Mumbai: With few months left for the 2019 general elections, the Union government has unveiled a slew of measures to woo India’s small and medium scale businesses, which have ostensibly been hurt the most because of the double whammy of demonetization and the goods and services tax (GST).
The steps announced in recent weeks ranging from doubling the exemption limit for GST registration to restructuring stressed loans for the sector may be well-intentioned but may be too little, too late to address the industrial sector’s woes.
Data from the Centre for Monitoring Indian Economy (CMIE’s) Prowess database— which tracks the performance of more than 40,000 companies across India— suggests that the performance of the MSME sector has been broadly in line with the rest of the corporate sector, and have shown signs of a recovery in the past fiscal year. Net sales for both set of firms fell between fiscal 2012 and fiscal 2016 before improving slightly since then (chart 1).
In this analysis, the enterprises are classified on the basis of their average annual turnover in the last five years. Companies with revenue of up to ₹5 crore in FY14-FY18 are considered ‘micro enterprises’, those with turnover between ₹5 crore and ₹75 crore as ‘small enterprises’ and those with turnover between ₹75 crore and ₹250 crore as ‘medium enterprises’. The classification is in line with the proposed new definition of the MSME sector, which was approved by the Union cabinet last year.
The improvement in net sales growth of these enterprises is almost entirely led by the manufacturing units. Sales growth in the services sector, on the other hand, declined for the third consecutive year in 2017-18 (chart 2).
To be sure, the improvement in net sales of manufacturing firms does not necessarily suggest an improvement in profits. The data on aggregate profits suffers from extreme volatility and it is therefore difficult to identify a conclusive trend.
Data on bank credit sourced from the Reserve Bank of India, which classifies the MSME sector as per the current official definition based on investments of enterprises in plant, machinery and equipment, shows that industrial credit growth has also improved in recent months, with the entire improvement led by credit growth to medium-sized enterprises (chart 3).
The trends in sales growth and credit flow largely represent the health of companies in the organized MSME sector but it is worth noting that the relief measures of the government are also aimed precisely at this sector since firms in the unorganized sector are outside the purview of regulatory controls and formal lending channels. The one area which seems to be of concern is jobs. The small and medium-sized enterprises (based on turnover) cut jobs for the seventh straight year in 2017-18, even as the corporate sector as a whole witnessed rising employment in recent years, Prowess data shows.
While demonetization and GST are blamed for the financial distress of these enterprises due to which many were said to have laid-off employees or shut operations, the fall in employment was the least in the demonetization year of 2016-17, according to Prowess data. Instead, the declining growth in employment in smaller-sized companies has been an ongoing trend since FY10 (chart 4).
Some relief for the MSME sector may therefore seem warranted given their contribution to overall employment but it is worth noting that size-based policy relief measures may end up being counter-productive over the long run. Such measures could discourage firms to grow by creating strong incentives to operate beneath the official size category.
There is some evidence to suggest that size-dependent labour regulations encourage smaller firms to employ non-permanent workers, and make them sub-contract output to other firms .
A recent survey conducted by IDFC Institute in collaboration with the government’s think-tank NITI Aayog shows that larger firms face more regulatory obstacles, which possibly explains why firms in India fail to grow big.
Policymakers would do well to focus on the structural bottlenecks holding back Indian industry—including regulatory red tape, uncertainties in tax and investment policies, and infrastructural deficits—which hurt both small and big firms, and limit growth.