Industrial Sector Updates – Industrial Policy, Ease of Doing Business, etc.

What makes MSMEs, most vulnerable to Covid-19 disruptions?

Note4Students

From UPSC perspective, the following things are important :

Prelims level : MSME Sector and its definition

Mains level : MSME sector of India and various inherent issues

  • The Covid-19 pandemic has left its impact on all sectors of the economy but nowhere is the hurt as much as the Medium, Small and Micro Enterprises (MSMEs) of India.
  • All anecdotal evidence available, such as the hundreds of thousands of stranded migrant workers across the country, suggests that MSMEs have been the worst casualty of lockdown.
  • A closer look at the anatomy of the MSME sector explains why MSMEs are so vulnerable to economic stress.

Possible mains question:

Q. Discuss how the nationwide lockdown to control the coronavirus outbreak has led to the resurfacing of inherent bottlenecks in India’s MSME Sector.

What are MSMEs? How are they defined?

  • Formally, MSMEs are defined in terms of investment in plant and machinery.
  • But this criterion for the definition was long criticised because credible and precise details of investments were not easily available by authorities.
  • That is why in February 2018, the Union Cabinet decided to change the criterion to “annual turnover”, which was more in line with the imposition of GST.
  • According to the proposed definition, which is yet to be formally accepted, a micro-enterprise will be one with an annual turnover less than Rs 5 crore; a small enterprise with turnover between Rs 5 crore and Rs 75 crore; and a medium enterprise with turnover less than Rs 250 crore.

How many MSMEs does India have, who owns them, and where are they situated?

  • According to the latest available (2018-19) Annual Report of Department of MSMEs, there are 6.34 crore MSMEs in the country.
  • Around 51 per cent of these are situated in rural India.
  • Together, they employ a little over 11 crore people (Chart 3) but 55 per cent of the employment happens in the urban MSMEs.
  • These numbers suggest that, on average, less than two people are employed per MSME.
  • At one level that gives a picture of how small these really are. But a breakup of all MSMEs into micro, small and medium categories is even more revealing.

Distributions of MSMEs

  • In terms of geographical distribution, seven Indian states alone account for 50 per cent of all MSMEs.
  • These are Uttar Pradesh (14%), West Bengal (14%), Tamil Nadu (8%), Maharashtra (8%), Karnataka (6%), Bihar (5%) and Andhra Pradesh (5%).
  • This breakup provides a sense of where the pain of the MSME crisis would be felt the most.
  • Chart 4 shows, 99.5 per cent of all MSMEs fall in the micro category.
  • The medium and small enterprises — that is, the remaining 0.5% of all MSMEs — employ the remaining 5 crore-odd employees.
  • While micro-enterprises are equally distributed over rural and urban India, small and medium ones are predominantly in urban India.

What kind of problems do MSMEs in India face?

  • No/Low Formal registration: To begin with, most of them are not registered anywhere. A big reason for this is that they are just too small. But, as it is clear in a time of crisis, it also constrains a government’s ability to help them.
  • Away from Tax norms: GST has its threshold and most micro enterprises do not qualify. Being out of the formal network, they do not have to maintain accounts, pay taxes or adhere to regulatory norms etc. This brings down their costs.
  • Lack of Financial buffer: According to a 2018 report by the International Finance Corporation (part of the World Bank), the formal banking system supplies less than one-third (or about Rs 11 lakh crore) of the credit MSME credit need that it can potentially fund (Chart 5). They don’t have the buffers of the bigger firms or access to cheap capital to help them tide over this period.

  • Bad credit history: The other big issue plaguing the sector is the delays in payments to MSMEs — be it from their buyers or things likes GST refunds etc. A key reason why banks dither from extending loans to MSMEs is the high ratio of bad loans (Chart 6).

How has Covid-19 made things worse?

  • The MSMEs were already struggling — in terms of declining revenues and capacity utilization — in the lead-up to the Covid-19 crisis.
  • The total lockdown has raised a question mark on workers payment primarily because these firms mostly transact on cash. That explains the job losses.
  • According to a recent survey he did for “small and medium” firms in manufacturing, only 7% said they will be able to survive for more than three months with their cash in hand if their business remains closed.
  • A big hurdle to restarting now is the lack of labour availability.

What can be done?

  • The RBI has been trying to pump money into the MSME sector but given the structural constraints, it has had limited impact.
  • There are no easy answers for the MSMEs’ sufferings.
  • However, the government can provide tax relief (GST and corporate tax), give swifter refunds, and provide liquidity to rural India (say, through PM-Kisan) to boost demand for MSME products.

What about credit guarantees?

  • Loans to MSMEs are mostly given against property (as collateral) — because often there isn’t a robust cash flow analysis available — but in times of crisis, property values fall and that inhibits the extension of new loans.
  • A credit guarantee by the government helps as it assures the bank that its loan will be repaid by the government in case the MSME falters.
  • To the extent such defaults happen, credit guarantees are shown as a departmental expense in the Budget.

Urgent attention required

  • Governments across the world have announced various measures ranging from wage support to direct subsidies to help these businesses tide over these difficult times.
  • But, in India, more than a month after the national lockdown was announced; there is still no blueprint of how the government intends to support these businesses during this period.

Way forward

  • There is a strong case for urgent government intervention — the costs of intervening early on will be much less than the price of delayed action.
  • To begin with, all dues owned by governments and public sector undertakings to MSMEs can be immediately cleared. This will help ease their immediate cash flow woes.
  • Second, with banks turning risk-averse, credit flow to MSMEs is likely to be depressed as solvency concerns will dominate.
  • In such a situation, the government could step in. It could set up a credit guarantee fund that backstops loans to MSMEs.
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