Role of Small and Medium Enterprises (SMEs)

SMEs have been playing a pivotal role in country’s overall economic growth, and have achieved steady progress over the last couple of years. From the perspective of industrial development in India, and hence the growth of the overall economy, SMEs have to play a prominent role, given that their labour intensiveness generates employment. The SME segment also plays a major role in developing countries such as India in an effort to alleviate poverty and propel sustainable growth. They also lead to an equitable distribution of income due to the nature of business. Moreover, SMEs in countries such as India help in efficient allocation of resources by implementing labour intensive production processes, given the abundant supply of labour in these countries, wherein capital is scarce.

The enactment of the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 was a landmark initiative taken by the Government of India to enable the SMEs’ competitive strength, address the issues and challenges and reap the benefits of the global market. SME policy initiatives at the national and state level are aimed at strengthening the role of SMEs at the base as well as at the higher level. The Tamil Nadu Government formulating an exclusive policy for micro, small and medium enterprises sector to encourage agro-based industries is a recent example of the changes taking place at the ground level. The policy offers a range of incentives and support for infrastructure development, subsidies for investment in industrially backward areas, capital investment and technology development aiming to sustain over 10% growth of the MSME segment in the food and agro sector. Some of the salient features of this policy include formation of multi-storied and flatted industrial estates for micro industries, liberal floor space index in plotted development of 1.5 to 1.75 for industrial sheds and 2.5 for multi-storied industrial units, 50% rebate on stamp duty and registration charges for micro and small enterprises in industrial estates and industrially backward areas.

With globalisation, all forms of production of goods and services are getting increasingly fragmented across countries and enterprises. With large players adopting different models of business that include involvement of the their traditional partners, suppliers or distributors at a different level, SMEs now are now experiencing a new model of functioning in the value chain. The past few years has seen the role of the SME segment evolve from a traditional manufacturer in the domestic market to that of an international partner. The restructuring of production at the international level through increased outsourcing is having significant effects on small and medium entrepreneurs in a positive as well as negative manner. Demand in terms of new niche products and services are providing more opportunities for SMEs that are in a better position to take advantage of their flexible nature of operations. However, at the same time they have realized their drawback in terms of inadequate availability of managerial and financial resources, lack of working capital, personnel training and inability to innovate on a faster pace.

The combined effect of market liberalisation and deregulation has forced the SME segment to change their business strategies for survival and growth. Some of the changes that SMEs are focusing on include acquiring quality certifications, increasing use of ICT, creating e-business models and diversification to meet the increasing competition. Globalisation, economic liberalisation and the WTO regime would undoubtedly open up a unique opportunity for the largest business community, i.e. SMEs through effective involvement in international trade by streamlining certain factors, such as, access to markets, access to technology, access to skills, finance, development of necessary infrastructure, SME-tax friendly environment, exchanges of best practices to name a few.

Production and Investment in SMEs

The total production of the SMEs showed a phenomenal growth in FY07 as compared to the previous year. The production at current prices experienced a growth rate of around 18% against 15.8% in the previous year, thereby raising its share to India’s GDP up to15.5% during the year. Economic activities such as export market, growing domestic consumption, conducive policy measures, improving production methods, technology, development of SME clusters have fuelled production and hence their share to India’s GDP. SMEs have maintained an equal growth rate vis-à-vis the overall industrial sector during FY03-07, which grew at a CAGR of around 17%.

The SME sector has also registered a consistently higher growth rate than the overall manufacturing sector. In fact, it plays a dual role since the output produced by SMEs is not only about final consumption but also a source of capital goods in the form of inputs to heavy industries. The table below indicates the growing significance of SMEs in the Indian economy. The output of SMEs is not only increasing, but also the productivity in terms of per unit is also growing at a higher rate in the last four years. The relative advantage of SMEs is well recognized by the resurgence of the manufacturing sector in India during the last two fiscals and is poised for higher growth in this fiscal, thus denoting the importance of SMEs to sustain it for a long time.

The table below suggests that the every ten millions of rupee invested by the SMEs’, it generated more than 4 times of employment opportunities than the overall economy, as per the data available in FY06. For instance, every ten millions of rupee invested by SMEs’ in FY06 generated employment for around 151.4 persons, whereas for the overall economy the same amount of investment generated employment for 37.4 persons.

SME exports growing in tandem with total exports

SMEs constitute an important segment of India’s industrial production with a contribution to 33% of its exports. During FY03-06, India’s total merchandise exports in US dollar terms witnessed a CAGR growth of 25%, while in the same period SME exports grew at a CAGR of 24%. The remarkable contribution of SMEs in generating employment in the country has been instrumental in addressing issues pertaining to poverty and inequality of income. As per the Third All India Census on Small Scale Industries-2001-02, highly populated states such as Madhya Pradesh, Uttar Pradesh, West Bengal, Maharashtra, Karnataka and Jharkhand together contributed to around 55.4% of the total exporting units in India. In terms of distribution of value of exports from the SME sector, states like Punjab, Haryana, Uttar Pradesh, Tamil Nadu and Maharashtra together contributed 64.75% of total exports.

The composition of export basket of SME’s in India, it has both traditional and non-tradition commodities in nature. There are few commodity groups which are exclusively exported by SMEs such as sports goods, cashew, Lac etc. In the commodity group of engineering goods, SMEs constitute around 40% of the total exports of this commodity group. Similarly, SMEs in basic chemicals & pharmaceuticals finished leather and leather products and marine products account for around 44%, 69% and 50% of the export share in their respective commodity groups. In view of the Government of India’s ambitious target of average GDP growth rate of 9% during the 11th Five Year Plan, SMEs have to play a vital role in achieving this target. It is imperative for the government to address the major issues plaguing the sector and take further inclusive growth oriented policy initiatives to boost the sector. This includes measures addressing concerns of credit, fiscal support, cluster-based development, infrastructure, technology, and marketing among others. As mentioned earlier, SMEs constitute 34% of India’s merchandise exports and in order to increase India’s export share to the global trade, SMEs are expected to enlarge their scope manifold.

Financing the SMEs

In Feb 2008, the Ministry of Micro, Small and Medium Enterprises (MSME), continued with its dereservation policy by removing 79 items from the list of 114 items reserved specifically for SSI (small scale industries) manufacturing. Only 35 items remain in the reserved category from the total 836 selected in 1994 denoting the declining monopoly of the SSI segment on the reserved products. However, the government has set up various schemes in place such as the Credit Linked Capital Subsidy Scheme, MSME Cluster Development Scheme and ISO 9000 Reimbursement Scheme to help SMEs for procuring timely funds. Also the government has put in place the Credit Guarantee Scheme to encourage banks to lend up to Rs 0.50 million without collateral. There has also been a recent budget announcement of setting up of a Risk Capital Fund.

Though SMEs are being touted as the priority sector within the economy, they continue to face problems pertaining to finance. When it comes to banks, they have a very traditional way of lending to this segment against collateral and SMEs end up being under financed. Evidently, the biggest challenge before the SMEs today is to have access to non debt based and non-traditional financial products such as external commercial borrowings, private equity, factoring etc.

Lately this segment has been witnessing winds of change in the new sources of capital- in the form of private equity (PE) and foreign direct investments (FDI). In Jan 2008, The Soros Economic Development Fund (SEDF), Omidyar Network and Google.org announced a Small to Medium Enterprise Investment Company with an initial corpus of $17 million for providing capital to SMEs in underserved markets.Mauritius-based Frontline Strategy launched a $200 million India Industrial Growth Fund (IIGF) for investment in SMEs targeting companies, primarily in the industrial space with revenues between Rs 200 – 1,000 million. In 2007, Mauritius-based Horizon advisors launched Ambit Pragma Fund I, an India dedicated PE fund, with a corpus of $100 million for providing equity capital and professional management advice to SMEs.

Mauritius-based Frontline Strategy launched a $200 million India Industrial Growth Fund (IIGF) for investment in SMEs targeting companies, primarily in the industrial space with revenues between Rs 200 – 1,000 million. In 2007, Mauritius-based Horizon advisors launched Ambit Pragma Fund I, an India dedicated PE fund, with a corpus of $100 million for providing equity capital and professional management advice to SMEs.

Investments in the SME sector are not only by PE funds but this sector is also attracting FDI. In this respect the government has removed the 24 per cent cap on FDI in the SME sector. Foreign entities are also keen on promoting traded and cooperation between SMEs of different countries. Genesis Initiative, an UK-based organisation consisting of entrepreneurs, policy makers and SMEs, is trying to forge mutual cooperation between SMEs in India and UK for in terms of JVs and partnerships in sectors such as textiles, IT, infrastructure etc.

A stock exchange purely dedicated for SMEs seems to be the next big thing. A SME-focused stock exchange is likely to boost the confidence of SMEs planning to tap the capital market to raise low cost capital. Currently only companies with a minimum paid up capital of Rs 100 million and a market capital of Rs 250 million are eligible to list on NSE while those with a post issue capital of Rs 30 million and a minimum market cap of Rs 50 million are eligible to list on the BSE. Thus SMEs which in spite of having a good track record of growth but do not meet this criteria are kept away from the listed category. Some examples of SME dedicated stock exchanges include AltX, Africa’s first alternative exchange for SMEs, a partnership between the Johannesburg Stock Exchange Ltd and the Department of Trade and Industry and AIM, a sub market of the London Stock Exchange that allows smaller companies to float shares with a more flexible regulatory system as compared to the main market. Although BSE IndoNext, an alternate national platform, a joint initiative by The Stock Exchange, Mumbai (BSE) and the Federation of Indian Stock Exchanges (FISE) exists, a separate exchange exclusively for SMEs might prove helpful for the SMEs to raise equity and debt as well as facilitate trading in such companies.