Who can make it in India?

Charan Singh, Natarajan Ramachandran and Ajosh K

THE financial managers in the Modi government appear to be convinced of the need to undertake large-scale industrialisation. The ‘sarkar’ is spending quite a bit of its political capital towards making it easy for the big business to become a partner in industrialisation. Consequently, it has not paid sufficient attention to the enormous potential of micro, small and medium enterprises to generate economic activity and jobs. The current policy needs to be tweaked accordingly.

The Government of India has been actively pursuing the objective of increasing output and employment in the country, especially at a time when the rate of youth unemployment is unusually high at nearly 25 per cent. Consequently, the measures that the government has been announcing include ‘Make in India’ across the country and the need for a second Green Revolution to be implemented in the Northeast. The government has been relentlessly following the objective of the above two schemes by ensuring financial inclusion through Jan Dhan Yojana and Micro Units Development Refinance Agency (MUDRA) Bank. 

In view of the gloomy economic situation, with expected El Nino as well as the rising non-performing assets of commercial banks, it is necessary that India is able to explore new growth opportunities within the country. In this context, micro, small and medium enterprises (MSMEs) can play an important role, as these have the potential to absorb a large number of people in employment — in 2013-14, 4.9 crore such units provided employment to nearly 12 crore people. The MSME sector is diverse in terms of its size, level of technology employed, and range of product and services produced. The products from the sector vary in range, from simple village-level output to complex components like micro-processors and electro-medical devices. 

Major challenges that MSMEs generally face include access to the markets — input and output, lack of infrastructure, stringent regulatory control, including labour laws and shortage of skilled labour. As profit margin of MSMEs is extremely thin, because of stiff competition and their small size, these units are first to crumble in face of any crisis. Uncertainty in terms of labour inputs and market for output impact MSMEs regularly and intensely. The government has been aware of these constrains and has regularly been initiating measures to address these problems. 

The most constraining factor in the development of MSMEs is lack of finance. MSME firms have always grappled with the issue of finding an affordable mode of financing for their ventures. With the inherent risks involved in the MSME sector, the inability of the firms to provide collateral and the unavailability of proper books of accounts, banks are reluctant to lend money to MSME units. This necessitates these units to depend on alternative sources of financing, which include local money lenders, who charge higher interest rates than those charged by commercial banks. 

Internationally, there are unique examples of financing MSMEs through different techniques. In Italy, Mutual Guarantee Institutions (MGI) are guarantee cooperatives that are set up in order to address the problems of information asymmetry between loan seekers and banks as well as to provide guarantee to banks for disbursing loans. Each MGI enrolls SMEs as members and creates a guarantee fund comprising contributions made by SMEs, in the form of membership fees, as well as by third parties, such as international organisations, local and central government, chambers of commerce, business associations, etc. The guarantee fund acts as collateral for bank loans issued to the SMEs affiliated with the MGI. 

Another viable financing scheme for MSMEs, called Kredi Garanti Fonu (KGF), has been implemented in Turkey. KGF was set up in 1991 as a private limited company, with shareholdings composed of Small and Medium Industry development organisations, Chambers of Commerce and Industry, Confederation of Tradesmen and Craftsmen, etc. KGF acts as a substitute security to MSMEs, providing guarantees to nearly 80 per cent of the loans taken by MSMEs. 

The government could consider extending the self-help group approach, or the joint liability model of micro financial institutions, to MSMEs. As delayed payments are a major concern and cause of financial distress for MSMEs, the government could consider extending loans through commercial banks to MSMEs by making the larger consumer of products of specific MSME to join in the group and provide guarantee to the bank, at a certain fee, for the loan extended to the specific MSME. In case of delayed payment by the consumer company of the products of a specific MSME, such a consumer company would be required to directly make payment to the bank. Similarly, where MSMEs are located in clusters, a group of MSME entrepreneurs can be formed into a self-help group to provide guarantee to the financial institution. 

To address the financing hurdles of MSMEs, there is an urgent need to set up a National Financial Institution. This national-level body should also have supporting infrastructure in the form of state-level counter-parties to assist in information gathering, dissemination of funds, credit rating and other support services. With the advent of the proposed system, the state-level agencies may provide funds to deserving MSMEs in their region, after due diligence of the firm's potential. State agencies may use rating agencies to validate the business model. Once the funding requirements across all states are collated, the national agency may float bonds to procure the required funding from the wider public without depending exclusively on banks. In the earlier years, until mid-1990s, a similar joint family approach was adopted by the RBI in borrowing resources from the market for the state governments. Funding and guarantee for such a scheme, amongst others, may also come from different chambers of commerce, industry associations, and the local and central government. 

On the basis of international experience, and India’s requirements to expand MSMEs, there is a need for infrastructural overhaul to ensure a nurturing and entrepreneur-friendly ecosystem in the country. While the second Green Revolution could provide jobs in the Northeast, in the rest of the country, encouragement to MSMEs is necessary to accommodate nearly 15 million people joining the labour force annually, for the next 30 years. The vibrant MSME sector is crucial to provide such avenues in India and tap the demographic dividend effectively. 

Charan Singh is the RBI Chair Professor of Economics, while R Natarajan and Ajosh K are MBA students, all at IIM-Bangalore.