Beyond state schemes, India’s MSMEs need strategic govt push to flourish

• Share of MSMEs in overall GDP growth has stagnated for many years now 


• MSME share in GDP was 29-30 percent between FY17 and FY23 


• Many government schemes envisage helping MSMEs function and flourish  


• MSMEs are yet to have access to superior technology, capital 


• Developing regional clusters of scale is still left to large industries 

India’s MSME sector is stagnating, or worse floundering. Recently, while talking to the media, Bhanu Pratap Singh Verma, the Minister of State for Micro, small and medium enterprises (MSME’s) noted In a Rajya Sabha reply that the share of MSMEs in India’s overall exports in FY23 stood at 43.6 percent, declining from 45.03 percent in FY22 and 49.35 percent in FY21. In reality, the share may be lower. India’s tariff code system or the Indian Trade Clarification based on Harmonized System (ITC-HS) does not distinguish whether some goods are manufactured by large enterprises or MSMEs. Speaking at an exports summit in February this year, Prafulla Chandra Mishra, Statistical Advisor, Directorate General of Foreign Trade (DGFT), Department of Commerce, had conceded: “There is no way we can distinguish exclusively ITC-HS codes reserved for MSMEs.”

If the export scenario looked bad, data on the share of the MSME sector’s gross value added in GDP clearly indicated stagnation. Between FY17 and FY23 the share of MSMEs has been stuck around the 29-30 percent mark. The manufacturing output of MSMEs as a share of overall manufacturing output has remained at around 36 percent over the last three years.

In FY20, the then minister for MSMEs, Nitin Gadkari had set an export target share of 60 percent for India’s MSMEs and 40 percent of GDP. Today, that target looks impossible. At a superficial level, it’s hard to discern why MSME numbers for India are stagnating. The government has issued many schemes targeting the sector. Both as a part of the Atmanirbhar Bharat agenda and through the production linked incentive schemes, the government had tried to incentivize growth for the sector. There are other schemes like the RoDTEP too. But none of these seem to have borne any fruit. In fact, a belief exists among SMEs that the PLI schemes are exclusively meant for large-scale businesses.

The government is now actively engaged in figuring out ways to connect MSMEs to global value chains via trade deals and agreements. FTAs with countries like the UK, Australia and the UAE are meant to specifically provide the initial steps to bring India’s manufacturing MSMEs into value chains designed to provide both technology assistance and other necessary parameters. FTAs with the EU, Canada and other nations are also the anvil and are meant to provide a boost to the sector.

But all this appears to merely scratch the surface. The creation of the right conditions where Indian MSMEs can acquire true global competitiveness in both price and quality seems to be lacking. Value is a function of both, and therein lies the catch. Technology, and more importantly access to the right technology together with capital, scale, innovation, and the hygiene factor of understanding what quality means in specific global contexts is critical. The strategically focused push that envisages the MSME sector as a vital link in a massive industrial value chain-driven machine is missing.

While the government is giving a great deal of importance to frontier technology, like electronics, and engineering sectors like automobiles, it’s yet to devise schemes that enable systemic network effects that propel Indian MSMEs into global value chains, let alone domestic value chains. The targeted task of building local or regional clusters, where manufacturing MSMEs can develop scale, technology, and quality, while simultaneously managing their cost structures efficiently, is left to large-scale industry.

The deliberate focus on incentivizing and building a chain, whereby interrelated production activities with upstream products are within an incentivized regional cluster is lacking. Export chains across engineering and other such manufactures cannot develop unless domestic value chains develop efficiently or clusters, where global competitive advantages accrue with necessary access to finance, are developed first. This is what would drive competitiveness and the flexibility and agility to compete in global markets.

Within clusters it's easier to both develop adjacencies and allow new knowledge to spatially move across a focused region, fostering both innovation and competition. SMEs in India are in many cases globally unviable since they start at a very small level of output and tend to remain there over decades. Neither finance nor consistently competitive technology is available to a limited player and obsolescence is the result. Scale economies and technology assimilation would ideally optimally develop if there were a combination of a strong domestic or global anchor with an equity incentive in the SME to push their agglomeration towards a global scale.

Deliberately incentivized, cost and technology-competitive clusters, would provide ease of operation for both transnationals entering India, avoiding critical historical pitfalls like land acquisition, and domestic large-scale manufacturers. Incentives for global JVs need to be provided for the MSME sector and more particularly, the SMEs. This would also help a key issue where Indian MSMEs flounder—digitization. A recent note by the analyst firm, Redseer, pointed out that just 12 percent of Indian MSMEs are digitized and 40 percent of capital investment to the sector flows into these firms. Access to global B2B e-commerce platforms is seldom utilized.

While traditionally Indian MSMEs prefer operating through debt rather than equity, given their traditional inclination towards control, cluster development with both Indian and global large-scale manufacturers forming the nucleus of the cluster, through a combination of global and domestic demand, offers ways to innovative forms of both debt and equity, something that could go a long way to ameliorate what has long been identified as a key bugbear for the sector—finance.

It's not that the PLI schemes do not envisage this factor. They do have an anchor-led model meant to incentivize import substitution. Ideally, they should have drawn considerable interest from MSMEs and global aggregators who operate for instance in the OEM and after-market space. They aren’t. The PLI schemes do not immediately offer prospects of an anchor. Large-scale manufacturing is somewhat geographically fragmented across the country, and available incentives are inadequate to interest SMEs in maintaining an export-led competitive scale and capacity utilization-driven operation.

Contrast the Indian MSME sector with China. Definitions for the sector may differ. In some cases, in China, even firms with up to 500 employees are designated small-scale. But the lessons lie in the way China has consistently built up its SME sector with highly incentivized manufacturing clusters on a regional basis. The success of China’s SME sector can be seen from an oft-quoted number within China—56789.  Private MSMEs contribute nearly 50 percent of taxes. They account for 60 percent of GDP, 70 percent of innovation, 80 percent of urban employment and make up nearly 90 percent of all firms in China. Nearly 70 percent of all patents applied for in China are from the MSMEs.

A further fall in India’s MSME numbers would be completely detrimental to its economy across multiple fronts. India has a window of opportunity over the next 2-3 years to develop into a force in global value chains, as a China plus one or perhaps through friend-shoring, and a fast-growing manufacturing MSME sector is critical to achieving that goal. It can’t all be done by the Centre. The Indian states need to move quickly too to assess the competitive global clusters they can develop and provide incentives for their MSMEs.