The Power Of I 2020

Let’s get MSMEs to dream big, by ending their nightmare

The backbone of the economy needs much more than stopgap fixes 

When King Eurystheus set the ten (and then twelve) labours for his cousin Hercules, he should have included one on setting up a manufacturing unit in India. What is slaying an armoured lion or lassoing a bad-tempered boar, when compared to getting a no-objection certificate (NOC). An aspiring entrepreneur in Maharashtra, Roshan Shah, wrote a blog about one such ‘labour’ he had recently, and it went viral. 

Shah wanted to build the unit on his agricultural land in Sangli, so he needed a NOC from the Revenue Department. He approached the officials and he was given a list of documents to get, and he did after three months, few thousands in legal fee and more than 20 visits to different offices. End of story, or so he thought. Except, he was directed to 11 other departments, from each of which he had to get separate NOCs! After nine months of chasing this paperwork and absent babus, he wrote his blog titled “I tried to start a manufacturing unit in India”. It has since been taken down because he writes that Revenue Department said that it was all a mix-up by an entry-level employee, and they have promised to sort it out. 

Setting up and running a micro, small or medium enterprise in India can try the nerves of the best of us. But these enterprises (together known as MSMEs) form the backbone of the Indian economy. They employ nearly 40% of India’s non-farm workforce, and contribute nearly 25% to the country’s GDP. Despite being so critical to our dreams of hitting the $5-trillion goal, MSMEs are largely informal, inefficient and stunted. What’s worse, they choose to remain so. 

Research shows that firms that start out formal are 2-3x more productive than informal ones and have a better chance of growing. However, most Indian firms prefer to remain informal because in most states, the cost of formalization and compliance is onerous. Here’s a snapshot: a typical MSME factory must file for 23+ registrations and licenses, 750+ compliances, and 120+ filings per annum; with labour regulations alone accounting for more than 50% of these filings. Over the past few years, MSMEs have also had to deal with demonetization, Goods and Services Tax (GST) rollout and a slowing economy. Then came COVID-19. Not to exaggerate, but this pandemic could be a mass-extinction event for smaller, informal firms — estimates suggest that 30-40% of MSMEs in India may cease to exist as the pandemic drags on.

Financial and regulatory support — such as the recently announced fiscal stimulus package — can help MSMEs restart operations and retain jobs in the short term. However, this segment needs more than these fiscal measures that help it survive. It needs medium-to-long-term structural reforms to revive and thrive.

Survive: Short-term measures to enhance liquidity and credit availability

The entrepreneur and the banker occupy different planets. Firstly, most MSMEs are informal set-ups and therefore cannot consider approaching a bank for financing. Then, the few enterprises that are formally registered face numerous hurdles when they do approach a bank. For example, a small-business owner is usually asked to give a projection of their enterprise’s profit and loss, balance sheet and cash flow for the next few years. The entrepreneur isn’t sure how to do this, nor does he/she have the resources to get this done. But since they need the credit desperately, they fall back on the informal credit system. After the pandemic lockdown, nearly 40% of these enterprises already attempted to borrow money to survive, with only 14% borrowing from formal sources. GAME’s data on MSMEs through COVID-19 suggests that more than half (57%) of micro-enterprises have no cash reserves while 65% had to dip into their personal savings to manage operations. A recent AIMO survey of 45,000 MSMEs shows that they are unclear about the eligibility, process and structure of the recent financial package announced by the government.

In light of this, we need to consider the following steps to help MSMEs survive.

1. The financial package announced should be well executed, through state governments and local industry bodies. For this, the details of the scheme should also be clearly explained to the MSMEs and banks. We have heard many bankers say that they are not clear about a particular scheme and therefore will not route any money through it. After clarifying the details, the government should mandate the release of 30% of the stimulus package to micro and small categories. Then, relax non-performing asset (NPA) classification so that borrowers can repay loans over a longer timeframe. Finally, digitize the bank guarantee process. 

2. Set aside funds specifically directed at nearly 10 million new-to-credit MSMEs with a condition to ‘formalize’ informal businesses.

3. Enable banks to support existing loans on MSMEs via a credit-guarantee fund and ensure easy repayment options for higher recovery. 

4. Increase uptake of supply-chain financing and bill invoicing (TReDS) initiatives using member networks of industry bodies.

5. Ensure quick disbursement of payables from government excise and tax departments to MSMEs.

Revive: Medium-term reforms to improve ease of doing business

India may have moved up 14 places to 63 in the Ease of Doing Business Index, but the MSMEs aren’t finding their day-to-day experience particularly easy. Consider this: to start and run a business today, an MSME must navigate a complex landscape of nearly 58,000 compliances; further, continuous updates compound this burden (For instance: 3,500 legal updates over the last year). If an entrepreneur, frustrated by the paperwork, decides to skip a few forms, he or she can face criminal charges. They can be imprisoned for three to 10 years. In such circumstances, is it any wonder that people are afraid to formalize their business? One entrepreneur told us that formalizing will only invite the attention of inspectors, who then come at every available opportunity to collect their hafta.

Therefore, we should try a different route, to bring more businesses into the formal fold. To begin with,

1. Simplify, simplify, simplify. Enable the implementation of BRAP (Business Reforms Action Plan 2019) in States by creating implementation guidelines, metrics for success and increased ownership of the Centre on key recommendations. Rationalize compliances through detailed assessment of associated laws. Identify seven key processes with highest impact and likelihood of implementation (registering a new business, registering property, construction permits, filling labor compliances, filling environment health and safety (EHS) compliances, availing credit, and tax compliances and payments) and pull out the red tape. 

2. Digitize and streamline processes to save time. Make formalization effortless by creating six key platforms — for labour compliance, EHS fillings, tax filings, Information Wizard, central inspection system and single window.

3. Decriminalize nearly 9,000 compliances. 

4. Evaluate ease of doing business at a state-level along with objective and measurable criteria and publish annual scorecard.

5. Support the sector through private and social partnerships. Strengthen the industry body network by rationalizing nearly 3,500 industry bodies and instituting a governance framework to ensure effective collection and escalation of grievances. Create an MSME support network, which includes a pan-India portal and partnerships with local NGOs, and industry bodies to redirect queries from the portal to relevant local stakeholders.

6. Get SEBI or MCA to mandate clearance of a percentage of invoice value within 45 days of receipt of invoice and set threshold guidelines.

Thrive: Long-term reforms to boost entrepreneurial dynamism and competitiveness

India has enterprise, ask any person who has seen an old cycle converted into a seeding machine or a clay refrigerator. But its enterprise — studies say 95% of it — is locked away in sub-scale and informal enterprises. Therefore, it can’t create many jobs and the little employment it creates does not provide proper wages or social security. To lend more dynamism to the MSME sector, we need the right “Seed” (education, ambition and entrepreneurial mindset), “Soil” (infrastructure including access to markets and credit facilities) and “Climate” (local culture that encourages enterprise). Ludhiana, which topped the ease-of-doing-business ranking done by Punjab, is a good example. Here, nearly every house has an entrepreneur. Karanjeet is one of them and she runs a textile unit that employs about 10 people. She said that running a business was an obvious choice because everyone she knows does it. She lives in a culture comfortable with risk-taking and failure, and that extends emotional and financial support to business owners. It is a mindset that can be replicated and furthered with the right ingredients. Therefore, we should,

1. Seed: Create a pipeline of entrepreneurs by investing in education and incubation by making an entrepreneurship curriculum compulsory in schools, ITIs and colleges, and by promoting tinkering labs, entrepreneurship cells and incubators in every school and college.

2. Soil: Introduce sector-specific initiatives. Set up land banks/SEZs with physical (plug-and-play infrastructure, logistics, shared services) and digital (connectivity, marketplace) infrastructure. Attract private anchor investors (Indian and international) to build an ecosystem around these hubs. Create a branding/marketing campaign around local products and establish marketing as a shared service for the hub to enable outreach. Streamline access to skilled labour through tie-ups with local institutions for apprenticeship programmes, and introduce vocational training around the hub through industry bodies. Increase credit availability through focused angel and VC funds as a PPP initiative, and institute supply-chain finance and digital-lending platforms.

3. Climate: To create an entrepreneurial culture, we must publicize the growth (such as export contracts and new hires) of local enterprises and celebrate their successes, and even tolerate failures, through well-planned events. For example, what about awarding the most environmentally-responsible supplier or a local businessman who has the best credit history. Such events could also bring the local ecosystem of corporate leaders, the government, bankers and VCs together, to support MSMEs.

The pandemic has made the differences between a formal and informal enterprise starker. For example, only 14% of micro enterprises were able to access credit from formal sources, while a vast majority dipped into personal savings or borrowed from family and friends. There are the government schemes, of the six-month moratorium on loans and the Emergency Credit Line Guarantee Scheme (ECLGS) but they just provide a boost and aren’t enough. For example, in July, 43% of the ECLGS scheme has been sanctioned but, as of August, only 33% has been disbursed. Therefore, what we need is more role and greater involvement of fintech players, who have brought more new-to-credit entrepreneurs into the formal fold than public banks, private banks, and NBFCs combined, according to BCG. Since MSMEs have little by way of credit history and can afford only smaller collateral, they should be given supply-chain finance to level the speed bumps. Finally, they should be encouraged to drop a business if it cannot be made big. With higher productivity, they can attract better labour and easier credit.

If we can manage to get the seed, soil and climate right, there is a golden harvest to be had. Roshan Shah’s post on his experience found an outpouring of support on Twitter. People shared similar experiences they have had, about years of waiting, of unending paperwork and permissions stuck in obscure departments. That is unsurprising because this narrative has not changed in years. No, decades.

What was also unsurprising was that Shah’s post was taken down swiftly to save the babus some blushes. No quarrel with that, but unless the ground reality changes as swiftly for this vital segment of the economy that is to make India realize its bigger and bolder ambition, it may be taken down by the weight of the rulebook, its creators and protectors. We have become prisoners of the past and some part of its immobility sticks to us.