics and

microelectronics.

IT/ITES sector-

The Indian IT industry has witnessed phenomenal growth over the past decade, rising

from a market size of USD 63 Bn in 2008 to USD 118 Bn in 2014. The IT MSME sector

accounts for around 15% of the overall IT/ITES sector. The market size of the IT MSME

sector has grown from USD 7 Bn in 2008 to USD 18 Bn in 2014 and is expected to grow

at a CAGR of 17% to reach a market size of USD 45 Bn by 2020. The IT MSME segment

has played a vital role in India's transformation from a mere cost effective destination to

an innovation center.

The increasing spends across sectors such as BFSI, government, retail, education and

healthcare, will continue to offer opportunities to IT MSMEs. As per the current trends,

increasing number of IT MSMEs are developing solutions to seize the opportunities

presented in the social, mobile, analytics and cloud space. The emerging business need

to reach out to diverse consumer segments for marketing & communication / branding

via social media offers significant opportunities to IT MSMEs to develop IT solutions to

address this requirement. Further, the rapid growth in smart phone users and

increasing trend of Bring Your Own Devices (BYOD) trend in enterprises offers

opportunity to IT MSMEs to develop products in the enterprise mobility space. With the

exponential increase in capturing data and rise of social media and multimedia activity,

growing number of businesses are looking to leverage data for business insights and

value. As a result, increasing number of IT MSMEs are adding data analytics in their

service portfolio. Finally, the growing demand for cloud services has led to increasing

opportunities for the IT MSMEs. Several MSME players have already joined the

bandwagon of building and offering services in the cloud space to meet the rising

demand from industry verticals such as BFSI, healthcare, media and telecom.

Pharmaceutical sector-

MSMEs continue to play a significant role in the growth story of the Indian

pharmaceutical industry and form an integral part of the sector. They are expected to

contribute between 35-40 % to the industry in terms of production with a turnover of

about USD 7 bn. The country's pharmaceutical sector derives its strength from the

MSME sector, as it forms an essential part of the supply chain for the larger players.

MSMEs operating in the domestic pharma sector are recognized as the backbone of the

industry.

Majority of the MSMEs in this sector engage in manufacturing of formulations which

relate to medicines of mass consumption and therefore have a huge market. India is the

largest exporter of formulations with 14% market share and ranks 12th in the world in

terms of export value. Double-digit growth is expected over the next five years.

Essentially, MSMEs in the pharma sector are focusing on niche marketing, contract

research and manufacturing services including clinical trials, bio pharma, Generics and

API manufacturing, Nutraceuticals and nutra-cosmetics, etc. MSMEs have strong re-

engineering skills, which help them provide a low-cost yet high-quality value

proposition across various pharmaceutical business processes. Increasing opportunities

in the generics pharmaceutical market, both domestic and exports are fueling the

growth of this sector.

While traditionally the pharma MSMEs have been less focused on exports in comparison

to large domestic firms, however, lately, there has been a noticeable change in this

approach. MSMEs are increasingly becoming preferred partners for the supply of active

pharmaceutical ingredients (APIs) and finished dosages for Indian as well as foreign

pharmaceutical firms. Furthermore, supportive government policies such as National

Pharmaceutical Pricing Policy, 2012, and slew of tax and export incentives, coupled with

growing domestic and global demand will continue to provide immense opportunities

to pharma MSMEs and drive their future growth.

Auto Components Sector-

The Indian automotive industry is the sixth largest in the world. In spite of the volatility

in the automobile sector in the last few years, the auto component sector has grown

progressively in the last decade. The market size of the Indian auto component sector is

USD 40 billion, with a 28% share accounting in exports. Steady growth of exports in

this sector indicates the growing standing of the Indian auto components in the global

market place. Many Original Equipment Manufacturer (OEM) in the world are sourcing

auto components from India and this includes several big names like Ford, General

Motors, Toyota, Honda, Suzuki, Daimler, BMW, Volkswagen and Volvo.

MSMEs account for approximately 80% of the auto component industry in India and are

expected to play an even bigger role going forward. MSMEs will have immense

opportunities as the demand for auto components, both in the domestic and export

market is expected to grow continuously for the next few years. MSMEs can target to

build capabilities to seize opportunities in the growing electronic hardware market for

automobiles; an area which is currently dependent on imports. Supply of rubber and

chemicals to the tyre manufacturers is also an emerging prospect. Further, under the

Automotive Mission Plan 2016-26 announced recently by the Government of India, the

target for the auto component industry has been set at an impressive USD 200 billion in

turnover by 2026, with exports in the region of USD 80 billion. The achievement of this

ambitious target will require support and contribution from MSMEs.

While the MSMEs have been able to effectively leverage the advantage of low cost and

skilled engineering manpower so far, however in order to seize the opportunities going

forward, they will need to focus on prudent engineering for cost competitiveness,

innovation for product differentiation, and zero defect quality to meet the growing

needs of customers that are constantly looking for maximum value for money in a

highly competitive auto market. When the MSMEs develop a strong backbone, the entire

auto component sector will become globally competitive and contribute significantly to

the Indian economy.

Railway sector-

Indian Railways (IR) is an Indian state-owned enterprise, owned and operated by the

Government of India through the Ministry of Railways.

It is one of the world's largest railway networks comprising 115,000 km of track over a

route of 65,808 km and 7,112 stations. In 2014-15, IR carried 8.4 billion passengers

annually or more than 23 million passengers a day. In 2014–2015 IR recorded revenues

USD 24 Bn.

Essentially, Indian Railways has been a bulk buyer from MSMEs and provides several

opportunities to this sector. They are-

a) Manufacturing of coaches, diesel and electric locomotives and high speed bogies.

With the government looking to adopt SMART (Specially Modified Aesthetic Refreshing

Travel) coaches, MSMEs can explore opportunities for the production of automatic

doors, bar-code readers, bio-vacuum toilets, accessible dustbins, vending machines,

entertainment screens, LED lit boards for advertising, etc.

b) Procurement of components for manufacturing of locomotives. IR procures around

4500 locomotive components from MSMEs

c) MSMEs play a crucial role in electrification, development / construction and

maintenance of railway lines. As per the Union Budget 2016, the government plans to

complete 1,600 km of electrification this year and 2,000 km in the next year. MSMEs can

play a key role in this.

d) MSMEs can explore opportunities in manufacturing of CCTVs and other surveillance

equipment for installation at railway stations.

e) Manufacturing of electronic equipment for coaches such as GPS-based digital display

that shows upcoming stations and Track Management System (TMS) and WIFI

equipment such as router, modems, etc. for stations.

f) MSMEs can develop mobile applications for dealing / addressing ticketing issues /

receipt and redressal of complaints and suggestions through social media integration.

Defense Sector –

India has the third largest armed forces in the world and ~ 60% of the defense

equipment requirement is met through imports. There are about 6,000 MSMEs that

operate in the Indian defense sector. They comprise 20-25% of the supply chain to the

defense PSUs, Defense Research and Development Organization, Ordnance factories and

armed forces, supplying mainly components and sub-assemblies.

High government allocation for defense expenditure and the government policy of

promoting self-reliance and indigenization provide immense opportunities to the

MSMEs in the defense sector. The focus of the government is on enabling MSMEs for the

supply of equipment, machineries and high technology products and services related to

defense sector.

To develop the Indian defense industry, the government amended the defense

procurement and offset policies. The new policy provides larger opportunities and

greater benefits to the Indian MSMEs. Under the new defense procurement policy,

mandatory offset requirements of a minimum of 30% for procurement of defense

equipment in excess of INR 3 Billion have been envisaged.

The offset guidelines benefit MSMEs by allowing foreign vendors to select MSMEs as

their offset partners. Offsets give Indian MSMEs an opportunity to integrate into the

global aerospace and defense supply chain, absorb critical technologies and develop an

industrial and service delivery base locally.

Majority of the offset opportunity for MSMEs in India lies in engineering service

outsourcing (ESO), maintenance, repair and overhaul (MRO), enterprise resource

planning (ERP), information technology, control systems, research and development.

Opportunities also exist for MSMEs in the fields of avionics, military electronics, radar

electronics, electronic warfare, missile electronics and other similar segments.

As India's spending on defense procurement increases, MSMEs can look forward to

integrate themselves into the supply chains of Indian and international defense majors.

Textile sector-

The textile industry in India is currently estimated at USD 74 Bn and is expected to grow

at a CAGR of 8% to reach a market size of USD 107 Bn in 2020.

The Indian textiles industry has established its supremacy in cotton based products,

especially in the readymade garments and home furnishings segment.

The readymade garment segment is the principal driver of growth even in the domestic

industry. The changing preferences of Indian consumers -- from buying cloth to

readymade garments -- have prompted several companies to move up the value chain

into the finished products segment.

Within the textile industry, the MSMEs can seize the emerging opportunities in the

technical textile industry segment.

The technical textile industry is the fastest growing segment in the textile industry.

Technical textile comprises of products manufactured for technical performance and

functional properties rather than aesthetic and decorative characteristics.

Technical textiles are widely used in several sectors ranging from Agriculture to

Defense. The technical textile industry can be classifies into 12 segments based on end

user segments – agrotech, builtech, clothtech, geotech, hometech, indutech, meditech,

mobitech, oekotech, packtech, pretech and sportech.

The government is sharpening its focus on the textile sector, which is evident from the

imminent launch of the new textile policy. Driven by an enabling environment and

supportive government policies, the textile industry is expected to offer plenty of

opportunities to the MSMEs in the above mentioned segments.

Other sectors - While we have covered some sectors which offer growth opportunities

for MSMEs, there are few other sectors which promise significant growth potential.

They are Media, Healthcare, Telecom, Biotechnology, Transport and Logistics,

Engineering and Process equipment, Retail, Tourism and Hospitality, education, civil

aviation and Real estate.

MSME Sector Challenges

A deeper analysis of the building blocks to creating and sustaining competitive

advantage lead us to key constraints faced by the MSME Sector. Although Indian MSMEs

are a heterogeneous and diverse group, they face common set of problems, as detailed

below:

Marketing related –

With advent of globalization, the canvas has grown for MSMEs. They not only have to

produce and compete against the India’s best but also the MSMEs from around the

world to ensure they stand competitive in their mix. In India so far, small units have had

an edge in neighborhood/local markets or when they are meeting a low volume

specialized demand which no large player can effectively cater to.

Since the majority of India's MSMEs, especially the small businesses, are still anchored

in the local or neighborhood market; they rely on traditional media like telephone

directories and newspapers to reach their customer base.

The sector needs to be provided better market access facilities in order to sustain and

further enhance its contribution towards output, employment generation and exports.

There is massive headroom to diverse product portfolio and enhance market reach

through deployment of effective marketing tools and strategies:

a) Ineffective Marketing strategies - Limited understanding of new age

marketing strategies cripples MSMEs especially in smaller / Tier 3 towns.

Limited access to market intelligence and marketing tools such as packaging,

labeling, barcoding, brand building, advertisement, etc. limits the survival /

growth prospects of MSMEs. Further, lack of sufficient selling outlets and

adequate infrastructure is a key concern disrupting marketing of MSME products

to the remote parts of the country.

b) Limited Market access and inability to identify new markets - MSMEs are

primarily small family run businesses which mostly cater to domestic market.

They majorly rely on traditional media like telephone directory, customer

references and tenders floated in the newspaper to reach customers. It has been

observed that MSMEs do not respond efficiently to the evolving market trends

and innovations thereby lag behind mid and large players in the market.

c) Lack of innovation to develop new products with unique differentiators-

There is a growing need to innovate and develop products with unique

differentiators among the MSMEs to offset the rising threat from established

players and global counterparts in the marketplace. Over the years, MSMEs have

largely ignored R&D requirements and have not embarked on new product

development or technological up-gradation at the requisite pace. Though the

MSMEs realize the importance of technological innovation, most of them still

favor importing technology rather than in-house development.

d) Focusing on inherent strengths is a low-hanging fruit, not yet fully

leveraged –Building strategies around latent strengths to cover -- products

which are labor intensive, items which cater to niche markets, low volume high

margin products, sub assembly tasks, outsourcing jobs. 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.

Finance related – As per the 4th Census on MSMEs, only 5.2% of MSMEs availed credit

from financial institutions, which brings to fore systemic issues regarding:

a) Non-availability of timely and adequate funds at reasonable cost - The

banks are usually found to be averse to offer credit to the MSMEs for a several

reasons, the foremost of which originates from a wide-ranging perception that

the credit risk in lending to MSMEs is very high. Banks regard this sector as high

risk segment for different reasons like low capitalization, lack of appropriate

accounting records, and unavailability of complete financial statements and

business plans. Precisely because of this banks demand heavy collateral, charge

higher interest rates and transaction costs from MSMEs. The lack of adequate

collateral further hampers availability of funds to the sector and hinders their

competitiveness.

b) High cost of credit Interest Rates- Interest rates for non-collateral as well as

collateral backed loans to SMEs are often very high and at times prohibitive. The

reason is attributed to the high risk of lending to SMEs.

c) Non-conducive bank Policies towards lending to start-ups- It has been

observed that the Banks give undue significance to business vintage and financial

statements / track record to compute eligibility for loan. India has witnessed

significant surge in the number of start-ups in the last few years. Majority of

them fail to meet this criteria and hence, not able to meet the funding

requirements of banks.

d) Lack of sufficient collateral: Banks seek tangible assets to secure their loans

against default. MSMEs normally do not have sufficient collaterals to obtain debt

finance. MSMEs especially start-ups/early stage firms do not possess sufficient

collaterals, and in case they do, the personal assets do not meet the loan to value

norms of the bank. Lack of adequate collateral translates to lack of adequate

funds required for working capital and/or capital expansion which further leads

to a lower growth rate. In some of the cases, the entrepreneurs are mandated to

provide home/office premises/land as collateral to secure funds from the banks.

Banks typically ask for a collateral value of up to 150 per cent of the loan amount

sanctioned. For example, on a property value of INR 100 lakhs, the bank

sanctions a loan of INR 65 lakhs only.

e) Lack of equity support inhibits the growth of the MSME sector. Further, equity

also acts as a leverage for raising debt finance from Banks.

Limited Accessibility of VCs / Angel investors – It has been observed that

MSMEs find it difficult to initiate contact with the VCs and Angel investors

in the absence of a reference or a previous relationship. VCs typically show

greater confidence in the idea/concept if it is referred by a credible

source/contact. This problem is more profound in tier 2 / tier 3 towns.

Further, entrepreneurs in these locations are not aware of the

process/mechanism to reach out to VCs.

Funding norms not favoring early stage firms- Stringent conditions set by

VCs such as minimum funding criteria, expectation of high returns, detailed

documentation requirements and acquisition of substantial equity stake

are some of the key reasons deterring MSMEs from approaching VCs.

f) Lack of owners capital reduces eligibility to raise debt finance- It has been

seen that MSMEs typically bring in capital into the business from their own /

borrowed money from relatives, which is a normally a small amount. Lending

agencies are reluctant to fund when they discover lower risk /capital

contributed by the entrepreneur.

g) Difficulty in loan proposal evaluation and high transaction costs involved: -

It has been observed that several areas of MSME businesses are challenging to

evaluate due to lack of adequate information / absence of proper records. In

such a situation, it becomes difficult for the lending agencies to appraise the loan

proposal. Further, due to low level of technology adoption and poor record

keeping-keeping and lack of efficient systems and processes, the whole process

of evaluation of loan application is extremely resource intensive and costly for

the lending agencies.

Technology related –

Technology is one of the most important aspects in the sustenance of the MSMEs. The

personal competence of the entrepreneur can take the company uptill a performance

and sustenance level, post that when the competition increases and the market

expectations mount, the “totality” of the workings of the enterprise becomes crucial. At

this stage, use of information and communication technology becomes imperative for

the growth of SME, if not for survival. This also has cascading impact on

competitiveness:

a) Lack of awareness and skills limiting adoption - Low level of technology

adoption in the MSME sector driven by lack of awareness has been a major cause

of low competitiveness of the sector. For a country which boasts of strong IT

labor poll and world’s top most technology firms, the penetration of ICT in MSME

sector has been rather low. Consequently, large number of MSMEs misses out on

the greater benefits of increased efficiency, better market linkages, and improved

customer service.

b) Low levels of modernization and technological up-gradation - Due to their

small size family driven nature, MSMEs have low access to new technology and

face challenges in modernization and technological up-gradation. This leads to

cost inefficiency and poor quality products. These result in the manufacturing

processes being cost inefficient and of poor quality standards.

c) High Cost: Given the financial tightrope, IT budgets are generally very small. In

addition, adopting IT is not only a onetime cost because it also requires ongoing

costs of maintenance, upgrade and human resource. Cost concerns are

exacerbated by low awareness of devices and solutions, such as software,

systems and processes. As a result, micro and small businesses have little faith in

their return on investment.

d) Poor Infrastructure: Further, most of MSME clusters are around Tier-2, Tier-3

cities, which completely lack adequate information and communication

infrastructure, be it high speed broadband connectivity or basic power outages.

Legal and Tax related-

a) Low relevance and innefective implementation of legislation on

Intellectual property rights (IPR)

Low relevance of IPRs in raising funds- It has been witnessed that majority

of the MSMEs are unable to leverage IPRs to raise funding from VCs or

Banks in the absence of formal mechanisms for evaluating IPRs.

Ineffective implementation of legislation on IPRs has adversely impacted

innovation-driven MSMEs. In the absence of stringent laws protecting

inventions, MSMEs are unable to monetize their innovation, thereby

discouraging future innovation in products.

b) No mechanism for quick revival of viable sick units and speedy shutdown

of unviable ones- At present there is no formal mechanism for systematic

handling of sick units even though financial assistance by way of debt

restructuring for rehabilitation of sick MSE is provided by primary lending

institutions.

c) Bureaucratic hurdles in setting new business- Start-ups face a major

challenge in getting themselves registered. It takes anywhere between 15 and

30 days for a company to get incorporated.

Infrastructure Related --

a) Insufficient Physical infrastructure- For MSMEs, land and infrastructure

constraints are major problem areas, especially in bigger cities and metros. The

state and maintenance of infrastructure in industrial estates (mainly

maintenance of roads, drainage, sewage, power distribution and captive power

generation, water supply, dormitories for workers, common effluent treatment

plants, common facilities, securities, etc.) is poor and unreliable.

b) Low / Low Quality network infrastructure – Lack of quality virtual and mobile

connectivity also limits business potential, especially in Tier 2 and 3 cities. E-

commerce and ICT can further the business potential by opening international

reach, however the lack of presence of quality infrastructure and then awareness

is currently limiting the scope.

c) Constraints in modernization and expansion

Human Resource Related –

In this sector, a lot of small businesses tend to be set up by first generation

entrepreneurs. They come armed with a product or service idea, some money, lot of

passion but limited knowledge about markets and procedures, cash flows, organization

structures or labor management. This is where mentoring for the founder and

development of employees becomes crucial. At times, this comes from an individual or

an NGO or a government scheme. However, this is episodic and unable to cover the

regular and complete requirements.

a) Complex labor laws – Labor policies, especially multiplicity of labor laws and

procedures for compliance of various labor regulations have added to the woes

of the MSME sector

b) Non-availability of highly skilled labour at affordable costs- In spite of the

fact, that India enjoys favorable demographic dividend with large pool of human

resources in the productive age group, the industry continues to lack skilled

manpower required for manufacturing, marketing, servicing, etc. Large firms

who are targeting high growth rates scour the market for talent and MSMEs can

never outplay large companies in terms of salary. Once the employee is hired,

ensuring he matches the skill set required for the job and continues to develop, is

a tremendous ask.

c) Continued Skill Development for increased productivity – First, the issues of

attracting and training the right talent. Second, is the issue of ensuring the

employees are continued to be trained on the job and given higher

responsibilities as the organization grows. This requires rigorous training

calendars which becomes difficult for the MSMEs to make and follow for the lack

of specific expertise. Also, the MSMEs are so heterogeneous that for the

government to be able to map each skill set against different levels and industry

verticals becomes a challenge – both to plan and execute.

d) Poor corporate governance mechanisms and weak organization structures-

Majority of the MSMEs are owner driven with lesser inclination towards formal

organizational structures. There is one (or two) owner and selected few core

people working under them co-handling key functions like accounts, production

and sales. There is no established governance mechanism with any clear process

of functioning, workflow or instruction flow. The non-corporate structure and

small size of the majority of MSMEs makes the venture capitalists and other risk

capital providers reluctant to investing in them due to higher transaction costs

and difficulties in exits out of such investments.

Others-

a) Unduly delayed payments especially from large-scale buyers- This disrupts

the cash flows and the ability of MSMEs to divert funds towards capex

requirements and R&D.

b) Low awareness of Government schemes and programs – Limited and low

levels of knowledge on key government schemes restrict their ability to avail

benefits under them.

Government Support & Policies

Some of the significant government initiatives / schemes for development of

MSMEs have been summarized below:

1. Incubation Support schemes

a. Livelihood business incubator scheme aims to create jobs at local level

and reduce un-employment by creating a favorable ecosystem for

entrepreneurial development in the country. The main objective of

livelihood incubation center is to take up those commercial activities,

which are need based to create enterprises in the rural areas of the

country.

b. Technology business incubator scheme focuses on those technologies

which need support for commercialization and further proliferation. The

purpose of the scheme is to incubate technological ideas to enable them to

reach the market place. This scheme provides financial, technical and

marketing support to MSMES to enable them to achieve higher growth.

c. Support for Entrepreneurial and Management Development of SMEs

through Incubators- The Scheme aims to provide early stage funding for

nurturing innovative business ideas in select fields including electronics

and software. Under this scheme, financial assistance is provided for

setting up of business incubators. The objective of the scheme is to

promote development of knowledge based innovative start-ups and

improve the competitiveness and survival ability of the MSMEs.

2. Business development & promotion / Marketing Support schemes

a. Scheme to promote International Cooperation – This scheme offers

assistance to MSMEs for exploring new areas of technology infusion/up

gradation and identifying new markets through Joint ventures and foreign

collaborations.

b. Marketing Assistance scheme offers assistance to MSMEs for undertaking

marketing promotion activities. Under the scheme, MSMEs can avail

financial assistance for organizing exhibitions, trade fairs, buyer-seller

meets and other marketing promotion events.

c. MSME Market Development Assistance scheme offers financial assistance

to MSMEs for using Global Standards in barcoding. The scheme also has

provides funding to MSMEs for participation in the international

exhibitions / fairs, producing publicity material and sector specific

studies and for contesting anti-dumping cases.

3. Manufacturing support schemes

a. National Manufacturing Competitiveness Programme- The NMCP is the

nodal programme of the government of India to develop global

competitiveness among Indian MSMEs. There are 10 components under

the NMCP targeted at enhancing the entire value chain of the MSME

sector. It includes programmes like establishment of new tool rooms,

benchmarking of the global competitors, enhancing of product and

process quality, cost reduction through lean manufacturing techniques,

etc.

b. Lean Manufacturing Competitiveness for MSMEs aspires to enhance the

manufacturing competitiveness of MSMEs through the application of

various Lean Manufacturing (LM) techniques.

c. Enabling Manufacturing Sector to be Competitive through Quality

Management Standards and Quality Technology Tools – This scheme

seeks to encourage MSMEs to understand and adopt latest Quality

Management Standards (QMS) and Quality Technology Tools (QTT) in the

manufacturing process.

d. Design clinic scheme - The design clinic scheme is an initiative of the

Ministry of MSME and National Institute of Design. The main objective of

the scheme is to bring the MSME sector and design expertise onto a

common platform and to provide expert advice and solutions on real-time

design problems, resulting in continuous improvement and value addition

for existing products. This model brings design exposure at the doorstep

of industry clusters for design awareness, improvement, evaluation,

analysis and design-related intervention. It aims to enhance industry

competitiveness and productivity with the help of design intervention at

various functional levels.

e. Scheme of Fund for Regeneration of Traditional Industries (SFURTI) –

This scheme aims to develop and enhance the competitiveness of

traditional industries. The traditional industries are broadly categorized

into Khadi, Coir Based Industries and village Industries (including non-

timber forest produces, handmade paper, agro based goods, textiles based

products, etc. This scheme is implemented by the Ministry of MSME and

its organizations (Khadi and Village Industries Commission-KVIC and Coir

Board), in collaboration with State Governments, their organizations and

non-governmental organizations.

4. Finance and credit rating support schemes

a. Financial assistance from SIDBI – SIDBI has created a corpus Fund of INR

60 Cr for providing financial support to MSMES with special focus on

technology enterprises.

b. Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)

scheme was launched by the GOI in 2000 to strengthen credit delivery

system and facilitate flow of credit to the MSME sector. To operationalize

the scheme, GOI and SIDBI set up the Credit Guarantee Fund Trust for

MSMEs. The scheme provides collateral free funding up to INR 1 Crore for

individual MSMEs. The CGTMSE Scheme is operated through a network of

Banks and FIs called Member Lending Institutions (MLIs).

c. Credit Linked Capital Subsidy Scheme – This scheme aims at facilitating

technology up-gradation of MSMEs by providing 15 % capital subsidy for

purchase of Plant & Machinery / Improved technology. Maximum limit of

eligible loan for calculation of subsidy under the scheme is Rs.100 lakhs.

At present, more than 1500 well established/improved technologies

under 51 sub-sectors have been approved under the Scheme.

d. ISO 9000/ISO 14001 Certification Reimbursement scheme for MSMEs

offers reimbursement of expenses up to 75% (subject to a maximum of

INR 75,000) incurred towards the acquisition of ISO 9000/ISO

14001/HACCP certification.

5. R&D, IPR support schemes- IPR schemes were launched for building awareness

on IPRs so as to enable MSMEs to use the tools of IPR effectively for innovative

projects. The Ministry of MSME has set up an intellectual property cell which

provides a range of IP related services such as prior art-search, validity search,

patent landscape, studies on technology development, etc.

a. Building Awareness on Intellectual Property Rights scheme endeavors to

enhance awareness among the MSMEs about IPRs. Under this scheme,

financial assistance is provided for conducing awareness programs on

IPRs including seminars, workshops, training, etc. Additionally, it also

offers one time financial support limited up to INR 25,000 on grant of

domestic patent and INR 2 lakh for foreign patent to MSMEs.

6. Other MSME schemes / initiatives

a. National Small Industries Corporation (NSIC) Schemes

i. Credit Rating and Facilitation – This scheme aims to encourage

MSMEs to upgrade their competence in terms of business and

technologies by getting rated through the rating agencies

empaneled with NSIC. The scheme strives to establish

independent and trusted third party opinion on the capabilities

and credit worthiness of MSMEs so as to facilitate swift loan

approvals from Banks and FIs. Under the scheme, the MSME can

seek partial re-imbursement of the rating fee, if the credit-rating is

undertaken by an empaneled rating agency of NSIC.

ii. Raw Material Assistance scheme provides assistance to MSMEs by

way of financing the purchase of raw material (both indigenous &

imported).

iii. Single Point Registration scheme aims at increasing the share of

Govt. purchases from MSMEs. This scheme offers MSMEs a single

point of registration for participation in Govt. schemes. The units

registered under the scheme are entitled to special benefits such

as issue of tender free of cost, exemption from payment of Earnest

Money Deposit (EMD), etc.

iv. Bill Discounting scheme covers purchase/discounting of bills

arising out of genuine trade transactions i.e., sales made by

MSMEs to reputed public limited companies / State and Central

Government Departments.

v. NSIC Infrastructure scheme offers MSMEs – a) Enabling

infrastructure supporting business incubation b) Exhibition halls /

Complex in Hyderabad and New Delhi for organizing exhibitions/

conferences c) Office space to IT/ITES and non-IT/ITES MSMEs in

STP’s in New Delhi and Chennai

vi. Infomediary and Marketing Intelligence Services.

b. Prime Minister's Employment Generation Programme (PMEGP) was

launched to generate employment opportunities in rural as well as urban

areas through setting up of new self-employment ventures / projects /

micro enterprises. Under the programmed, beneficiaries can set up micro

enterprises by availing of margin money subsidy of 25% (35% for special

categories) of the project cost in rural areas.

c. Skill Development initiatives – To meet the challenge of skilling at scale

with speed and quality, the Ministry released the 'National Policy on skill

Development and Entrepreneurship 2015'. Ministry has also done 'Skill

mapping' and prepared a complete catalogue on skill requirements and

skill providers across the country.

d. Public Procurement Policy for MSMEs - The ministry of MSME formulated

the Public Procurement Policy for MSMEs, which mandates every Central

ministry/Department/PSU to achieve a procurement goal of at least 20 %

of the total annual purchases of the products or services, produced or

rendered by MSMEs. The policy seeks to promote MSMEs by improving

their market access and competitiveness through increased participation

in Government purchases and encouraging linkages between MSMEs and

large enterprises

In a move towards promoting ease of doing business, the MSME Ministry

has done away with the tedious process of submitting hard copies of

documents to avail benefits under several schemes. Now the MSMEs can

avail the benefits through the sites of the schemes by putting in the Udyog

Aadhaar Number along with the normal Aadhaar number. Some of the

schemes, whose benefits could now be availed online are Bar Code, ISO

Certified Subsidy Scheme; and Technology & Quality Upgradation Support

Scheme.

7. Union Budget 2016-17 highlights for MSME sector- The Union Budget for 2016-

17 introduced a series of policy initiatives to boost growth of Indian MSMEs.

Some of the significant initiatives have been summarized below –

a. No tax on income from Startups: In order boost economic growth and

employment a 100% deduction of profits for 3 out of 5 years for start-ups,

during April, 2016 to March 2019

b. Capital Gain Tax: The Long Term Capital Gains Tax has been a huge bone

of contention for the Startup community. While listed companies do not

attract LTCG beyond a holding period of 12 month, unlisted companies

attract 20% till a holding period of 3 years. Under the new norms, the

holding period has been reduced from three to two years to get benefits

of long term Capital Gain regime in case of unlisted companies.

c. One-day incorporation: The budget has proposed provisions that will

enable registration of a company in one day

d. Skilling India: To provide a boost to entrepreneurship, 1500 multi skill

training institutes across the country will be set up under the Pradhan

Mantri Kaushal Vikas Yojna.

e. MUDRA scheme: The Pradhan Mantri Mudra Yojna was launched for the

benefit of the bottom of the pyramid entrepreneurs.

f. Presumptive taxation scheme: Under the presumptive taxation scheme

under Section 44AD of the Income tax Act, the limit of turnover or gross

receipts has been raised to Rs. 2 crore from the exiting Rs. 1 crore rupees

to benefit about 33 lakh small business people. It frees a large number of

such assesses in the MSME category from the burden of maintaining

detailed books of account and getting audit done.

g. Service Tax exemption: Service tax on services provided under Deen

Dayal Upadhyay Grameen Kaushalya Yojana and services provided by

Assessing Bodies empanelled by Ministry of Skill Development and

Entrepreneurship are proposed to be exempted.

h. Government allocated Rs 500 crore for scheduled caste, scheduled tribes

and women entrepreneurs under the Standup India scheme. The scheme

is expected to benefit at least 2.5 lakh entrepreneurs in this category.

‘Make in India’, ‘Startup India’ and ‘Digital India’

The government's emphasis on 'Make in India', 'Start-up India' and 'Stand-up

India' is expected to strengthen Indian MSMEs and make them competitive.

'Make in India' initiative launched by the Prime Minister in 2014 is one of the

most aspiring and ambitious initiatives to raise India’s ranking up the global

value chain and make the country a promising global manufacturing hub.

Make in India initiative aims to increase the manufacturing sector

contribution in the Gross Domestic Product (GDP) from 14-15% at present to

25% by 2022. This provides an excellent opportunity for MSMEs across

several sectors including telecom, electrical, automobile, agriculture, bio

medical, paper, defense, aviation, satellite, etc, to establish unprecedented

place in the global value chain.

‘Make in India’ campaign is driving various initiatives at national, state and

district level and are enabling Indian MSMEs sector to galvanize their growth

and development. To make the campaign a success, the government is

pushing for a supportive framework through policy reforms so as to provide

holistic growth opportunities to SMEs.

Under the ‘Make in India’ initiative, the government has announced two

‘Startup India’ schemes:-

i. Self-Employment and Talent Utilization (SETU) - SETU is devoted to

strengthening incubators and setting up ‘tinkering labs’ where ideas can

be shaped into prototype before they are ripe for funding.

ii. Atal Innovation Mission (AIM) - AIM focuses on supporting aspiring

entrepreneurs to solve India’s contemporary socio-economic problems

The ‘Digital India’ revolution also provides a great opportunity to promote

MSME participation in the Information, Communication and

Telecommunication (ICT) sector, in line with the government vision.

Key considerations / imperatives

for MSME growth

Given the current economic scenario, some of the key considerations to drive MSMEs

into the next wave of growth have been summarized below:

Fostering a culture of entrepreneurship and of innovation - With India’s growing

importance in the global market place, there is a strong need for building a nationwide

entrepreneurial ecosystem and an innovation strategy for the domestic MSMEs to help

them compete at a global level.

A holistic and integrated focus on building a nationwide entrepreneurial ecosystem can

reform India’s socio-economic landscape in the next decade and enhance its socio-

economic dimensions of growth.

Entrepreneurship helps in developing solutions to several economic problems such as

poverty, employment, skill development, affordable health care, energy dependence,

urbanization and financial inclusion, etc.

Nationwide entrepreneurship development with appropriate scale and scope can

propel MSME growth to the next level.

Global studies have indicated a positive relationship between innovation and the

growth of MSMEs.

The principal sources of innovations are the academia, R&D organizations and

individual innovators.

In India, typically the MSMEs with innovative ideas often work in isolation. Many Indian

MSMEs innovate and offer new products and services that address a multitude of

problems, but such innovations are not institutionalized.

Cooperation and linkages between the MSMEs and R&D / academic institutions remain

low despite the several government initiatives aimed at strengthening the innovation

potential of the MSMEs.

A strong culture of communication between universities and MSMEs can play a critical

role in unleashing a country’s innovation potential.

Skills development: One of the thrust areas for increasing the competitiveness of

MSMEs includes skills development.

Skills development not only helps in improving productivity but also fosters

entrepreneurship.

Hence, it is imperative for the concerned governmental agencies, trade associations and

MSMEs to come together and discuss on how to make training programmers relevant

and attractive for MSMEs.

The lack of human resources has been a long-standing problem faced by MSMEs in the

country. Despite India’s large pool of human resources, the MSMEs continue to lack

skilled manpower required for manufacturing, marketing, servicing, etc.

Majority of the graduates passing out each face difficulties in getting employed in

MSMEs due to the lack of job / role specific skills.

Also, it has never been easy for MSMEs to hire the right workers at affordable prices.

Another area of concern is low focus of MSMEs on skills development.

Even though MSMEs are investing in infrastructure, technology and manufacturing

practices, development of skilled manpower still remains a major concern.

There is evidence that suggests that MSMEs that have invested in skill development

have witnessed better business performance.

Skill development programs with a blend of industrial engineering, quality

management, general management and soft skills can enable the MSMEs to reach the

next level of growth.

Create a business environment to support and nurture startups: It is imperative for

the policymakers to create an enabling business ecosystem that fosters

entrepreneurship.

Though some initiatives have already been taken in this direction, like the recent launch

of the Startup India mission, which is expected to make it easier for Indian

entrepreneurs to set up and run their new ventures.

The new startup policy also aims at providing funding support to MSMEs, with a corpus

of INR 10,000 crores already allocated for investment in start-ups over 4 years.

However, building a thriving ecosystem will require more action on the ground and

long-term commitment for improvement from the stakeholders.

Despite holding significant talent resource, the country is not able to churn out large

number of entrepreneurs due to the lack of a proper ecosystem.

There road to building start-ups in India needs to be improved. Risk taking should be

encouraged and entrepreneurs should be supported to overcome roadblocks.

Though the country boasts of several policies and schemes for skill development,

innovation, funding, etc., aimed at the MSME sector, there is low focus on the

implementation of such schemes, which is evident from the lack of proper records to

track the performance of such schemes. Information on the success / failure of the

schemes is not easily available.

A critical step towards developing a conducive business ecosystem, is to enhance focus

on implementation of schemes that target start-ups. This can be achieved by increasing

engagement between MSMEs and government bodies.

Start-ups and existing entrepreneurs should be encouraged to approach the designated

government bodies with innovative ideas, which will help them to translate the ideas

into a reality.

Generate employment opportunities for special segments such as women

workforce and physically challenged: Recognizing the importance of

entrepreneurship, and given the Indian government’s strong push on MSMEs with

priority to reserved classes, another deserving segment is the women-owned

enterprises.

The role of women entrepreneurs is critical for a thriving Indian economy. At nearly 3

million women-owned enterprises, they represent about 10% of all MSMEs in India and

employ over 8 million people.

Women entrepreneurship is mainly inclined towards smaller sized firms, as almost 98

percent of women-owned businesses are currently micro-enterprises. As per a recent

study, India ranks much lower than its global counterparts such as United States,

Canada and Australia, when it comes to opportunities for women to start

entrepreneurial initiatives.

Even though the government has launched some initiatives aimed at promoting women

entrepreneurship, the efforts need to be further strengthened to bring about a

significant change.

Create opportunities for developing indigenous capabilities so as to reduce

dependence on imports: India depends significantly on the import of large number of

goods and services. While import of certain products like crude oil is unavoidable, there

is considerable scope to reduce import dependency on many other products by

encouraging MSMEs to develop such products.

There is a considerable scope for indigenization across many areas such as healthcare,

automotive, defense, electronics and telecom.

However, this will require significant amount of support and guidance from the policy

makers, industry associations and academia to equip the MSMEs with the necessary

capabilities so that they can develop products that can substitute imports.

Leverage new and innovative technologies to be globally competitive- Technology

is the catalyst that is required to drive growth in the Indian economy and hence, is also

an important enabler for the MSMEs.

MSMEs in India, especially in the urban areas have already started investing in

technology in order to derive the benefits of enhanced productivity, improved

performance and competitive advantage in the global marketplace. Despite the benefits

technology offers, still a large number of MSMEs have not leveraged technology in

business practices.

Therefore, it is the need of the hour to drive technology adoption in such MSMEs.

In order to achieve this, policy makers will have to create an environment that

accelerates development of indigenous technologies and facilitates partnership between

MSMEs and global businesses for technology transfer / adoption, etc.

Hence, it is imperative for the various industry stakeholders - industry bodies and

associations, academia, government, large enterprises and MSMEs to come together and

build a strategy for developing indigenous technology, across sectors like IT,

Electronics, Manufacturing, Pharmaceuticals and Biotechnology.

Further, R&D institutions and academia could collaborate with MSMEs on research

initiatives and help provide technology support to commercialize innovative products

and service ideas.

In this regard, sector specific incubation cells can be started that provide guidance to

MSMEs on technology implementation, development and scaling up.

Effectively leverage ‘Make in India’ and other government initiatives to create

opportunities for the MSME sector –The government is expected to push for more

policy reforms to drive the ‘Make in India’ agenda, which will create more opportunities

for the growth of Indian MSMEs across several sectors.

Focus on transforming SMEs into emerging enterprises - Below are some of the key

focus areas that can drive MSMEs to a higher growth trajectory.

Enhance venture capital funding opportunities for MSMEs - Venture capital /

Private Equity provide financial assistance primarily by way of equity or equity-linked

capital investment. Besides infusing capital, VCs also bring expertise, superior advice

and other skills that help the MSME to develop marketable products.

While the government has taken some recent initiatives to attract substantial capital

investments from offshore and domestic investors for start-ups, the efforts need to be

further intensified. Exemption from capital gains tax will encourage more high risk

investments into the ecosystem.

Intensify focus on Export oriented MSMEs – In the last few years, the export-oriented

businesses have witnessed a deceleration compared to the high growth seen in the

domestic-focused businesses.

It is essential to have a strategy to enhance export competitiveness of MSMEs through

capacity building, cheaper credit, better marketing, robust infrastructure, technology

and nurturing innovation and skill development and putting in place conducive

environment for their growth.

Develop factoring market for MSMEs in line with global trends- Under this mode of

finance, the MSME sells or assigns its accounts receivables to a finance company (a

factor) at a discount to meet its immediate funding requirement, thereby provides

better liquidity to the MSMEs.

This method of financing evolved so as to minimize the adverse effect of delayed

payments by large scale customers on the operations of MSMEs. Factors buy the right to

collect on invoices raised against any sales by the MSME and releases 80-90% of the

invoice value to the firm.

The Indian factoring market is still at a nascent stage, and still far from reaching the

growth witnessed in global markets. There are approximately 10 factoring companies in

India, and the oldest among them are Canbank factors and SBI Global Factors.

With a view to develop the factoring market in India, the RBI in 2014 proposed setting

up of an electronic trade receivables discounting system.

The move was made to facilitate financing of bills raised by MSMEs to corporate and

other buyers, including government departments and PSUs.

However, the proposal is still awaiting implementation.

Good Governance and Business Ethics – Empower SME Management /

Encouragement on compliances as well as improving productivity and quality – There is

an urgent need to design a simple, capacity-appropriate tax regime for SMEs. SMEs find

it particularly burdensome to comply with tax.

The Doing Business 2016 report of The World Bank Group, which measures ease of

doing business highlights India’s poor showing in the area of tax compliance: India

ranks 157th out of 189 economies on the ‘paying taxes’ indicator. It is critical to reduce

costs of tax compliance for SMEs, to free their time and resources to be deployed to

productive activities.

Conclusion

The importance of MSME has been recognized in recent years for its significant

contribution in gratifying various socio-economic objectives such as higher growth of

employment, output, promotion of exports and fostering entrepreneurship. They play a

crucial role in the industrial development of any country. This sector even assumes

greater importance now as the country moves towards a faster and inclusive growth

agenda. MSMEs have also shown an ability for innovation, creativity, and flexibility

which qualifies them to respond promptly to changing market conditions and to adapt

the dynamic needs of the consumers.

A dynamic global economic scenario has thrown up various opportunities and

challenges to the MSME sector in India. On the one hand, numerous opportunities have

opened up for this sector to enhance productivity and look at new national and

international markets. On the other hand, these opportunities compel the MSMEs to

upgrade their competencies in terms of larger volumes of mechanized production,

better designs and marketing of products at lower costs. In order to compete with the

large firms and global players in the market place, it will be imperative to develop

competitiveness beyond just cost.

This would also necessitate support from the Government towards formulation of

supportive and friendly policies to provide the necessary impetus to the sector. Of late,

the sector has seen increased focus from the government and other government

institutions, corporate bodies and banks. Policy based changes; investments into the

sector; globalization and India’s robust economic growth have opened up several latent

business opportunities for this sector. Prime Minister’s flagship campaign ‘Make in

India’ is a progressive step in the same direction. With the right pushes, it holds key to

herald a new revolution for the identified manufacturing and service sectors.

Contemporary MSMEs Financial Needs and Solutions

Mr. U. K. Joshi Director, ASSOCHAM

Introduction

Indian economy is dominated by a vibrant set of enterprises, which are prestigiously

known as MSMEs for their scale of operations.

Only 1.5 million MSMEs are in registered segment while the remaining 24.5 million that

constitute 94% of the units are in unregistered segment.

The role of MSMEs in economic and social development of country is widely

acknowledged. They are nurseries for entrepreneurship, often driven by individual

creativity and innovation contributing significantly towards country’s GDP,

manufacturing output exports and employment generation.

Finance – The Essential Need

Bank lending is the most common source of external finance for many MSMEs and

entrepreneurs, which are often heavily reliant on straight debt to fulfill their start-up,

cash flow and investment needs.

While it is commonly used by small businesses, however, traditional bank finance poses

challenges to SMEs and may be ill-suited at specific stages in the firm life cycle.

There are limitations of traditional debt financing for responding to the different

financing needs that SMEs encounter along their life cycle, and for sustaining the most

dynamic enterprises. In particular, debt financing appears to be ill-suited for newer,

innovative and fast growing companies, with a higher risk-return profile.

The “financing gap” that affects these businesses is often a “growth capital gap”.

Substantial amounts of funds might be needed to finance projects with high growth

prospects, while the associated profit patterns are often difficult to forecast.

The financing constraints can be especially severe in the case of start-ups or small

businesses that rely on intangibles in their business model, as these are highly firm-

specific and difficult to use as collateral in traditional debt relations. Yet, for most

enterprises, there are few alternatives to traditional debt.

This represents an important challenge for policy makers pursuing sustainable recovery

and long-term growth, since these companies are often at the forefront in job creation,

the application of new technologies and the development of new business models.

While alternatives to traditional debt finance are particularly important for start-ups,

high-growth and innovative SMEs, the development of alternative financing techniques

may be relevant to the broader population of SMEs and micro-enterprises.

Capital gaps exist also for companies seeking to effect important transitions in their

activities, such as ownership and control changes, as well as for SMEs seeking to de-

leverage and improve their capital structures.

The thin capitalization and excessive “leverage” (excessive reliance on debt financing

compared to equity) impose costs, as loans to companies that already have considerable

amounts of debt tend to have higher interest rates, and increase the risk of financial

distress and bankruptcy.

The long-standing need to strengthen capital structures and to decrease dependence on

borrowing has become more urgent, as many firms were obliged to increase leverage in

order to survive the recent economic and financial crisis.

Indeed, the problem of SME over-leveraging may have been exacerbated by policy

responses to the crisis, which tended to focus on mechanisms that enabled firms to

increase their debt (e.g. direct lending, loan guarantees).

At the same time, banks in many countries have been contracting their balance sheets in

order to meet more rigorous prudential rules. While bank financing will continue to be

crucial for the SME sector, there is a broad concern that credit constraints will simply

become “the new normal” for SMEs and entrepreneurs.

It is therefore necessary to broaden the range of financing instruments available to

SMEs and entrepreneurs, in order to enable them to continue to play their role in

investment, growth, innovation and employment.

Alternative Financing Instruments

Asset-based finance

Asset-based finance, which includes asset-based lending, factoring, purchase-order

finance, warehouse receipts and leasing, differs from traditional debt finance, as a firm

obtains funding based on the value of specific assets, rather than on its own credit

standing. Working capital and term loans are thus secured by assets such as trade

accounts receivable, inventory, machinery, equipment and real estate.

The key advantage of asset-based finance is that firms can access cash faster and under

more flexible terms than they could have obtained from a conventional bank loan,

regardless of their balance sheet position and future cash flow prospects. Furthermore,

with asset-based finance, firms that lack credit history, face temporarily shortfalls or

losses, or that need to accelerate cash flow to seize growth opportunities, can access

working capital in a relatively short time. In addition, asset-based financiers do not

generally require any personal guarantee from the entrepreneur, nor that s/he give up

equity. On the other hand, the costs incurred and/or the complexity of procedures may

be substantially higher that those associated with conventional bank loans, including

asset appraisal, auditing, monitoring and up-front legal costs, which may reduce the

firm’s levels of profits. Also, funding limits are often lower than in the case of traditional

debt.

Across OECD countries, and increasingly also in emerging economies, asset-based

finance is widely used by SMEs, for their working capital needs, to support domestic and

international trade, and, partly, for investment purposes. In Europe especially, the

prevalence of these instruments for SMEs is on par with conventional bank lending, and

the specific financial segment has grown steadily over the last decade, in spite of

repercussions of the global financial crisis on the supply side.

Through asset-based finance, firms obtain funding based on the value of specific assets,

including accounts receivables, inventory, machinery, equipment and real estate, rather

than on their own credit standing. In this way, it can serve the needs of young and small

firms that have difficulties in accessing traditional lending. Asset-based lending, which

provides more flexible terms than collateralised traditional lending, has also been

expanding in recent years, in countries with sophisticated and efficient legal systems

and advanced financial expertise and services.

While asset-based finance is a widely used tool in the SME financing landscape,

alternative forms of debt have had only limited usage by the SME sector, even within the

larger size segment which would be suited for structured finance and could benefit from

accessing capital markets, to invest and seize growth opportunities.

In fact, alternative debt differs from traditional lending in that investors in the capital

market, rather than banks, provide the financing for SMEs.

To foster the development of a corporate bond market for SMEs, mainly mid-caps,

policy makers have especially targeted transparency and protection rules for investors,

to favour greater participation and liquidity. Recent programmes have also encouraged

the creation of SME trading venues and the participation by unlisted and smaller

companies.

In some countries, public entities participate with private investors to funds that target

the SME bond market, with the aim of stimulating its development.

Alternative external financing techniques for SMEs and entrepreneurs

Trade Credit

Trade credit is also an important source of finance for many SMEs and start-ups, which

can substitute or supplement short-term bank lending. This mainly consists of the

extension of traditional credit instruments and credit-mitigation tools, such as loans

and guarantees, to sustain import and export activities. Guarantees can take the form of

letters of credit (L/C), which represent a bank obligation to pay, thereby reducing an

export's payment risk on an importer/buyer.

Hybrid Instrument

The market for hybrid instruments, which combine debt and equity features into a

single financing vehicle, has developed unevenly in OECD countries, but has recently

attracted interest of policy makers across the board.

These techniques represent an appealing form of finance for firms that are approaching

a turning point in their life cycle, when the risks and opportunities of the business are

increasing, a capital injection is needed, but they have limited or no access to debt

financing or equity, or the owners do not want the dilution of control that would

accompany equity finance.

This can be the case of young high-growth companies, established firms with emerging

growth opportunities, companies undergoing transitions or restructuring, as well as

companies seeking to strengthen their capital structures.

At the same time, these techniques are not well-suited for many SMEs, as they require a

well-established and stable earning power and market position, and demand a certain

level of financial skills. In recent years, with the support of public programmes, it has

become increasingly possible to offer hybrid tools to SMEs with lower credit ratings and

smaller funding needs than what would be the practice in private capital markets.

Governments and international organisations mainly intervene through: i) participation

in the commercial market with investment funds that award mandates to private

investments specialists; ii) direct public financing to SMEs under programmes managed

by public financial institutions; iii) guarantees to private institutions that offer SMEs the

financial facility and; iv) funding of private investment companies at highly attractive

terms.

Equity Finance

Equity finance is key for companies that seek long-term corporate investment, to

sustain innovation, value creation and growth. Equity financing is especially relevant for

companies that have a high risk-return profile, such as new, innovative and high growth

firms. Seed and early stage equity finance can boost firm creation and development,

whereas other equity instruments, such as specialised platforms for SME public listing,

can provide financial resources for growth-oriented and innovative SMEs.

Factoring

Factoring is a supplier short-term financing mechanism, whereby a firm (‘seller’)

receives cash from a specialised institution (‘factor’), in exchange for its accounts

receivable, which result from the sales of goods or provision of services to customers

(‘buyers’). In other terms, the factor buys the right to collect a firm’s invoices from its

customers, by paying the firm the face value of these invoices, less a discount.

The factor then proceeds to collect payment from the firm’s customers at the due date of

the invoices. The difference between the face value of invoices and the amount

advanced by the factor constitute the “reserve account”.

This is paid to the seller when the receivables are paid to the factor, less interest and

service fees. Typically, the interest ranges from 1.5% to 3% over base rate and service

fees range from 0.2% to 0.5% of the turnover.

Factoring is thus a transactions funding technology, based on ‘hard’ data, similar to

asset-based lending, as the financing depends on the value of an underlying asset, rather

than on the creditworthiness of the firm.

However, it is different from asset-based lending in the following aspects:

i) it involves exclusively the financing of accounts receivable, rather than a broader

range of assets;

ii) the underlying asset is sold to the factor at a discount, rather than collateralized;

iii) it is a bundle of three financial services, i.e. a financing component, a credit

component, and a collections component, as in most cases the borrower outsources to

the factor its credit and collection activities.

Conclusion

Broadening the finance options available and accessible to SMEs is a key challenge for

policy makers in the quest for fostering their development and sustaining the most

dynamic enterprises, in a credit constrained environment. It also represents a long-term

challenge to improving the SMEs’ capital structure and investment capacity, and

reducing their over-reliance – and vulnerability – to the traditional lending channels.

About ASSOCHAM

THE KNOWLEDGE ARCHITECT OF CORPORATE INDIA

Evolution of Value Creator

ASSOCHAM initiated its endeavour of value creation for Indian industry in 1920. Having in its fold more than 400 Chambers and Trade Associations, and serving more than 4,00,000 members from all over India. It has witnessed upswings as well as upheavals of Indian Economy, and contributed significantly by playing a catalytic role in s haping up the Trade, Commerce and Industrial environment of the country. Today, ASSOCHAM has emerged as the fountainhead of Knowledge for Indian industry, which is all set to redefine the dynamics of growth and development in the technology driven cyber age of ‘Knowledge Based Economy’. ASSOCHAM is seen as a forceful, proactive, forward looking institution equipping itself to meet the aspirations of corporate India in the new world of business. ASSOCHAM is working towards creating a conducive environment of India business to compete globally. ASSOCHAM derives its strength from its Promoter Chambers and other Industry/Regional Chambers/Associations spread all over the country.

VISION

Empower Indian enterprise by inculcating knowledge that will be the catalys t of growth in the barrier less technology driven global market and help them upscale, align and emerge as formidable player in respective business segments.

MISSION

As a representative organ of Corporate India, ASSOCHAM articulates the genuine, legitimate needs and interests of its members. Its mission is to impact the policy and legislative environment so as to foster balanced economic, industrial and social development. We believe education, IT, BT, Health, Corporate Social responsibility and environment to be the critical success factors.

MEMBERS – OUR STRENGTH

ASSOCHAM represents the interests of more than 4,00,000 direct and indirect members across the country. Through its heterogeneous membership, ASSOCHAM combines the entrepreneurial spirit and bus iness acumen of owners with management skills and expertise of professionals to set itself apart as a Chamber with a difference. Currently, ASSOCHAM has more than 100 National Councils covering the entire gamut of economic activities in India. It has been especially acknowledged as a significant voice of Indian industry in the field of Corporate Social Responsibility, Environment & Safety, HR & Labour Affairs, Corporate Governance, Information Technology, Biotechnology, Telecom, Banking & Finance, Company Law, Corporate Finance, Economic and International Affairs, Mergers & Acquisitions, Tourism, Civil Aviation, Infrastructure, Energy & Power, Education, Legal Reforms, Real Estate and Rural Development, Competency Building & Skill Development to mention a few.

INSIGHT INTO ‘NEW BUSINESS MODELS’

ASSOCHAM has been a significant contributory factor in the emergence of new-age Indian Corporate, characterized by a new mindset and global ambition for dominating the international business. The Chamber has add ressed itself to the key areas like India as Investment Destination, Achieving International Competitiveness, Promoting International Trade, Corporate Strategies for Enhancing Stakeholders Value, Government Policies in sustaining India’s Development, Infrastructure Development for enhancing India’s Competitiveness, Building Indian MNCs, Role of Financial Sector the Catalyst for India’s Transformation. ASSOCHAM derives its strengths from the following Promoter Chambers: Bombay Chamber of Commerce &

Industry , Mumbai; Cochin Chambers of Commerce & Industry, Cochin: Indian Merchant’s Chamber, Mumbai;

The Madras Chamber of Commerce and Industry, Chennai; PHD Chamber of Commerce and Industry, New

Delhi and has over 4 Lakh Direct / Indirect members. Together, we can make a significant difference to the

burden that our nation carries and bring in a bright, new tomorrow for our nation.

ASSOCHAM Corporate Office

5, Sardar Patel Marg, Chanakyapuri, New Delhi - 110 021

Phone: +91-11-46550555 (Hunting Line) • Fax: +91-11-23017008, 23017009

E-mail: assocham@nic.in • Website: www.assocham.org

ASSOCHAM Southern Regional Office D-13, D-14, D Block, Brigade MM, 1st Floor, 7th Block, Jayanagar, K R Road, Bangalore-560070 Phone: 080-40943251-53 Fax: 080-41256629 Email:events@assocham.com events.south@assocham.com, director.south@assocham.com ASSOCHAM Eastern Regional Office F-4, “Maurya Centre” 48, Gariahat Road Kolkata-700019 Tel: 91-33-4005 3845/41 HP: 91-98300 52478 Fax: 91-33-4000 1149 E-mail: Debmalya.banerjee@assocham.com

ASSOCHAM Western Regional Office 608, 6th Floor, SAKAR III Opposite Old High Court, Income Tax Ahmedabad-380 014 (Gujarat) Tel: +91-79-2754 1728/ 29, 2754 1867 Fax: +91-79-30006352 E-mail: assocham.ahd1@assocham.com assocham.ahd2@assocham.com ASSOCHAM Regional Office Ranchi 503/D, Mandir Marg-C, Ashok Nagar, Ranchi-834 002 Phone: 09835040255 E-mail: Head.RORanchi@assocham.com

AUSTRALIA Chief Representative ASSOCHAM Australia Chapter Suite 4, 168A Burwood Road Burwood | NSW | 2134 | Australia Tel: +61 (0) 421 590 791 Email: yateen@assochamaustralia.org Website: www.assochamaustralia.org UAE Chief Representative ASSOCHAM – Middle East India Trade & Exhibition Centre M.E. IBPC-SHARJAH IBPC-SHARJAH P.O. Box 66301, SHARJAH Tel: 00-97150-6268801 Fax: 00-9716-5304403

JAPAN Chief Representative ASSOCHAM Japan Chapter Colors of India Center 1-39-3 Ojima Koto-Ku, Tokyo 136-0072 Japan Email: international@assocham.com tceindo@hotmail.com USA Chief Representative ASSOCHAM – USA Chapter 55 EAST 77th Street Suite No 509 New York 10162

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