Recent growth data for India reveals that there has been a significant slowdown in the industrial growth rate, especially manufacturing, in the first quarter, April-June, 2015.
According to the recently released Annual Report (AR) of the Reserve Bank of India (RBI), gross capital formation has been declining over the years, especially households. The performance of the agriculture sector has also been slower than the previous year because of uncertain rains in the last few months. In context of continuing uncertainty in the agriculture sector because of substantial dependence on rain-fed irrigation, an alternative power pack, unutilised, is micro, small and medium enterprises (MSMEs).
The MSME sector in India employs nearly 11 crore people through the operation of 5 crore enterprises producing a heterogeneous basket of about 7,000 different products. As MSMEs are generally labour-intensive, they have the capability to create more jobs to cater to a young demographic country like India. Further, in view of the continuing implications of climate change, it is necessary that the MSME sector is prepared to absorb millions who may be rendered unemployed in the agriculture sector.
The government and the RBI have been initiating a series of measures to encourage MSMEs, but these are generally supply-side efforts. The need is to generate demand-side requirement from the general public to set up MSMEs. Therefore, there is need to nurture entrepreneurs from a young age. There is a difference between risk and opportunities, and this needs to be emphasised for the young in India. If the country has to successfully launch the ‘Make in India’ programme, it needs to train young entrepreneurs, in addition to developing skills at skill development centres.
In the case of existing as well as potential MSMEs, entrepreneurs mainly face the problem of finance. The government and non-governmental organisations seek to finance and allocate resources for MSMEs, but these resources often do not reach the targeted audience. The successful launch of the Jan Dhan Yojana (JDY) could be used to direct financial resources to targeted MSMEs. Still, access to bank finance may be difficult for some MSMEs, and therefore there is a need to consider various alternative sources of finance. In the case of Japan, the government has imposed a cap on interest rates on loans that a money lender extends to MSMEs. As money lenders continue to play an important role in India, it is worth considering whether money lenders could be brought under regulation now, given technological progress, as achieved in the case of Japan, and an interest cap be imposed for lending to MSMEs.
In India, commercial banks are mandated to lend to MSMEs. In such cases there is also a need to ensure that the public sector does not crowd out the private sector. Further, MSMEs generally suffer from poor conduct by major banks. In some cases, mis-selling of financial products is a general complaint of entrepreneurs. This can take the shape of higher fee or interest rate, failure to explain exit costs, and sometimes threatening them with refusal to extend regular credit. Illustratively, weighted average lending rate of commercial banks, as reported in the RBI’s latest AR, is the highest for MSMEs when compared with loans extended to agriculture, large industry and infrastructure. Therefore, the role of financial education is very important for MSMEs in assessing appropriate start-up finance and in empowering them to use financial products and services to manage risks and other business needs.
Not all banks can do MSME financing as this is a specialised area and requires specialised skills to assess the institutions that can benefit from bank finance and yield higher production. Therefore, skill development of bankers is also necessary for assessing MSMEs that can be bank-financed. These skills would include standardising simple format for accounting purposes for MSMEs, competent development of human resources, cultivating business ethics and standards, and also imparting training to MSMEs which are being served by the bankers. The initiatives by the RBI in this regard need to be strengthened in instituting similar training programmes in different commercial banks.
In addition to financing, there is a need for focussed coordination of activities of different government authorities to encourage MSMEs. This coordinating agency could serve in building a database and repository information on a shareable basis, measuring levels of productivity for different product groups, and identifying products in need of research and development.
In economic literature, no country has catapulted from a developing country to an advanced economy without industry contributing significantly in output. So far, the growth story in India has been different, with the services sector overtaking industry in a short span of time. This has been perplexing economic historians. This opportunity in slowdown of growth can be taken to correct that worrisome situation by building a sustainable and widespread manufacturing base. Therefore, government needs to prepare a roadmap for the MSME sector in addition to various ad hoc initiatives undertaken regularly. It needs to delineate proper objectives, vision and a mission, as it did in the case of JDY. Then, it needs to consider appropriate funding mechanisms for MSMEs. The government could also consider an appropriate guarantee system to be offered to the MSMEs availing loans under various government schemes. To inspire confidence, the government needs to strengthen the legal structure and establish a credible redressal mechanism. To prepare a vision document and an achievable roadmap that can place the Indian MSMEs to compete with those in China, Japan and Germany, there would be a need to engage researchers, industry groups and stakeholders. Therefore, there is much to be accomplished before the MSME sector can take off. India needs to make a start now.
(Charan Singh is RBI Chair Professor of Economics, IIM Bangalore.)