Home / Opinion / Online Views /  Why India needs vibrant small enterprises

The life of a small entrepreneur is a tough one. He faces the worst of the inspector raj that makes India such a tough place to do business. He has to battle credit constraints that hurt his ability to grow his business. Whatever bank finance he can access comes at far higher interest costs than what large enterprises can negotiate. He works with very long receivables cycles that make a mess of working capital management. He has little access to trained labour, technical progress and management support.

This is despite the fact that small enterprises are the best bet right now to create the millions of jobs that India needs to create every year if it is to maintain social stability. New data released by the Reserve Bank of India last week provides a good glimpse into how small enterprises are the champions of the Indian growth story right now.

The data on 237,398 small private limited companies that are neither owned by the government nor are in the business of financing shows that output by these enterprises has been growing faster than the underlying nominal gross domestic product. This is in contrast to the more sluggish growth in the 5,788 listed companies whose financial performance dominates public discourse—especially the over-leveraged giants that are so important in the various stock market indices.

Small enterprises include both private limited companies that report their annual accounts to the Ministry of Corporate Affairs as well as the larger pool of unincorporated enterprises—or what Indian Institute of Management Bangalore professor V. Vaidyanathan has described as India Uninc. They do a lot of heavy lifting in India. They account for less than a tenth of GDP but nearly 45% of industrial output and 40% of exports. They employ an estimated 60 million people because small enterprises generally have lower capital intensity.

Even large economies such as Germany or Japan tend to have a rich base of small enterprises even though they are better known for their giant corporations. In fact, many of these middling companies are tied into corporate networks as suppliers. Data from the Organisation of Economic Cooperation and Development shows that even the US is not an exception: small and medium enterprises made up 98.9% of its total enterprises in 2005 and were responsible for 57.9% of jobs in that country.

India had tried to encourage small companies after the 1970s with the help of two barriers of protection. First, the ridiculously high levels of import tariffs for the entire economy. Second, reserving the production of certain goods for small companies. These two policies created inefficient small firms that were neither capable of scaling up nor facing global competition after the 1991 reforms.

The challenge now is to create a policy environment that will encourage the growth of more small companies that can hold their own in a competitive market. The examples from the rich countries shows that this is possible. A government committee headed by T.K.A. Nair, in its 2010 report, identified credit constraints as one of the key problems faced by small enterprises. It remains to be seen whether new institutions such as MUDRA Bank can prise open the credit markets for small enterprises.

The recent economic census showed that India has millions of tiny enterprises that seem to have absorbed the millions who have left farming out of desperation. The average Indian workplace hires only 2.24 workers, a sign that too many enterprises are dwarfs that cannot grow, to borrow an analogy from Manish Sabharwal of hiring firm Teamlease; but there are also millions of babies that can grow into vibrant and competitive enterprises if they get the right environment.

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