MSMEs need access to global value chains and cheap funds

Indian MSMEs face export barriers
Indian MSMEs face problems in facilitating exports and integrating in global value chains.

By Arpita Mukherjee and Drishti Vishwanath

India’s growth rate has been projected to be (-) 10.3% in 2020 which is much lower than the global growth projection of (-) 4.4% by the International Monetary Fund because of the coronavirus (COVID-19) pandemic related economic slowdown and supply chain disruptions. Exports from India have declined from $330 billion in 2018-2019 to $313.4 billion in 2019-20 and then to $150.5 billion in 2020-21 (April-October). Reviving growth and exports is, therefore, a priority for the government and in this endeavor, micro small and medium enterprises (MSMEs) play a key role.

MSMEs accounted for almost half (49.6%) of India’s exports and provided employment to around 110.9 million people in 2019-20. Acknowledging that MSMEs will play a key role in economic revival, the government has placed them at the centre of the Atmanirbhar Bharat Abhiyan, or ‘self-reliant India’ policy of Prime Minister Narendra Modi. The central government aims to increase the contribution of MSMEs to 50% of the gross domestic product (GDP) from 29% at present and enhance their share in exports to 60% in the next five years. Some states such as Uttar Pradesh are targeting to double the exports from MSMEs in the next three years.

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To achieve these targets, the government has come up with several initiatives. For example, the trade receivables discounting system was introduced as a digital platform to facilitate financing through multiple financiers in 2014 by the Reserve Bank of India. To simplify the registration process of MSMEs, the ministry of MSME notified the Udyog Aadhaar Memorandum in 2015 as a single system for registration for MSMEs to avail the benefits of central/state government schemes. The International Cooperation Scheme, 2016, provides financial assistance to promote technological upgradation and promotion of exports through participation of MSMEs in international fairs, exhibitions, trade fairs and buyer-seller meets for exploring new areas of technology infusion and joint ventures. In February 2020, the NIRVIK (Niryat Rin Vikas Yojana) scheme was introduced to provide enhanced insurance cover of up to 90% (from the average of 60%) of the principal and interest, reduce the premium for small exporters in key sectors and simplify procedures for claims and settlements.

In the wake of the COVID-19 pandemic, the government has announced an economic package worth Rs 30 trillion, which include an emergency credit line to MSMEs from banks and non-banking finance companies (NBFCs) up to 20% of outstanding loan credit up to 31st October 2020; Rs 200 billion subordinate debt for stressed MSMEs; Rs 500 billion equity infusion for MSMEs through fund of funds for expanding size and capacity. The government is also trying to generate a database for MSMEs through the Udhyog Aadhaar portal and is planning to launch a global market intelligence system in various languages and establish 100 export facilitation councils to boost exports. Efforts are being taken to set up an MSME Gateway to serve as a unique digital platform for Indian MSMEs to conduct business with SMEs (small and medium enterprises) in other countries and attract foreign direct investment.

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In this context, a survey was conducted by the authors during November-December 2020 covering 35 stakeholders including MSMEs, Federation of Indian Micro and Small and Medium Enterprises (FISME), and export promotion councils. Five MSMEs were selected from 4 sectors namely apparel, engineering, tourism, and agro-processing to understand the sector-specific issues and requirements. The respondents were asked how their business models have changed pre-and-post- COVID-19, the key issues that they face and the support that they need from the government.

The survey participants pointed out that less than 10% of MSMEs in India are engaged in exports. For exports, MSMEs are often sub-contracted by the tier 1 partners. Only 50% of the MSMEs interviewed had got direct contracts through buyer-seller meets or personal contacts, and 4 firms said that they have got business by connecting on-line. Prior to the COVID-19 pandemic, very few MSMEs were using online technology to get business. After the lockdown in March 2020, they have adopted digitalisation at a fast pace, but they need finance and support for digitalisation.

MSMEs face export barriers

In the last two years, the top issues faced by Indian MSMEs in facilitating exports and integrating in global value chains (GVCs) include lack of access to finance, an inability to meet the higher quality standards for some products like processed food, stiff competition in markets like the European Union and the United States from firms from developing countries such as China and Vietnam, and technology gaps. All MSMEs and their associations pointed out that MSMEs were adversely impacted by the sudden demonetisation in 2016, which slowed down their growth. The single goods and services tax (GST), although implemented with a good intention in 2017, had several issues leading to higher compliance costs, multiplicity of procedures and difficulties in filling the GST on time. In 2019, the withdrawal of the Generalised System of Preferences (GSP) by the US adversely impacted MSMEs in certain sectors such as engineering.

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While over 90% of MSMEs are present in the informal sector and do not have access to formal institutional credit, banks have not been able to use their funds targeted at MSMEs under the priority sector lending scheme. MSMEs face high interest rates; the Export-Import Bank of India provides loans at the rate of 10-12% compared to countries like China where loans are provided at rates below 1%. MSMEs are also considered high risk and they are unable to provide collateral; they do not pass the rigid credit conditionalities of banks or institutions like Small Industries Development Bank of India. There is also lack of a unified alternative credit rating mechanism in India.

The survey found that Indian MSMEs are losing their competitiveness in traditional markets mostly due to rigid standards and quality requirements and are, therefore, exploring new markets in ASEAN (Association of South East Asian Nations) Africa, SAARC (South Asian Association for Regional Cooperation) and African countries. Given that they have faced competition from firms in China and ASEAN countries, 20 out of 25 companies pointed out that they were relieved when India decided to come out of the Regional Comprehensive Economic Partnership (RCEP) agreement. However, they are very worried about the current geo-political tensions with China as their supply chains for raw materials and intermediate products are getting disrupted.

MSMEs and their associations do not have much awareness about trade agreements; they find it difficult to understand the modalities and benefit from it. They pointed out that multiple tariff lines and frequent tariff changes are confusing and unilateral lower tariffs are much easier for them to abide by. India has signed a limited number of free trade agreements with lower levels of commitments and does not have agreements with its key export partners such as the US and the EU. Given this, MSMEs from countries like Vietnam, Chile and Mexico are at an advantage vis-a-vis Indian firms. Further, the existing training offered in India through joint capacity building programmes with importing countries is far less than offered by other developing and least developing countries like Cambodia. The MSMEs and their business organisations agreed that there are quality issues in the exports, but this is mostly related to their lack of knowledge and understanding of the standards and requirements.

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India gives export-linked subsidies such as the merchandise exports from India scheme (MEIS) which are not WTO compliant subsidies, unlike countries such as Vietnam. Indian exports can, therefore, be countervailed by importing countries and in 2019 India lost the export-linked subsidy dispute to the US in the WTO in 2019. However, phasing out these subsidies will reduce the competitiveness of MSMEs, due to higher cost of operation and higher logistics costs. In India, the cost of power is much higher than in countries like China. The logistics cost is around 14% of the GDP, which reduces global competitiveness of MSMEs.

The MSMEs face constraints in technology adoption due to lack of digital access, insufficient resources and knowledge to innovate, lack of requisite skills, amongst others. While many of them opined that an e-commerce platform is necessary, there are very few business-to-business reliable e-commerce platforms in India. Less than 20% of MSMEs had e-commerce presence prior to the COVID-19 pandemic. Further, four survey participants mentioned that they faced payment related frauds and two said that the approved quality was not delivered leading to financial losses. Around 95% said that there is limited support from government for technology and skill upgradation.

Survey participants pointed out that the clearances across multiple agencies for exports take a lot of time, despite of India signing the Trade Facilitation Agreement. India is yet to adopt comprehensive technology-based risk management systems integrating Customs and other clearance agencies. Multiple clearance bodies have overlapping processes, and importers and exporters have to pay fees for the services rendered by each of these agencies, which increases the cost.

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The pandemic and the sudden lockdown in March 2020 led to a situation where MSMEs could not meet deliveries on time due to disruption of supply chains, shortage of containers, and shut down of factories. This led to cancellation of orders and lack of access to finance and working capital. Workers could not be paid and have migrated back to their native villages and towns. The labour shortage continues, as many of these workers have not returned back. Due to lack of capital and orders, many MSMEs have either shut down or are at high risk of closing permanently.

While MSMEs have welcomed the measures taken by the Government, they also pointed out that post-COVID 19 incentives did not benefit them. Schemes such as NIRVIK, though announced in the budget 2020-21, have not been implemented till January 5, 2020. A majority of the respondents pointed out that government initiatives under the Atmanirbhar Abhiyan have been narrow in scope, since they target only MSMEs which are registered (which is around 10% of total MSMEs) or have access to formal institutional finance (which is only around 6-7% of total MSMEs). Thus, the benefits of the schemes have not percolated down to the firms that are in actual need of finance. Even for MSMEs with a bank account, no measures have been taken to support their working capital unlike in the case of farmers where there has been a direct money transfer to their bank accounts.

Further unlike countries such as Germany, Singapore, UK and Japan which provided wage subsidies, loan guarantees, direct lending to SMEs the financial incentives to MSMEs in India were limited during the pandemic. In India, no new incentives have been offered for MSMEs which seek to export through online channels, while countries such as China and Indonesia have increased efforts to provide SMEs with access to e-commerce platforms and support digitalisation for market expansion.

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With the sudden lockdown and import controls, especially from China, there are issues in imports of raw materials in sectors such as pharmaceuticals and steel. For example, steel is a key input into the engineering sector and some of the recent import controls have increased the price of steel in India by 50 percent in 2020 while the rise has been around 20 percent globally. This has adversely impacted MSMEs in the engineering sector and reduced their global competitiveness.

Prior to the pandemic, MSMEs faced issues in accessing funds for marketing and brand building. Not able to meet their buyers face-to-face has been a key issue post the pandemic as most of the buyer-seller meets are now on-line. The timing difference between countries for online meetings has been an issue for some of the MSMEs and their participation in buyer-seller meetings have been low.

The way forward for MSMEs

There is need for targeted interventions to help MSMEs boost exports and integrate into the GVCs. First, the schemes like NIRVIK announced for the MSMEs should be implemented properly and should ensure maximum coverage. Awareness building measures must be undertaken so that MSMEs can utilise existing schemes better. The survey found that Indian MSMEs will need training/capacity building/support to know about the standards and quality requirements of export markets, they need finance for technology, skill upgradation, marketing and brand building. Incentives may focus in these areas. Greater financial support for research and development will benefit the MSMEs. It is also necessary to help MSMEs train their workforce in digital skills. Incentives can be provided to integrate MSMEs into e-commerce platforms for global markets. Government has now created a database of MSMEs. This may be used for direct benefit transfers and for creating a MSME trade centre and trade related support system like an online 24X7 helpline.

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There is need to build capacity and awareness among MSMEs about the trade agreements, standards and processes and requirements of importing countries. It is important to do research on how other countries have used trade agreements for the benefit of their MSMEs.

The government should focus on the need of the MSMEs with respect to access to finance, which includes financing gaps in working capital, access to funds at lower interest rates, etc. The government should encourage banks and fin-tech companies to enter into partnerships to develop innovative non-collateral based financial packages and processes for digital financial inclusion of MSMEs and encourage the development of hybrid and flexible digital products customised to their needs and requirements. India may also look at best practices of countries such as France (the Francenum programme) and Indonesia (MSMEs Go Online programme) in the context of development of online business models, advancement of digital capabilities and capacity building and adopt them.

To conclude, there is no doubt that without boosting the competitiveness of its MSMEs and their integration in GVCs, India cannot become “self-reliant” in a modern globalised world. Schemes and policies alone may not help unless they are targeted and monitored regularly. Given that targets have been set out for the contribution of MSMEs to economic growth and exports, it is important to lay down a vision document on how these targets will be achieved in the next five years.

(Arpita Mukherjee is Professor, Indian Council for Research on International Economic Relations (ICRIER). Drishti Vishwanath is Research Assistant, ICRIER. Views expressed are personal. Contact: